29 Aug 2014 Is Financial Planning Really That Important?
I’ll be the first to admit that the idea of “financial planning” can sound about as exciting as an invitation to a friend’s daughter’s third grade violin concert. Throw in the fact that we are in-the-moment creatures, not naturally focused on the future and we begin to understand why planning is such a challenge for us. We are so busy managing the chaos of our daily lives, we simply can’t afford to take the time to consider a future that seems to be coming at us faster than we can adjust.
There are indeed a few times we consider our financial future. When markets crash, we fear bankruptcy, and when they rebound wildly or for extended periods, we extrapolate huge returns well into the future. But during the other 80% of the time, we remain content to leave it all on auto pilot, with no real idea of how current conditions impact our financial well being.
We inherently understand that we can’t become fit without exercise, nor can we stay healthy without eating right. We can’t accomplish mastery of an instrument or a discipline without practice and training. And we don’t reach a destination without planning or direction. So why the disconnect with financial planning?
Part of the problem is with the way we measure our financial well-being. We most often mistake returns as the best measure for progress in growing our money. In fact, the vast majority of 401K plan participants select their investments for retirement, 10, 20, and 30 years into the future, based on historical returns of 3, 5, or 10 years’ past. This practice is terribly wrong; first because as economist Mark Perry points out “there is absolutely zero correlation between a manager’s past or recent performance and what may happen in the future. The out performers of last year are equally likely to outperform next year as they are to under-perform, statistically speaking.”
Second, it is wealth that we spend, not returns. Moreover, it is the timing of returns that determines how much wealth you will have, not the returns themselves. In the figure below we took the actual US market returns since 1926 and a series of 37-year retirement periods through the returns. There were 576 in all. Each couple started with $1.2 million and spent $100,000 each year (adjusted for 3% inflation). Look at the huge range of wealth at the end of their lives. The couple who started in June of 1932 died with an estate of over $16.5 million. Sadly, the couple who started in September of 1929 went broke at age 73 for him and 71 for her. By their death, they were over $2.6 million in debt. The point is, we can’t predict or control the timing of returns, but financial planning assisted with the continued use of probability analysis known as Monte Carlo, can inform required adjustments along the way to avoid unfortunate outcomes.
The returns, by the way, are calculated after all the numbers were in. They were all over the board during each couple’s retirement period and offered no effective guidance.
Another part of the reason we don’t eagerly embrace financial planning is that for most, their best understanding of goals is that they are so far in the future. There are too many pressing issues and exciting interests today to occupy our time. Throw in a dose of self-confidence (or hubris) that says if we keep doing what we are doing, things will work out fine and we can see why we blindly accept the status quo advice to set some savings aside in our 401k, pay off our debts, and buy an annuity when it’s time to retire.
Worse, unplanned futures can even look dark and scary. Without goals and mile posts to reference the things we aspire to, we have no way of gauging where we are relative to them. When life throws us challenges, we easily fall prey to the belief that we are falling short of our fuzzy goals or of people we compare ourselves to. With no better information or tools we begin to imagine a future far short of our dreams. The condition can easily devolve into self-fulfilling prophesy.
When the performance of our investments are our only benchmarks for progress, we set ourselves up for all kinds of emotional highs and lows along with the behavioral mistakes they drive. Markets’ movements can best be described as long periods of boredom interrupted by short periods of madness (up and down). Without direction, it is in these short periods of madness that we so easily derail ourselves.
Unfortunately, much of the financial services industry is eager and ready to supply a host of products and strategies designed to make us feel that we are addressing the emotional highs and lows created by markets. Problem is, these products or strategies do not work well for long because markets change – unexpectedly.
Good financial management and planning is not product based. It is not done once and forgotten. And it should not be done in isolated segments i.e. estate, insurance, long term care and goal planning. With a plan that well defines what we want our futures to look like, guidance of a financial advisor who helps us align and stretch our ideals, combined with the oversight of powerful probability analysis to continually re-evaluate in the face of constant change, we have no way of knowing where we are or if today’s madness or boredom presents threats or opportunities for our unique future.
Investing and planning done well requires attention, but it does not have to be dull or a chore. Properly executed, the experience can be fun and enriching in itself. After all, the subject of conversation is our favorite topic – us. It also provides a venue of celebrating our financial successes to better purpose than at cocktail parties or golf courses. During the planning process, we first learn to imagine a future we want to live into. As we grow more confident, we improve at creatively stretching our imaginations in the directions we want to go. Incredible opportunities and realities begin to appear when clients and their financial advisors optimally align goals and priorities in order to achieve their most valued aspirations. A really good financial planning process frees people from worrying about the mechanics of returns and investment selection in order to consider and achieve far better financial futures than they might accomplish if they continued to rely on their status quo auto pilots.
Why not consider putting your financial future on a regime to achieve the very best possible, just as you do for better health, fitness, or golf? After all, as Mark Twain reminds us, “The future is where we will live the rest of our lives.”