Last week I was talking with a friend and the topic of retirement planning came up (my conversations are so hip these days). He told me he was overwhelmed by the sheer number of variables that come into play when trying to plan for something that is decades out into the future.
The entire process is overflowing with uncertainties, assumptions, and guesswork. Here’s my list of uncertainties involved in the retirement planning process:
- Future financial market returns
- The future path of interest rates
- The severity and timing of bear markets
- The magnitude and timing of bull markets
- The sequence of your returns
- Your personal spending needs
- Your financial needs and desires
- Where you are in your financial lifecycle
- How much longer you plan on working
- What you plan on doing with your money some day
- How long you’ll live after retirement
- Whether you’re going to be a net saver or spender in the near future
- Your current and future income levels
- Your ability, willingness and need to take risk
- How your perception of risk will change over time
- Unexpected life events and challenges
- Withdrawal strategies during retirement
- Future tax rates
- Your future savings rate
- Social security elections and benefits
- Healthcare expenses
- Changes in the cost of living where you live
- Your debt levels
- How many people are dependent on you financially
- Insurance needs
- Your ratio of human to financial capital
I’m sure I missed a few things here, but you get the point. Retirement planning can be a daunting prospect. This is one of the reasons so many people put it off. It’s something that’s vitally important but for most people, it’s not urgent, so we put it off to focus on what’s in front of us right now.
So how are you ever supposed to make rational decisions in the face of such uncertainty?
First of all, you have to understand that financial planning is a process, not an event. Investors are too easily distracted by all of the underlying assumptions involved in creating a comprehensive plan. Yes, those assumptions are important, but how you react when life invariably gets in the way is far more crucial. A real world plan rarely plays out like it does on a spreadsheet.
Therefore the implementation of the plan is the real key to success. I really like the way Carl Richards describes this idea in his book, The Behavior Gap:
The process of planning may — in fact, probably will — require us to chart a course that’s headed in the direction we hope to go. That may involve making some assumptions about the future. But reality-based planning acknowledges that such assumptions are mere guesses. We make the best guesses we can. Then we move on to the more productive business of investigating our current motives and circumstances, so that we can act from a place of understanding — not hope, not fear, but clarity.
I tell my clients that I’m giving them permission to let go of the need for precision in planning. Make the best guess you can and then move on. Put a stake in the ground thirty years out; think of it as a marker that you can always move later when you have more facts.
Think of the difference between a flight plan and an actual flight. Flight plans are really just the pilot’s best guess about things like the weather. No matter how much time the pilot spent planning, things don’t always go according to plan.
In fact, they rarely go just the way the pilot planned. There are just too many variables. So while the plan is important, the key to arriving safely is the pilot’s ability to make the small and consistent course corrections. It is about the course corrections, not the plan.
The idea that you can create a financial plan and then sit back while all of the pieces slowly fall into place is absurd. The markets and life, in general, are constantly throwing curve balls at you. There’s an old saying that it’s better to be vaguely right than precisely wrong. This is how I approach retirement planning.
You make your assumptions. You set your plan. You try to account for as many variables as you can. But then you let go of all of those factors that are completely out of your control. You update your priors as new information comes to light. Eventually, real world results replace your assumptions and you get a better sense of how well reality fits within your initial plans.
Financial planning is a process because it never really stops. Once you understand this fact it becomes much more manageable.
The Behavior Gap
Lessons From The Behavior Gap