Most people do not know how to accurately assess the possibilities and assess the risks in their financial planning. As a result, their financial plan is likely to collapse the moment something goes wrong. Which means it’s approx Always It breaks down, because there are a million things that happen in life that we can’t predict, have not taken into account or simply forget to think about.
It’s not that planning is pointless. We need to treat planning as a process, not a one-time event that we set and forget. We also need strategies to build stronger financial plans that can actually withstand the inevitable misfortune, bad decisions, or bad assumptions that happen along the way.
You don’t have to predict the future to build a better plan. At our financial planning firm, we don’t try to be right all the time. Instead, our goal is to give risks – in investments and in life – the respect they deserve and build solid financial plans that understand how probability actually works. Here’s how you can do the same.
1. Avoid false security motives
The average person (and even those inclined towards mathematics) tend to struggle to apply probability to real-life scenarios. We saw that clearly after the 2016 election when people were shocked by Donald Trump’s victory. The best survey organizers Gave it a 30% chance. (Opens in a new tab) of a positive result. “Not possible” does not mean “impossible”.
Most people equate to a lower probability of success number The probability of success, but a 30% chance of something happening is very, very different from a zero percent chance.
To build a stronger financial plan, you can’t rely on models that give you “likelihood of success” as the final approval stamp. Monte Carlo simulation Very useful, but can also be incredibly misleading. This is especially true when you are younger, when there is more time for variables to play out in different ways than you expected.
Avoid looking at situations where the math formula tells you that you have a 70% chance of success and thinking that you are fully prepared. It’s certainly a good indication that you’re on the right track, but building a solid plan requires you to constantly reevaluate over time – and realize that what’s likely isn’t the same thing as foolproof or risk-free.
2. Consider your assumptions carefully and choose actions that you can stick to consistently
Planning can take into account the potential for downside risks to arise by avoiding the use of strong assumptions. I love this paraphrased quote that came from CFP, author and speaker Carl Richards (Opens in a new tab) At the Financial Planning Conference: Risk is what appears after you think you’ve thought of everything.
Meaning, that one thing you forgot to include in the plan is the thing that will most likely pop up and throw you in a loop! You can’t explain every fact that will happen, though. What you can do is use reasonable assumptions that are not based on everything that goes your way. It’s not necessarily about “conservative” planning. The way you build a foolproof financial plan is Planning (Opens in a new tab)continuously.
For example, if you are in your forties and at the height of your career and earning years, you might expect your rapidly growing salary to continue to increase over time. You’d probably expect to see a 5% to 7% increase each year (because that’s what I’ve seen for the past few years).
That may not be sustainable for another 10, 15, or 20 years. If you use this assumption and your income growth slows down or drops, your plan may not work. So instead of using a strong assumption, we can simply assume lower income growth over time (such as 2.5%).
You don’t need to assume the worst case scenario at every turn… but you can’t assume Better With every variable either. By adjusting what you expect to happen, you can build a plan that works regardless.
Here is a quick summary of some of the assumptions that go into the plan:
- Earnings and how long you expect to work or earn a certain salary.
- Living expenses now and in retirement.
- Investment returns and time horizon for your investment.
- Specific goals, costs and timelines.
Depending on the variable, you may want to underestimate what you expect (as with income and investment returns) or overestimate (as with expenses or inflation).
3. Remember that life happens outside of spreadsheets
Any financial plan is only as good as the information you put in it. You can make a lot of scenarios on paper; If you’re good with spreadsheets, you can get the numbers to tell you the story you want to hear. But spreadsheets don’t capture the context of your everyday life.
The quality of that time matters, because this is how you actually experience your life: as your current self, in the short term. In the meantime, your financial plan requires you to make long-term decisions for your future self. This “self” you don’t know at all.
Strong plan realizes that friction and aims to find the balance Between enjoying life today and responsible planning for tomorrow.
4. Do not rely on one factor to get you to success
Along with using assumptions that are reasonable and not aggressive or overly optimistic, be careful about how much weight you put on any one factor in your plan. It’s just like your investment portfolio: Diversify rather than put all your eggs in one basket!
These scenarios are common when we see customers trying to over-reliance on one variable:
- Constant dependence on big bonuses, commissions or targeted profits.
- Expect to receive equity compensation consistently over time through refresher grants (not actually guaranteed).
- Using the expected pension 20 years from now (and not considering what happens with a career change).
- Waiting for an IPO that may not happen, and a high share price that can fluctuate.
It might be a good idea to show these things for a year or two, but relying on them for the next 10, 20, 30 years is making a plan to fail.
If you expect bonuses, commissions, or target earnings to add 100% to your salary, expect 50%. If you have a pension, drop your retirement income with the amount of the pension you include today against the expected pension income you would receive if you worked another 20 years at the company.
If you get RSUs Today, consider these participants, but don’t expect additional grants for the next five years. If you are expecting an IPO…don’t do it! This is completely out of your control, and you can’t build an entire financial plan on the assumption that (a) your company will have an IPO, and (b) you will profit well if you do.
5. Account to change
Plans that have a high probability of success Building in a natural buffer zone (Opens in a new tab) life changes. These changes may be external in nature, and they are beyond your control, such as economic downturns that lead to corporate layoffs, pandemics, or other natural disasters that halt economic growth (and thus, investment returns).
There may be other factors under your control, and these are not necessarily bad things. You can simply change your mind about your career, living situation, or goals. Personal or family dynamics can change in unexpected ways that can throw a major wrench into your financial plan.
I personally experienced this when my wife and I decided to have children. For years, we’ve been on the fence (and even tend to be child-free by choice). Our financial plan reflected our current reality. We didn’t have the goal of “save for college” or the higher cash flow account in general that we need to manage the expenses of a larger family.
What we did, however, was to build a buffer room in our plan. Our specific strategy was to set a very strict “retirement” goal; We planned as if we would stop receiving income when I turned 50. Actually, I didn’t Wants to retire early. I love my job and my job, and assuming all of our income would blatantly stop and that we would start living off our investments at that point was highly unlikely.
But this version of the plan required a very high savings rate to work, which we stuck with even though we didn’t feel likely to retire so young. This huge rate of savings for many years allowed us to rise when we decided to have children.
We modified the plan by pushing our retirement age out and lowering our current savings rate. We can afford to take this step because we saved so much many years previously, and lowering our savings rate freed up cash flow to manage newborn expenses (as well as to fund new priorities, like college savings).
Without the proper buffer room in the plan, the plan will break and possibly fail in a way that does not allow for an easy recovery. We want to avoid this failure when we plan.
The point is that change isn’t always bad, but it almost inevitably happens in some form or form. A solid financial plan is one that allows the pivot without forcing you to give up what is most important to you.