Akweli Parker: Retirement today is complicated. With the barrage of financial and lifestyle decisions to make, compounded by certain risks, it’s easy to get overwhelmed, lost even. So is there a financial-advice equivalent to GPS to guide investors and their advisors through the winding road of retirement?

Hello, and welcome to Vanguard’s Investment Commentary podcast series. I’m Akweli Parker. In this month’s episode, which we’re recording on April 30, 2018, we’ll be talking about the road map to financial security. It’s a new Vanguard research paper that serves as a guide for making decisions in retirement.

With us here in the studio today, we’ve got Kelly McShane. She is an investment analyst in Vanguard Investment Strategy Group and one of the authors of the research. Kelly, welcome and thanks for being here.

Kelly McShane: Thanks, great to be here.

Akweli Parker: All right, so Kelly, you and your colleagues worked on this research that Vanguard recently published. The full title is Vanguard’s roadmap to financial security: A framework for decision-making in retirement. Can you give us the 20,000-foot view of how this framework came together?

Kelly McShane: Absolutely. So as you mentioned in the intro, we realized that retirement can be complex for individuals, and the retirement planning process can also be complex. It can produce competing goals, and numerous risks, and a lot of decisions that investors and advisors have to work through. It’s a road map, and I like to use the analogy of setting out on this journey as if you kind of know where you’re going, you know where your end destination is to retirement, but when you hit that road, you really don’t have a lot of road signs, your GPS apps aren’t working, and as you can imagine, it can be overwhelming and hard to navigate.

We like to think of this framework as handing investors—and advisors to hand their clients—that road map, that navigation to get to financial security and their end destination. We really thought through what are the things that investors have to think through? What questions should they be asking themselves when planning for retirement?

There are four steps to our framework that we believe are essential. Number one is investors—and advisors with their clients—should think through what are the goals they want to achieve? Then evaluate the risks that may derail those goals. Understand the resources that they may have available to them to help them achieve goals and mitigate risks. And then, finally, develop the plan. Put all those pieces of the puzzle together to then get them on that road and hit their end destination of financial security.

Akweli Parker: All right, so that phrase, financial security. You just mentioned it. It’s right there bold in the title. That can mean different things to different people, so just to make sure that we’re all driving in the same direction, can you tell us what you mean by that?

Kelly McShane: We use the term financial security because we define it as that peace of mind that investors have when they know they’re going to achieve their financial goals. The road map to get there may look different for everyone, based on their own unique circumstances. However, that concept of feeling secure in that your resources are aligned to make sure that you can achieve the life that you want, that is financial security, and that’s what we center our framework around.

Akweli Parker: Thanks for that great summary. A follow-up question for you. When is the best time to be thinking about this framework, whether you’re an individual investor or you’re an advisor helping folks out with this? Is it too early to start thinking about this if you’re not yet retired?

Kelly McShane: We actually recommend using this framework five to ten years out before retirement. I think of my dad. He’s getting ready to retire, and I sent him this paper last week to say, “Hey, think through this thing with your financial advisor. Look at these different steps, because that’s actually the ideal time.” And the reason being, Akweli, is five to ten years out is when you can start to think through these steps and make changes if you need to. That being said, the beauty of this framework is it can be used whenever and however, and we encourage investors to use it as a continuous process.

Akweli Parker: Excellent. Your dad sounds like a lucky guy.

Kelly McShane: He is, absolutely.

Akweli Parker: All right, let’s take a look under the hood, if you will, of some of the big components that you identified just a moment ago. Now, you noted that the first step is determine goals. I remember commercials “back in the day” saying, “Know your numbers,” like this big dollar amount at the end of the retirement rainbow so you don’t have to eat cat food when you retire. But I think it’s a little bit more complicated than that, right?

Kelly McShane: Absolutely. What you mentioned is how retirement is often thought of. It’s a single goal. It’s an account balance or a level of monthly income. That is the traditional definition of how you hit your retirement goal. The reality is, investors have different things that they want to achieve in retirement, right? It’s actually multiple goals, so we believe in the value of using a multigoal framework.

Akweli Parker: All right, what is that?

Kelly McShane: In our framework, we define four different goals. We talk about basic living expenses being one, so your food, your clothing, your housing, those essentials.

The second goal is contingency reserves. So if something happens, a financial impact, how are you going to cover that? [Make] sure that you have a plan to mitigate or cover those expenses.

From there, discretionary expenses; that’s the third goal. And that’s really how you can think of above and beyond your basic living expenses. So those expenses that help you achieve a certain lifestyle. Think of vacations or dining out, travel, those things that maybe you don’t need, but they help you feel a little bit better or enjoy your retirement a little bit more.

And then, finally, [is] a legacy goal, so donating to a charity or leaving a bequest to your heirs.

Akweli Parker: All right, so the multigoal approach, [there are] a lot of moving parts there. How do investors or their advisors go about figuring out how to prioritize these goals? What comes first?

Kelly McShane: I would say that most would argue that it’s a good idea to have a clear strategy to cover your basic living expenses.

Akweli Parker: You need to eat. Roof over [your] head.

Kelly McShane: Well, you would like to, right?

Akweli Parker: Yes.

Kelly McShane: So making sure that those things are covered. And then from there, it’s also a good idea to have a plan for a contingency reserve. So in case something happens, how are you going to fund it? We encourage individuals to accept the risk of maybe not achieving aspirational goals, to make sure that they achieve those goals that are most important to them. That’s where that trade-off and that prioritization really comes into play. We encourage investors and their advisors to think through, “What am I willing to give up to make sure that I achieve what’s most important to me?”

Akweli Parker: Well, thanks for steering us in the right direction on how to set those retirement goals. Maybe we could take a look now at the next step you mentioned, which are the risks, really. What are some of those?

Kelly McShane: Yes, so we define five risks in our framework, market risk, longevity and mortality risk. Longevity risk is the risk of outliving your assets or living longer than you had planned for.

Akweli Parker: Whoever thought living too long would be a bad thing, right?

Kelly McShane: And it’s actually a good thing. I think the risk here is, though, living longer, which is great—you have this longevity bonus, which is fabulous—but not planning for that can be a risk.

Mortality risk, on the other end of that, is maybe passing away sooner than you would have expected. You leave an unintended bequest or you leave your spouse or partner in a situation that they may not want to be in.

And health risk, again [is], a big concern. It’s the risk of deteriorating health physically or cognitively, and then also the risk of something happening and you not being able to pay for it.

Event risk, those things that you don’t plan for. So something happens to your home or you have a legal expense or a family expense.

And then tax and policy risk is one that a lot of people don’t think of, but it’s absolutely a risk. Around the world, there are policies and situations in place that help retirees, but those things can change.

That’s how we think about risk in our framework. So making sure that you’re aware of those in order to mitigate those as much as possible.

Akweli Parker: All right. So, obviously, you can’t control these things outright. But should people just throw up their hands in despair, or are there actually constructive ways to think about these risks and maybe even to manage them?

Kelly McShane: That’s why they’re risks, right? You don’t know if they’re going to happen or when they’re going to happen. However, what’s the probability that one of these risks could impact me? And then what is the actual impact to my plan? How large is that impact? That’s how we encourage investors to think about these risks we may not be completely able to mitigate. However, understanding those in context of your goals sets you up for financial success.

Akweli Parker: A big piece of this, obviously, is identifying the resources, how you’re going to pay for it. And just the thing that springs to my mind is, the analogy here is, that’s the fuel, right? So where should people start in figuring out what these funding sources, these fuel sources, are, if that’s an accurate metaphor?

Kelly McShane: It is, and I love that metaphor because, to stay in theme on the road map to financial security, the role of resources in retirement planning is really to help you achieve the goals that you set out in that first step and then mitigate the risks that you’re most concerned about, that second step. That’s where you employ those resources and put those to work to put you on the path to financial security.

I would say that retirement resources can come from various sources, so employer plans or government benefits or even your own savings. We, in our framework, regroup them into three different buckets. We group them into your guaranteed income, so think about things like Social Security here in the United States or defined benefit pension plans, even annuities, those sources that are guaranteed; they’re lifetime.

Akweli Parker: Got it.

Kelly McShane: The second step is your liquid assets, so defined contribution plans or your own savings. Maybe you sold a business or you have an inheritance. Those liquid assets that you really have control over. And then, finally, those additional resources. In our framework, we lay out homeownership, work, insurance—those things that can supplement the guaranteed income and then your liquid assets in order to help you achieve your goals.

Akweli Parker: Excellent. So follow-up to that. What are some things that people should really be taking into account as they’re assessing these resources and just really considering all the options available to them as far as funding?

Kelly McShane: So investors will arrive at retirement with different resources. Everyone has their own situation, but what’s important here is to really understand your resources in-depth and the factors that may impact the amount you may have and the length of time or the stability of that resource.

It really depends on the resource here, but asking questions such as “Is this an income stream or is it a liquid pool of assets?” That’s a big question there, the nature of the resource. Also, what other factors may impact that; you think of Social Security or, around the world, some government benefits. Thinking through, is it means-tested, meaning does it depend on the level of income that I have, is it based on my marital status? Really understanding those factors at play that could impact the level of income you may receive over time is important.

Akweli Parker: I want to go back to something that you mentioned just a minute ago. You talked about work as a potential resource. Now I think about my grandparents; when they retired many years ago, they both had pensions. So when they hit retirement, they were done. No more work. But that doesn’t seem to be as prevalent these days. Can you talk about that a bit?

Kelly McShane: Yes, absolutely. My dad will laugh at me because I tell him frequently, you know, “Hey, you’re going to have to work a little longer, Dad, because you’re going to live longer.” And that’s really where work comes into play. As I mentioned earlier, people are living longer around the globe, which means that retirement’s longer for most people. As great as that is—longevity bonus—it also means you have to fund a longer retirement. You have more years of expenses, and that’s where work can actually be a really effective resource. It may not be traditional or how people define retirement, however, like I said, it can be effective. There are a few ways to use work in retirement. You can work longer. Like I told my dad, “Hey, grind it out for a couple of more years.”

Akweli Parker: He must have loved that.

Kelly McShane: He doesn’t like to hear that at all.

You can work part-time. Also, some people take off a few years and then go back to work. The beauty of using work as a resource is it’s flexible. There are a lot of things that [could] impact the ability to use work as a resource, right?

So something happens to your health that could prevent you from working longer, or there may not be opportunities to work longer. So when building it into a plan, as great as it is and as effective as it can be, we also encourage investors to think through these things that can impact their ability to use it.

Akweli Parker: Okay, so think of it as an add-on, but don’t necessarily depend or count on it being there, absolutely.

Kelly McShane: Absolutely. It can be effective, like I said. It can be used in addition to your guaranteed income and then your liquid assets.

Akweli Parker: Excellent. All right, so we’ve talked about determining goals, understanding risks, assessing the financial resources available. How do investors and the advisors who are helping them out, how do they bring this all together into a working, sustainable plan?

Kelly McShane: As I mentioned, financial security, this idea of feeling secure and confident that you’re going to meet your financial goals, is central to everyone’s retirement. But the path to get there may look different, and this is where this fourth step in our framework comes into play, and that’s developing a plan. It’s how you put all these pieces of the puzzle together in order to set yourself up to achieve financial security. We would say that this is where you look at the resources that you have, you’ve done a thorough assessment, and then you align them effectively to the goals that you want to meet and the risks that you want to mitigate. That’s really the crux of the framework, and that’s really what sets you on that final leg of the journey to financial security.

Akweli Parker: In other words, we’re not talking about a one-size-fits-all kind of deal, right?

Kelly McShane: Absolutely not, no. It looks different for everyone.

Akweli Parker: Okay. So you’ve given us some really fantastic information today. What else would you say on this topic to people who are planning their retirement or, of course, to the advisors who are working with them?

Kelly McShane: I would say, and you hit it, Akweli, it’s really not a one-size-fits-all. Retirement planning and a retirement road map looks different for every individual, and that’s where this framework comes into play. And that’s where this can be a really useful tool for advisors with their clients or investors. It doesn’t give you the answers, but it outlines those questions that you should be asking, the trade-offs you may need to make in order to make sure that you’re setting yourself up for financial security. It’s taking a good, hard look at where you’re at to make sure that you achieve what you want to and live that last chapter of your life in the best way possible.

Akweli Parker: Excellent. Well, with that, I think we’ve just about crossed the checkered flag on this podcast. So, Kelly, I want to thank you again for sharing all this great, helpful information.

Kelly McShane: Thanks so much.

Akweli Parker: And thank you for joining us for this Vanguard Investment Commentary podcast. If you’d like to learn more about today’s topic, download the research report that we’ve been talking about. It’s called Vanguard’s roadmap to financial security: A framework for decision-making in retirement. And you can get that on our website, Be sure to check back with us each month for more insights into the markets and investing. And if you’re not doing so already, please go ahead and follow us on LinkedIn and Twitter. Thanks for listening.


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