"I'm not sure what [the next decade] will look like, but I'm sure that it will be very little like we expect, so we should plan accordingly."
This quote served as the ending paragraph on a memo written by Pentagon official Lin Wells. In his book Superforecasters: The Art and Science of Prediction, Phil Tetlock shares the story of how that memo was eventually passed around the White House in 2001.
The memo went across the desk of President George W. Bush that spring, months before the 9/11 attacks did indeed ensure the next decade would look nothing like the one that came before it.
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This idea — that the future is inherently unknowable, and therefore, we should plan for precisely that unpredictability — is counterintuitive for most people. Most people aren’t good at probabilistic thinking, nor are they comfortable sitting with uncertainty (let alone wrestling with it enough to draft a plan that addresses it directly).
But this makes perfect sense if you're a financial planner who works with clients that lead very dynamic, ever-changing lives. At my firm, our goal when working with our financial planning clients is to do everything we can to ensure they're ready for the ups and downs that make up life.
You can’t perfectly predict the future, but you can plan for it
Predicting what will happen in the next 10 years (or 20, or 30, or even more, depending on your current age and the time horizon of your most important goals) is not the same thing as making a reasonable plan to get you from today to that distant tomorrow.
For one, it’s virtually impossible for most people to make meaningfully accurate predictions about the future. But it is very possible, and highly recommended, to spend the time on planning exercises for that same, unknowable future.
A good financial plan is not one that shows you where you’ll end up if everything goes perfectly. That is, in fact, a wish or a dream, but not a strategy with clear tactics you can follow to get to a desired outcome.
And it might sound strange, but the best plans are not dependent on certainty or precise data points. In fact, getting stubborn about being precise can backfire, creating tunnel vision where you miss key pieces of new information that you should have stopped to notice and incorporate into your plan — information that would leave you with an entirely new plan based on the change you encountered.
The key characteristic of a good planning process: Adaptability
One of the most critical aspects of a good plan of any kind, financial or otherwise, is that it responds to new information. A good financial plan is one that ensures you’re well-positioned to adapt to whatever comes at you so that you’re able to achieve what should be your number-one objective in your wealth accumulation years: keep going.
You can keep contributing to your portfolio; you can stay invested in the market; you can avoid unforced errors — all because you had a plan that accounted for likely risks, built in safety nets to break your fall from all the risk you didn’t see coming and had buffer room for mistakes and just plain bad luck.
A good planning process allows you to capitalize on opportunities, adapt to the unexpected and recover from a negative event that would otherwise have devastated your financial life.
Five tips to implement in your own financial plan
We don't need to know what the future holds. We only need to know that things will change, the unpredictable will happen and we have to be ready for all of it. Here are five tips you can use to plan accordingly.
1. Save more than you think you need
Our baseline recommendation for our financial planning clients is to save 25% of gross annual income. That’s a minimum targeted savings rate.
Does this seem like overkill? Maybe it is, in a perfectly predictable world where everything goes your way. But we live in a world of constant change, uncertainty and sometimes downright chaos.
Saving more than you think you’ll need protects you against the scenarios in which you had an 80% chance of things working out the way you wanted them to. Those are pretty good odds, but it means that for every 100 times you run that scenario, you’ll come up short in 20 of them. If you’ve “oversaved,” you’re less likely to struggle through that 20% chance that things didn’t work out your way.
2. Insure against the obvious risks
There are known and obvious risks that each one of us faces: the risk of dying. The risk of illness. The risk of losing a job. The risk of physical losses from theft or property damage. The risk of car accidents, injuries or even litigation against you.
You can easily protect yourself from the negative financial impacts of these threats with various insurance policies. Hold the appropriate coverage for life and disability insurance, consider umbrella insurance once you have a net worth of $1 million, and maintain property and casualty policies to protect your physical possessions.
3. Protect against the risks that are impossible to predict
To paraphrase Carl Richards, author of The Behavior Gap, “risk” is everything you didn’t see coming and didn’t plan for. How can you protect against something you could not possibly have predicted?
- Save more than you think you need
- Minimize the load from big fixed expenses in your working years (i.e. don't borrow the maximum the bank will let you to buy a house)
- Plan for retirement assuming you may spend more than you think you will
- Keep an appropriate amount of liquidity (have cash on hand)
- Identify lots of contingency plans before you have to use them — know your “escape routes” if you need to unexpectedly change plans (what spending could you cut, what goals could you tweak, how could you quickly adapt your lifestyle if you had to?)
4. Keep spending in check
How much you spend has a huge impact on your overall financial plan. The less you spend, the less you’re required to save to reach financial independence, and the more freedom and flexibility you likely have because you have smaller obligations.
The best strategy I know of to better manage spending is to prioritize savings first. Once you’ve hit your annual savings rate target, whatever is left over can be freely enjoyed however you’d like — because what you spend on doesn’t matter; it’s how much you spend.
5. Plan iteratively
Don't let it be a one-time process. Planning is a proactive exercise, one in which you should adjust your assumptions about the future every single time you get a new piece of information or have a new experience.
A plan on paper is outdated the moment it’s finalized, but ongoing planning can help you maintain good positioning over time so you can achieve your goals and enjoy more of what’s most important to you.
Eric Roberge, CFP®, is the founder of Beyond Your Hammock, a Boston financial planning firm that provides wealth management strategies to couples and young families. To jumpstart your financial planning journey, get a free copy of Eric's ebook on 5 Strategies to Optimize Your Finances.
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