Bedrock or quicksand of financial planning and decision making
The divorcee sat across the table from me and told me her financial advisor assured her she can count on $3,500 a month in investment income for the rest of her life. I knew she had a portfolio currently valued at $500,000. She was a healthy 57 year old woman. I asked her, "On what assumptions is he basing his projections?" She bristled, uncomfortable, and annoyed. She had no idea how her investment advisor arrived at his calculations.
Later in the interview she stated she thought she would live into her 90s. And, it was very clear that income requirements for her current lifestyle exceeded $5,000 a month. She had no healthcare insurance. She had no plans for employment and the investment portfolio was her only source of cash flow/income. She had been married nine years so she would not be entitled to share in her husband's Social Security benefits.
The situation was perilously defective, riddled with faulty assumptions. However, the client was focused on my obnoxious habit; asking too many questions.
All financial plans from global economies to personal finance are prepared using assumptions. Assumptions are the bedrock or quicksand supporting financial planning and decision making.
The Six Rules For Assumptions
(1) Assumptions must be realistic.
(2) When in doubt use shorter time horizons. Short-term assumptions are easier and more reliable to forecast. Using short-term assumptions provides an opportunity to build confidence and skills for setting longer term assumptions as your plan becomes more complex.
(3) Assumptions must be reviewed and, when appropriate, revised annually. Reviews provide an opportunity to adjust for life changing events and economic trends. Don't be discouraged or timid about adjusting financial assumptions.
(4) Work with advisors who respect your assumptions. Advisors may not agree with your assumptions but they must be willing to provide all projections using your numbers as well as their own. Professional advisors have a lot more information than the average client. However, most of their information is based on statistical evaluations and historical trends. Your assumptions are based on your unique lifestyle and beliefs. Melding the two is ideal for planning. Think of it as using the statistical data and skewing it in the direction of your unique situation.
(5) Assumptions are never guarantees. Whenever you are working with an advisor and find yourself swept into believing their assumptions are guarantees it's a red flag for a scam or predatory situation. If an advisor provides assumptions that sound like guarantees, ask for it in writing and beware.
(6) Document all assumptions used for financial decisions and projections. All financial decisions, from grocery budgets to investment allocations, are based on assumptions and subject to re-evaluation. The first step in re-evaluation is a review of the assumptions made when the decision was finalized.
Almost every case of regret for previously made financial decisions can be traced back to faulty assumptions.
Make a Plan That Works For You!