Let’s talk about your odds of success.
To get started, let me be clear . . . you’re the only one that can define your unique, personal definition of success. This is why there is no rule of thumb or one-size-fits-all financial plan that works for everyone.
In financial planning, there are a few, critical things that are within your control.
And there are many, many things that fall well outside of your control.
The short list of what you can control is your cash flow (spending vs saving), the time and timing of goals (when things happen and how long they will continue), and your investment risk (primarily the mix between stocks and bonds in your portfolio).
If you haven’t already read last week’s article about the best way to figure out your investment risk, you can read it here.
Among the near-endless list of things no one can control (or predict) is how long you’ll live, the investment markets, interest rates, tax legislation, political climate, and . . . well, you get the picture.
As a quick aside, isn’t it interesting how much time the media and many advisors spend discussing things outside anyone’s control?
Food for thought . . .
Financial planning is as much art as it is science, but we do our best to apply logic and method to the important work of helping you plan for and live your best life with the financial resources you have.
To this end, working with you, we create a financial plan and stress-test the sustainability of your plan through 1,000 different lifetimes and investment environments. This is an application of Monte Carlo (or probability) analysis.
Part of our unique approach to planning and wealth management is our Comfort Zone which targets a level of confidence in your plan that falls between 75% and 90%. Below 75% leaves too much to chance, and more than 90% indicates an overconfident future at the cost of your lifestyle today.
What I want to highlight today can be explained with an example from a client.
They’re a retired couple around age 70. They’ve done a great job preparing for themselves and their family through diligent saving and responsible financial decision-making.
Today, they have a net worth of approximately $5.75 million.
Part of their financial plan includes a goal to leave $1 million (in today’s dollars) in liquid savings and investments to their children, grandchildren, and church. This amount is in addition to any life insurance, real estate, or personal property.
Through our ongoing planning, we’ve targeted a confidence level of 83% which happens to fall right in the middle of the Comfort Zone. This includes them leaving $1 million to their heirs.
In plain English, out of the 1,000 simulated lifetimes we used to stress-test their plan, they were able to meet or exceed all their goals in 830 of the 1,000 simulations. This is how we arrive at a plan confidence level of 83%.
But what’s interesting is looking at the range of potential outcomes for this couple and their family.
In the best possible scenario we ran for them, they leave over $23 million behind to their heirs.
In the worst scenario we simulated, they run out of money in their mid-80s.
And the 50th percentile results show them leaving more than $3 million behind. More than 3X their goal. The 50th percentile is essentially the same as flipping a coin.
I believe, and assume you’d agree, that we don’t want to plan your family’s future based on the odds of flipping a coin and it either working. Or not.
This is why, at a minimum, we want 75% confidence or success in at least 750 of the 1,000 simulations.
But again, we’re not targeting 75%. Instead, we’re aiming for the middle of the Comfort Zone which is around 82-83%.
And no matter how good a job we do of working with you to create your plan, it’s gonna change. This is why ongoing planning (adjustments, accommodating new information, etc.) is more important than creating an initial plan.
Looking at another client who is targeting a zero liquid estate to be left behind, has a 50/50 chance of leaving more than $1.5 million at the end of their lives.
All this to say . . . financial planning is about making informed decisions with imperfect information.
And yet, while things can “go south” and we’ll have to make some necessary adjustments along the way, there’s also the opportunity that things could turn out much better than we planned.
So what about you?
Does your financial plan (you have one, don’t you?) focus on the things within your control and stress test the things we can’t control?
If you’re ready to discuss putting this type of plan in place for yourself, or if you’d like to get an objective review of your current financial planning efforts, please get in touch and let me know.