Summary
Lifestyle Definitions: Categories of "Must Do," "Plan To," and "Dream Of" represent essential, comfortable, and aspirational spending levels, respectively.
Mainly informs the assessment of a client’s capacity for loss, a crucial aspect of defining their risk profile.
Helps to establish a client’s essential income needs and visualize potential retirement lifestyles.
Assists in articulating the client’s comfort range for financial outcomes, influencing their willingness to take on investment risk.
Lifestyle Definitions guide discussions but do not affect the numerical calculations in the Timeline Planning tool.
Description
In Timeline Planning, Lifestyle Definitions are categories or labels that can be used to describe different levels of spending, based on a client’s goals and comfort level. These definitions are intuitive and client-friendly terms that can help clients to relate their retirement aspirations with their financial plans.
We include the following categories:
Must do: Covering essential living expenses
Plan to: Essential living expenses plus some luxuries such as regular holidays and leisure activities
Dream of: A retirement lifestyle with significant discretionary spending
However, it’s crucial to understand that these Lifestyle Definitions, while illustrative and useful in discussions with clients, do not directly influence the numerical calculations within the Timeline Planning tool.
Capacity for Loss in Risk Profile
The primary purpose of Lifestyle Definitions in Timeline Planning is to inform the assessment of a client’s capacity for loss. This is a crucial element of a client’s risk profile, which in turn plays a role in defining a suitable investment strategy.
Identifying Essential Needs: Lifestyle Definitions help to establish what level of income is essential for a client to maintain a basic standard of living. This is the income level below which a client would experience material detriment.
Establishing a Comfort Zone: Beyond essential needs, Lifestyle Definitions can also help to visualize what a more comfortable or luxurious retirement might look like, and what level of income would be required to support that.
Informing Risk Tolerance: By contrasting a client’s essential income needs (the 'floor') with their more aspirational goals (the 'ceiling'), Lifestyle Definitions can help to articulate the range of outcomes that a client might be comfortable with, and hence their capacity to take on investment risk.
Example
Let’s consider Jane, who is planning for her retirement. Based on a discussion with her financial planner, her lifestyle definitions are set as follows:
"Must Do" Yearly Spending Level: £60,000
"Plan To" Yearly Spending Level: £80,000
"Dream Of" Yearly Spending Level: £90,000
These figures represent, respectively, her basic living expenses, her desired lifestyle that includes some comforts and leisure activities, and her aspirational, dream lifestyle in retirement.
Risk Profile and Capacity for Loss Assessment:
To assess Jane’s capacity for loss, we stress-test her plan based on historical market performance. Through this rigorous analysis, it is determined that under a worst-case scenario, Jane’s maximum sustainable yearly spending in retirement would potentially be £68,900.
Breaking Down the Numbers:
With this worst-case sustainable spending level of £68,900, let's examine how Jane's lifestyle goals are impacted:
Her "Must Do" expenses of £60,000 are fully covered. This means that even in a worst-case scenario, Jane can maintain her basic standard of living. These are the non-negotiable expenses – the essentials that she needs to live comfortably.
Beyond the "Must Do" level, Jane has an additional £8,900 (£68,900 - £60,000) available for discretionary spending in this worst-case scenario.
Her "Plan To" expenses are set at £80,000 per year. In this worst-case scenario, she can cover all of her "Must Do" expenses and £8,900 of her "Plan To" expenses, totaling £68,900. This is equivalent to covering about 44% of the expenses beyond her "Must Do" level (i.e., (£8,900 / £20,000) * 100%).
Unfortunately, in this worst-case scenario, Jane's "Dream Of" level of £90,000 is not attainable. She will need to adjust her plans and expectations based on this potential outcome.
Conclusion
Lifestyle Definitions in Timeline Planning are a powerful tool for framing retirement goals and assessing a client’s capacity for loss in terms of their risk profile. They serve as a qualitative, client-friendly way to initiate discussions about retirement planning. However, they are not used in the actual computations within the Timeline Planning tool, which are based on detailed financial data and assumptions.