Mention the words "financial planning" to some people, and they throw their hands up in the air. If the future is unknown, they might say, there's no use in putting pen to paper (or cursor to Excel spreadsheet) and base big financial decisions on what might turn out to be "iffy" projections.
It's true that the great arc of life can go in many directions and markets don't go up or down in straight lines; it's impossible to control all outcomes. But we do have two human superpowers: the ability to control our behavior and our ability to adjust to new information. A good plan will help you stay on track, monitor your progress toward whatever financial goals you set and alter your actions or expectations when necessary.
Your plan will have a lot in common with the financial statements of a public company. Here's what I think a plan should start off with, at a minimum. It should lay out your:
• Assets — business value, investments, real estate, bank balances and values of any art and other collectibles.
• Liabilities — mortgages, student loans, credit card balances and any other debt.
• Sources of income, along with their duration and expected growth.
• Projected expenses.
• What you want to happen and need in the future, along with their projected costs — river cruises and new roofs.
That part of the plan is straightforward. The next part is a bit trickier and, depending on how much time you are planning for, may have far more of an impact: estimating the rate your assets and income will increase over time and how quickly your purchasing power will decline over time because of inflation.
Just how important the rate of income increase is can be seen in the difference in the projected purchasing power of $50,000 after 20 years, given two very different projected rates of return. If you expect your investments to gain an average of 6 percent per year and inflation to be 3 percent per year, you expect your real wealth to increase by 3 percent per year. After 20 years, you would expect your wealth (net of inflation) to be $90,306 in today's dollars.
But if you project your wealth to increase by only 2 percent per year, that original $50,000 would grow to a target of $132,665 in today's dollars. In a nutshell, the higher return you can attain on your assets, the less you'll be required to save to achieve your financial goals.
Great, but what happens if, in year 16, your investments increase by 30 percent but the following year they drop by 27 percent? We all know that markets don't move in a straight line, so some financial professionals may run a thousand simulated paths to get an estimate of how likely it is you'll achieve the goals you've set. They do that via a statistical process called the Monte Carlo simulation. Monte Carlo isn't perfect, but it will help you decide whether you might need to save more to be more confident about hitting your number or if you can live with accepting the risk of not achieving a goal. Maybe you can still live well if you don't end up buying a Caribbean island.
One more suggestion: Once you write up a plan, don't bury it under last year's tax returns. A plan should be a living document. It's best to always keep your goals right in front of you, but at least review your plan once a year.
Note to readers: I will lead a discussion on "Rising Dividend Investing in 2018" at 10 a.m. Thursday at One Sarasota Tower, Suite 1200, at 2 N. Tamiami Trail in Sarasota. RSVP to Jamie at 941-906-2829.
Evan Guido heads a wealth management team in Sarasota focused on retirement planning. He is a director in the Private Wealth Management Division at Robert W. Baird & Co. Contact him at 941-906-2829 or eguido@rwbaird.com.