Pensions: Who's the Patsy?

"Will I have enough?" We all ask ourselves this question, and more than once. It strikes at the heart of our own sense of financial security. Although there can't be a definitive answer as it depends on so many variables far in to the future, we can all clearly improve our prospects by formulating an effective plan of action and executing it well.

Now the question becomes "What is an effective plan?" This is where the controversy begins. Most investors are still directed towards a plan based on investment return projections, and come to assume that all they have to do is achieve a certain return on their assets and all will be well. Unfortunately, this approach is highly theoretical and dangerously oversimplifies the investment process. Not only does it start you off on very shaky ground it creates additional problems as you go along.

This is also the approach that has been used to analyze and value Defined Benefit Pension Plans (DBPP) with disastrous results. DBPP are now being abandoned as fast as corporations can get rid of them, and the PBGC, the federal agency which is designed to support them, is now essentially bankrupt. Shouldn't that tell you something about their financial planning?

There is another approach, which I believe makes much more sense, one based less on pie-in-the-sky and more on what we can realistically plan for. For this plan, the starting point is how much we spend each year or plan to spend. This is something we all have direct control over. It defines at the outset what is the essential purpose of all our assets, which is primarily to meet our living needs and places our investment approach in this context.

There are a number of great benefits to this approach, and three in particular stand out:

• Benefit #1 - This approach gives an immediate and realistic assessment of where you stand financially. Also you can continue to measure your progress year to year. You will not suddenly wake up one year before retirement and find that, after all, you do not have enough to live on.
• Benefit #2 - Your attitude to investing can be appropriately viewed in the context of your financial position. This will inform the level of risk and type of risk that is appropriate for you to take, which should be the first consideration before you start investing.
• Benefit #3 - This methodology appropriately avoids the one-size-fits-all approach to financial planning, which often suits the planner better than then client. Your investments need to be tailored to your own particular needs and objectives.

With so much uncertainty about future pension provision we all need to take charge of our own personal financial plan. Make sure that you have a good plan, and that you understand all the risks and assumptions you are making. You need to be confident that you have an approach that works in practice and will stand the test of time.