When advisors talk about the "success" of a retirement income plan, clients naturally think it means something like "living a great life." After all, surveys tell us that retirees' top goal is having a high quality of life.
In other words, retirees tend to focus on using their resources to fund as comfortable and fulfilling a life as possible, including experiences with spouses, friends, children and grandchildren. While this goal includes not running out of money or being a burden on children, leaving money behind after death consistently ranks as a very low priority among retirees.
When I ask advisors what their goal is when working with retirement clients, they consistently express similar aspirations: helping clients live the best life they can. "Success" here doesn't mean working magic so everyone lives in a fantasy land where anything is possible, but rather helping people live the best life they can in the financial world they happen to be living through.
Unfortunately, one of the most common measures used in retirement planning — the "probability of success" score — drives clients toward underspending and leaving money behind at death, while also driving up anxiety. That's not exactly "living the best life you can."
The problem is that the word "success" in this score means something very different from what clients understand it to mean. Fixing this problem will require abandoning "probability of success" in retirement planning.
Dropping the 'Scrooge Score'
A plan with a 100% probability of success does not have a 100% chance of providing the best life possible. Instead, it means that in every single simulated scenario in a Monte Carlo analysis the clients could actually spend more and still hit all of their other goals, including not running out of money.
In other words, that 100% score means there is a 100% chance that this plan is underspending the clients' resources. The word "success" here doesn't mean "winning at the game of retirement." It means underspending,
It might be more accurate to call "probability of success" the "Scrooge score," after the famously miserly Ebenezer Scrooge in Charles Dickens' "A Christmas Carol."
Clients, of course, do not know or understand this. Why would they? After all, "success" already has a meaning in the real world, and it's not "underspending." And worse, when clients see a success score they quickly do the math and produce a probability of failure.
Any probability of failure greater than 0% can lead to anxiety. Naturally, clients want to maximize chances of success and minimize chance of failure. Who wouldn't?
Advisors who help clients plan for retirement aren't hoping to maximize underspending and the "Scrooge score." They are trying to balance the two main risks of retirement: the risk of overspending and the risk of underspending.
Overspending is the risk of depleting resources too quickly. Underspending is the reverse. It is the risk of being so frugal that clients don't meet their goals, and instead find themselves in the regret zone.
The "regret zone" is the point in life when retirees look back and realize that they skipped experiences they could have afforded — trips with grandkids while they're still young or bucket list items with a spouse or with friends — and they'll never be able to turn back the clock.
It's the point when clients' resources so outstrip their goals that they realize that, in a sense, they worked extra years "for free" since they'll never be able to use those extra resources in their lifetime.
While lack of resources for retirement is indeed a problem for a large part of American society, underspending and regret are major problems for those who do have resources for retirement but aren't using them optimally.
