5 Ways to Build a Stronger Financial Plan

This article was originally published on Kiplinger.

Most people do not know how to accurately assess probabilities and evaluate risk in their financial planning. As a result, the plan is likely to fall apart the moment something goes wrong…

…which means it almost always falls apart, because there are a million things that happen in life that we can’t predict, didn’t account for, or simply forgot to consider.

It’s not that planning is pointless. It’s that we need to treat planning as a process, rather than a one-time event that we set and forget.

We also need strategies for building stronger plans that can actually withstand the inevitable bad luck, bad decisions, or bad assumptions that happen along the way.

You don’t have to predict the future accurately to build a better plan. At our financial planning firm, we’re not trying to be right all the time.

Instead, our goal is to give risk — in investments and in life — the respect it deserves, and build strong plans that recognize how probability actually works.

Here’s how you can do the same.

1. Avoid False Senses of Security

The average person (and even those who are mathematically inclined) tends to struggle to apply probability to real-life scenarios.

We saw that vividly illustrated after the 2016 election when people were shocked that Donald Trump won. The best pollsters gave him about a 30 percent chance of a positive outcome.

Note that “not as probable” doesn’t mean “impossible.” But most people see a likelihood of 30 percent, and round down.

They equate the lower probability of success to no probability of success… even though 30 percent chance of something happening is very, very different than a 0 percent chance.

When you’re trying to financially plan for the rest of your life, a 30 percent chance of something happening has plenty of time to actually show up.

To build a stronger financial plan, then, you cannot rely on models that give you a “probability of success” as the end-all, be-all stamp of approval.

Monte Carlo simulations are very helpful, but they can also be incredibly misleading. This is especially true the younger you are, and the more time there is for variables to play out in different ways than you’ve assumed in your model.

Avoid looking at situations that a math formula tells you have a 70 percent likelihood of success, and think you’re all set.

It’s certainly a good indicator that you’re on the right track, but building a strong plan requires you to continually reassess as time passes — and recognize that what’s probable is not the same thing as guaranteed or risk-free.

2. Consider Your Assumptions Carefully, and Choose Actions You Can Stick with Consistently

Your planning can account for the potential for downside risk to show up by avoiding the use of aggressive assumptions. I love this paraphrased quote that came from Carl Richards at a financial planning conference:

“Risk is what shows up after you think you’ve thought of everything.”

Meaning, that one thing you forgot to factor into the plan is the thing that is most likely to pop up and throw you for a loop!

You can’t possibly account for every reality that will come to pass, though.

What you can do instead is use reasonable assumptions that aren’t predicated on everything going your way. It’s not necessarily about planning “conservatively.”

The way you build a foolproof financial plan is by planning consistently.

For example, if you’re in your 40s and at the peak of your career and earning years, you might expect your fast-growing salary to continue to increase over time. Perhaps you expect to see 5 to 7 percent increases every year (because that’s what you’ve seen over the past few).

That may not be sustainable for 10, 15, or 20 more years, though. If you use that assumption and your income growth slows or drops, then your plan might not work.

So instead of using an aggressive assumption and building a plan that requires you sustain a very high salary for a long period of time, we could simply assume a smaller growth in income over time (like 2.5 percent).

You don’t need to assume a worst-case scenario at every turn… but you can’t assume the best with every variable, either. By moderating what you expect to happen, you can build a plan that works regardless.

And as things happen and unfold in your life and your assumptions become what did or didn’t happen, you can incorporate that into the plan and iterate from there with the new facts.

Here’s a quick rundown of some of the assumptions that go into a plan:

• Earnings, and how long you expect to work or make a certain salary
• Living expenses now and in retirement
• Investment returns, and your investing time horizon
• Inflation
• Specific goals and their costs and timelines

Depending on the variable, you might want to underestimate what you expect (as with income and investment returns) or overestimate (as with expenses or inflation).

3. Remember That Life Happens Outside of Spreadsheets

Any financial plan is only as good as the information you plug into it. You can make a lot of scenarios work on paper; if you’re good with spreadsheets, you can get the numbers to tell you the story you want to hear.

But spreadsheets don’t capture the context of your everyday life.

You can make a lot of financial plans work, but the actions you’d have to take to get to sucess and the length of time you’d have to commit to taking those actions might make it difficult (or impossible) to actually implement.

The quality of your day-to-day life matters, but finding the balance between today and tomorrow is incredibly hard because we don’t know exactly what happens down the road.

Knowing the exactly correct balance is impossible, because ultimately, we don’t know how long your money has to last (no one knows when they’ll pass).

A major challenge with financial planning is that it requires you to make long-term decisions for the benefit of your future self.

Meanwhile, you actually experience your life as your present self, in the short-term.

A strong plan recognizes that friction, and aims to find the balance between enjoying life today and planning responsibly for tomorrow.

4. Don’t Depend on a Single Factor to Get You to Success

Along with using reasonable rather than aggressive or overly optimistic assumptions, be careful about how much weight you put on any one factor in your plan.

It’s just like your investment portfolio: diversify rather than putting all your eggs in one basket!

These scenarios are common when we see clients trying to over-rely on a single variable:

• Continually relying on large bonuses, commissions, or on-target earnings
• Expecting to receive equity compensation consistently over time via refresher grants (that aren’t actually guaranteed)
• Using a projected pension payout 20 years from now (and not considering what happens with a career change)
• Waiting for an IPO, which might not happen, and a high share price, which can fluctuate

It might be okay to project these out for a year or two, but to rely on them for the next 10, 20, or 30 years is setting a plan up for failure.

If you expect bonuses, commissions, or on-target earnings to add 100 percent to your salary, project 50 percent.

If you have a pension, project your retirement income with the pension amount that you are guaranteed today versus using the projected pension income that would be received should you work another 20 years at the company.

If you get RSUs today, factor those in but don’t project additional grants for the next 5 years.

If you expect an IPO… don’t! That is completely out of your individual control and you cannot build an entire financial plan on the assumption that (a) your company will go through an IPO and (b) you’ll profit handsomely from it if it does.

5. Account for Change

Plans that have a high likelihood of success build in a natural buffer for life changes. Those changes could be external in nature, which are out of your control.

That includes everything from economic recessions that may force your company to lay you off, to pandemics or other natural disasters that shut down economic growth (and therefore, your investment returns).

Other factors could be within your control to influence, and these aren’t necessarily bad things.

You could simply change your mind about your current career, living situation, or set of goals. Personal or family dynamics can shift in unpredictable ways that can throw a major wrench in your existing financial plan if you haven’t built in room for flexibility and calling an audible or two.

I experienced this personally when my wife and I decided to have children. For years, we were on the fence (and even leaning toward being childfree by choice).

Our financial plan reflected our current reality; we didn’t have a “saving for college” goal or account for the generally higher cash flow we’d need to manage the expenses of a bigger family.

What we did do, however, was build buffer room into our plan.

Our specific strategy was to set a very aggressive “retirement” goal; we planned as if we would stop receiving income when I turned 50. In reality, I didn’t want to retire this early.

I love my work and my business, and assuming all our income would come to a screeching halt and we’d start living off our investments at that point was pretty unlikely.

But that version of the plan required a very big savings rate in order for it to work, which we stuck to even though we didn’t feel it was likely that we’d retire so young. That intense rate of savings for many years is what allowed us to pivot when we decided to have kids.

We were able to adjust the plan to account for that new reality. We pushed our retirement ages out, and chose to start saving less.

We could afford to reduce our savings rate since we had kept such an aggressive pace on savings for many years previously, and reducing the savings rate freed up cash flow to use to manage the expenses of a new baby (as well as to fund new priorities, like that college savings goal that became relevant).

Without the proper buffer room in the plan, the plan breaks, and maybe even fails in a way that doesn’t allow for an easy recovery. We want to avoid this failure when we plan.

The point is that change isn’t always bad, but it almost inevitably always happens in some shape or form.

A strong financial plan is one that allows for a pivot without forcing you to give up what’s most important to you.

If you’re ready to optimize your financial life and enjoy the confidence that comes with knowing you’re making all the right moves to grow wealth and increase your assets, start here.