“For the simplicity that lies this side of complexity, I would not give a fig, but for the simplicity that lies on the other side of complexity, I would give my life.” – Oliver Wendell Holmes
The most basic forms of financial planning are nearly worthless. This is because they are based on overly simplistic assumptions of a linear path in life and money that are simply unfounded.
In reality, whether you are creating your first budget to manage income from a summer job or you are determining your income requirements in retirement, we must first and foremost accommodate the only guarantees in financial life planning: surprises, change, and failure.
But fear not. We can systematize countermeasures in our lives and financial planning to minimize this trifecta’s negative impact.
Surprises require margin. Change requires flexibility. And failure requires grace.
Margin is a lost art, and it’s missing in nearly all phases of life in our all-too-hurried, uber-productive, stressed-out lives. We don’t leave enough empty space on our calendars, so if we get stuck in traffic or stop to help a stranded motorist, we’re likely to be late for something else. We can’t do anything spontaneous because every minute is already filled.
And because all of our time is spoken for, we also don’t have much in the way of blank canvas in our heads, and all too often our hearts. This is especially true of our finances; because every dollar is already spent or pledged, often even small emergencies or organic opportunities can’t be absorbed or funded. There’s no margin for error.
Therefore, regardless of your phase in life or your preferred method (or lack thereof) for budgeting, the most important line item should be a “margin” or “buffer” category designed to absorb surprises that arise throughout your week, month, year, or retirement.
Our lack of margin feeds our inflexibility. We often don’t even consider the possibility of change because we don’t have the time. Change, therefore, is inevitably also a surprise, compounding the discomfort. But we often struggle to accommodate even predictable change. Can your finances adapt to another child – even if the pregnancy was planned – or reduced income caused by an industry-wide, career-affecting change that was – or wasn’t – anticipated?
How about your retirement plan? Can it accommodate a major market downturn, which we know to be more of a “when” than an “if”? A major expense due to illness or helping out a family member?
That which doesn’t bend, breaks. This is why, for example, a retirement rule-of-thumb based on a static annual withdrawal rate is fundamentally flawed. Yes, it may be true that some statistical analysis of the past suggests that you should be able to multiply the balance in your retirement savings by a certain number (say, 4%) and then set up an auto draft for that amount (plus an annual increase for inflation) to live off through your retirement years. But the future is not bound to deliver past results.
Therefore, while a calculation like this may prove to be helpful as part of a simple retirement stress test, relying on it to secure your retirement into perpetuity would be a vast oversimplification. Instead, consider a dynamic spending rule, adjusting your annual retirement spending in accordance with the prevailing reality.
There are several interesting dynamic retirement spending rules, but the consistent theme is adaptation to inconsistency. For example, if market performance is a primary driver of your retirement income, you should feel more comfortable taking the entire extended family to Europe in the year where your portfolio outperforms; alternatively, when the market constricts, it’s usually a good time to tighten your budget belt as well.
This doesn’t mean that you should ignore long-term retirement planning, like running Monte Carlo simulations designed to anticipate a host of probable market return sequences throughout retirement. It just means that, when the very real present deviates from the future we envisioned, we must be willing to adjust course.
For most of us, so much of our life is spent protecting ourselves from failure that it can be devastating when it arrives. And it will. Failure is simply a natural byproduct of our human imperfection. (Even if you’re perfect, I can assure you that many upon whom you rely are not.) If you’re unable to view failure as the most successful people often do – as an opportunity for invaluable education and personal growth – please consider diminishing failure’s grip, if only for pragmatic purposes.
Remember the major-leaguer who qualifies for the all-star team when he only succeeds a third of the time (a .333 average in professional baseball isn’t bad). That’s where grace comes in. Grace is being forgiven – or forgiving ourselves – when we’ve screwed up, slouched, or squandered. You don’t have to feel like you deserve it to receive it.
The whole point of financial planning, therefore, is to help anticipate (prepare for), enjoy (endure), and reflect on (recover from) those events in life, both common and uncommon, welcome and unwelcome.
Birth and death. Marriage and divorce. Graduations and dropouts. Hiring and firing. Promotions and demotions. Windfalls and losses. Illness and disability. Success and failure.
Good financial planning may put your money in order, but great financial planning places your life at its center and positions your money in support of your hopes, dreams, and goals – all while accommodating the inevitable surprises, change, and failures that are sure to come.
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