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I started my university days happily pursuing engineering studies. Then, in my third year, I discovered my new passion and began moving to finance and business.
It turns out that engineering has allowed me to assist clients in managing their nest eggs. Mixing engineering concepts with wealth strategies pays off, so let’s look closer.
What is reverse engineering?
Reverse engineering usually involves taking an object apart and analyzing it in detail: something that engineers are skilled at.
I specifically refer to reverse engineering of retirement goals: working backwards from the desired end results to design a prudent plan for each family.
Reverse engineering retirement consists of two main components:
- Estimating the size of nest egg that represents the retirement goal.
- Ballparking the investment rate of return to achieve or maintain that goal.
Let’s consider this sample situation:
Assume the nest egg to be accumulated is $1,500,000. Say there are 10 years to go until retirement and today’s portfolio value is $700,000. That implies an annual return of over 7.9% to get there. Perhaps optimistic for today’s low-return environment.
However, an annual saving capacity injection of $10,000 reduces the rate of return to near 6.9%. Increasing injections to $20,000 or $30,000 per year reduce the rate close to 5.9% and 4.9% respectively. Let’s capture this case with a simple table:
| Annual Saving Capacity Injection | Required Investment Return |
|---|---|
| $0 | 7.9% |
| $10,000 | 6.9% |
| $20,000 | 5.9% |
| $30,000 | 4.9% |
The analysis demonstrates the impact of scaling down the need to incur investment risks. Every case can be structured to achieve personal goals. Additional analysis can take the form of “what if” the family needs more or less capital resources.
I relate portfolio review discussions to the client’s rate of return, not to market moves.
This example is a simplification of the number-crunching power of reverse engineering; the scope of what the portfolio has to achieve to deliver a successful retirement. It points to the yardsticks in need of tweaks to make retirement happen. Much strategy can be discussed before selecting any investment for this journey.
Using the reverse analysis
The most critical element of the analysis is the estimated return that achieves the retirement targets. That rate becomes the “personal investment benchmark” for the family’s long-term game plan. I relate portfolio review discussions to the client’s required rate of return, not to market moves. This allows the client to take charge or regain control of the game plan.
The reverse engineering analysis contributes essential guidance for the client’s game plan. One constant question is “What does it take to build the client’s retirement vision?” Reverse engineering definitely provides the right toolbox of tools and is extremely useful. Particularly, in making sense of the monetary implications of retirement goals.
Looking backwards is a powerful instrument to assess the finances of retirement. I also call it the capital needs analysis.
Every client has one and understands the implications of such analysis before the investing starts. Every investor would also be wise to conduct some reverse engineering.
Adrian Mastracci, Discretionary Portfolio Manager, B.E.E., MBA started in the investment and financial advisory profession in 1972. He graduated with the Bachelor of Electrical Engineering from General Motors Institute in 1971, then attended the University of British Columbia, graduating with the MBA in 1972. This blog is republished here with permission from Adrian’s new website, where it originally appeared on April 18th.