Can you outlive your life savings?

A good financial plan must identify the reasons why a person may run out of money in his lifetime and find a workable solution to it

Good personal financial planning is just like good corporate strategy. 

Let’s first look at good corporate strategy and then look at good personal financial planning.

Good corporate strategy is identifying the most important threat that a company faces and finding a workable solution to it, even if it is a partial solution. In the unlikely case that there is no threat, corporate strategy must identify the most important opportunity a company faces and find a way to utilise it.

I was once helping the chief executive officer (CEO) of a company figure out what to do about a new line of business that was losing a significant amount of money each month. All the other competitors were also making significant losses. Further, it was not clear whether this was a temporary problem in a nascent line of business or a permanent problem in a fundamentally flawed line of business.

If the company closed this new line of business, it was possible that it would give up too early. It would then be left with only its core business which faced significant regulatory risks. And if the company continued with this new line of business, then the massive losses could soon destroy the entire company, including the core business.

The superficial corporate strategy would have been to conclude that the three previous managers were not able to turn around the new line of business but hope that a fourth manager would be able to do so.

A good personal finance (PF) plan is also about identifying the most important reason why a person could run out of money in his lifetime and finding a workable solution to it, even if it is a partial solution. In the unlikely case that there is no such risk, it means identifying the most important new freedom the individual could aim for and how to go about it. The most common reasons why a person might run out of money in his lifetime are not saving enough for retirement, having too high an allocation to equity, and using high-fee investment products. However, the way that this threat manifests in each person’s case is different. Also, the threat may not even lie in one of these three categories.

In some cases, the client may have already partially identified the most important reason. For example, the client may have identified that quitting his job to become an entrepreneur could hurt his retirement. But the client may not have identified the even deeper reason. For example, from the point of view of retirement funding, it is likely that the start-up barely surviving for decades is a worse scenario than it failing quickly. In other cases, the client may not be even partially aware of the most important reason. For example, the client may not have recognised that the significant portion of his net worth that is invested in supposedly safe ‘structured products’ is actually extremely risky.

Superficial personal financial plans usually do not identify any major threat and instead present a rosy picture to the client. This allows the advisor to either charge a very high fee from a client who is in an optimistic mood, or minimise the adviser’s effort and hence maximise his revenue.

It takes a skilled advisor and a massive amount of effort from both the client and the advisor to craft good corporate strategy and a good personal financial plan.
 

The writer is an hourly-fee financial planner and a Sebi RIA at Fiduciaries.in. He was a private-equity investor for 12 years