Financial Plans vs Financial Planning

Posted by Rick Miller on October 28, 2015

“…Plans Are Useless, But Planning Is Indispensable”  — Dwight D Eisenhower

All of our financial plans come with caveats (as does every professional financial plan):

* The price level in ten years is unknown. The plan can’t reflect future asset prices and amounts accurately.

* Your income will change, and probably increase, but it isn’t prudent to spend now as if you are certain that will happen.

* Stock market returns and bond market interest rates are unpredictable, so no one can know what your assets will be many (ten, fifteen, twenty) years from now.

Financial plans are full of numbers, and most of them refer to the unknown and unknowable future. Why bother to write them down if they are certainly wrong?

The epigraph from President Eisenhower suggests one answer. The process of planning and thinking about future events and how they might evolve is valuable in and of itself. Outlining a number of possible futures and how you might respond to each of them prepares you to respond when life actually happens, even if life never happens precisely the way any of us anticipates.

Financial planning also implies or recommends important actions to take today that will directly affect you in the future: saving, saving location, insurance purchases, estate planning, and investment decisions.

If you want to have resources (in excess of Social Security and Medicare benefits) to spend after you retire, you have to save. You have to save now even though the future is unknown. Perhaps most importantly, you have to decide how much to save. That requires planning. Implicitly or explicitly, you have to estimate how much you will spend each year after you retire, and forecast how much your savings will earn each year. Together, those two planning assumptions will help you figure out how much to save.

Your forecasts of the returns on your savings may be (will be!) incorrect. As time goes on, and you get older, you’ll revise your earlier post-retirement spending plans. Your nest egg will grow. Even once you retire, however, your future will still be mysterious. Your lifespan, your health (and health expenses) during retirement, and future investment returns are all still unknown. New information will require you to adapt throughout retirement.

You may end up with more savings than you need. You won’t know for certain until the end of retirement. Better too much savings than too little, however. If you run out, you’ll know you didn’t save enough, but it will be too late to do anything about it.

Where (in what accounts) should you place your savings? There are several major choices: employer retirement plans (e.g., 401(k)s and 403(b)s), personal retirement plans (IRAs), Roth IRAs (and employer plans), or ordinary savings and brokerage accounts. Each has different implications for investment choices, tax timing and fund accessibility.

You make your initial choices (or at least, you should) based primarily on your expectations for when you might need the money and what your tax rates will be then. As time goes on and you learn more about both of those topics you can update your plan. If your initial choices turn out to be wrong, you may pay greater costs than you would have had you only known what was going to happen, but you are still likely to be much better off than if you don’t do any planning at all.

You have to decide how much life, disability and long-term care insurance you want to buy. Again, drafting a lifetime plan is very helpful in deciding now how much you need now. As your life develops, you learn more about your income and your health. If your income gets larger, you’ll likely need more life insurance. [If your spouse’s income gets larger, you may need less!] If your health declines, more life insurance may become more expensive, or even unavailable. If you move from working at someone else’s company to starting your own, you will want to get an individual disability income policy (if you can). Growing income and wealth may mean that you need less long-term care insurance. Updating your lifetime plan will help you decide.

“Estate plan” contains the word “plan,” which is something of a hint. Your estate plan takes over when you cannot make decisions. Ensuring that your plan works the way you intend requires that you update it regularly. Many life changes require estate plan adjustments. Having more children, your children growing up, buying or selling your home, growing wealth – all of these may outdate your existing estate plan. Or, one of your children could become very wealthy and give you money (but your financial plan probably shouldn’t rely on this possibility!). Knowing that your estate plan may need to change in the future doesn’t mean it’s a waste of time to do one now, it just means that you’ll need to keep updating it.

Investment decisions also rely on what you think will happen in the future. If you expect to earn enough so that you can spend what you want and still save a lot, you may be comfortable with a lot of stock in your portfolio. If you later learn that you’ll be earning less, and you still want to spend the same amount, you may want to reduce the proportion of stock. On the other hand, if you win the lottery (think Powerball!) and your plans for earning and spending don’t change (at least, no major changes other than the Maserati and the First Class trip to Hawaii…), you may be comfortable with even more stock. Your best response to each of these surprises will require some sense of what your future income and spending are likely to be as your life continues to unfold. To assess each surprise fully, the context your financial planning process can provide is enormously helpful, even if the plan that emerges from that process is a guide only to today’s decisions and is out of date by next year.

Nevertheless financial plans are useful. Many clients refer to their plans for guidance from year to year. After five to seven years, however, life is sufficiently different than they first envisioned that a plan update makes sense.

Almost without exception, clients find that the financial planning process is invaluable, even leaving the decisions (saving, insurance, investments, etc.) out of the equation. Just thinking explicitly about the future and (for couples) sharing those thoughts with their partners provides perspectives on their lives that seem not to be available in any other way.