Do you have a financial plan in place? Estimates say that only about 25% of adults in America do. If you are one of them, congratulations! But unfortunately, I have some bad news for you. Your plan is all wrong! Now, don’t get me wrong. You are way ahead of those who have not put a plan in place. Study after study shows that people with a plan are more likely to manage their money successfully and are more confident about reaching their financial goals. Yet most people don’t make an effort. Interestingly, many don’t think they have enough wealth to put a financial plan in place. I would say that they are the people who might need one the most.
Why do I say that your plan is wrong? I should first point out that, as a financial planner and investment manager, I can guarantee very few things. But one thing I can absolutely guarantee is that your financial plan is wrong.
The reason why your plan is wrong is that a financial plan, by its nature, is built on many assumptions. When putting together a plan, we make assumptions about a lot of things. We assume the amount of money you might need to live on in retirement; how long you might live; your future earnings; inflation rates; income tax rates; portfolio return rates; your future goals; and many other things. We do the best we can to make the assumptions as accurate as possible. But as life happens, the assumptions will certainly change.
An easy-to-understand example would be the returns earned by your investment portfolio. We will look at the assets you own and come up with an expected return based upon the historical returns of each holding and your asset allocation. Let’s say that the expected return of your portfolio mix is 7% annually. The projections in the plan will assume that your portfolio continues to average 7% per year. That’s 7% this year, 7% next year, 7% the year after that, and—well, you get the picture. But we all know that markets don’t work like that. We may get 14% this year and 0% next year. The average may be 7%, but the sequence of returns will make a big difference in the amount of wealth you have to work with. So, the future values projected in the plan will be wrong.
And then there’s that whole assumption about how long you are going to live. If we only knew the answer to that question, this planning stuff would be easy! At our fiduciary advisory firm, we will do our best to come up with an estimate based upon your health and family history, but it’s still just a guess. We will typically add a few years to that estimate because we want to make sure that you have more money than breath. Once again, an assumption that will have a major impact on your plan is probably wrong.
Tax laws will change. If we had developed your financial plan before 2018, all the assumptions that we used to estimate your future tax liabilities would be wrong because of the new tax laws. And we are surely going to see changes to the tax laws in the years ahead.
Your life will change. The future that you envision for yourself right now will most likely change as life comes at you. Changes in your situation, like marriage, divorce, health, a new job, the death of a spouse, etc., will all have an impact on your plan.
So, why go through the effort of planning if the results are going to be wrong? First, it’s important to note that a good plan will add a stress test of some type to determine a level of confidence in the results. For example, the planning software we use will run a thousand variations of potential returns in a portfolio. The results will reflect the percentage of potential scenarios that resulted in you being able to reach your goals. We are generally looking for a confidence level of 75% or more. If your plan comes in below that number, we know we have some work to do.
The other part of the solution is a regular review of the plan. You should update the numbers in the plan regularly, usually annually. You can run the projections again based upon updated assumption to see if you are still on target. Another good time for an update is after any of those major life transitions that we discussed earlier.
You should look at financial planning as an ongoing process. It should serve as a road map for where you want to go in life. But just as a road trip can change as traffic and weather have an impact, your financial plan will change as your life will. You should develop your plan based upon where you are today and the most current economic assumptions. As life happens, you will have some twists and turns in the road, and maybe an occasional roadblock you need to work around. But if you keep your road map updated, you will be able to continue down the road with confidence.
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