Planning and Uncertainty About Finance

download-36Benjamin Franklin once wrote, “Tis impossible to be sure of any thing but Death and Taxes.” But even death and taxes are uncertain enough to present significant financial planning challenges.

Unfortunately, it is quite easy to conclude that financial planning is a waste of time because no one can know the future. But we do know that we’ll need to set something aside for the future, we won’t earn wages out entire life, and prices will probably continue to inflate. The only other crucial assumption we need to make in financial planning is that every other assumption we make is wrong.

Let’s face it, managing our finances and making important money decisions involve making a lot assumptions:

  • How much will I save? Spend?
  • How much money will I be making? For how long?
  • How much will I need for emergencies?
  • Should I buy or rent?
  • What if I need to move for work?
  • How much should I invest? Keep in cash?
  • How much money will I need to retire?
  • Inflation?
  • When will I retire? Will that be in a bull or bear market?
  • How much risk should I take?
  • What will the markets return?
  • How much insurance do I need?
  • How much will healthcare cost?
  • What will my future tax liability be?
  • How long will I live?

Just about everything about financial planning is uncertain, but some of these uncertainties become less uncertain overtime. As we get closer to future events, often the very same events that we’re planning for, the range of possibilities becomes narrower because we will have more information available. And at some point, we will have our certain answer, but by that point, is is usually too late to have done anything different before we knowing better.

Assumptions are temporary placeholders

Perhaps instead of thinking about the role of assumptions in financial planning as what we think will happen, we should think of them as a way to better answer the question of what to do now. Often, long-term assumptions are used to answer questions like, “how much should I be saving now,” “how much can I spend now,” and “how much risk should I take now.” An assumptions is really nothing more than a temporary placeholder for a piece of information we do not yet have, so we can dosomething, not just anything right now.

Trial and error is a skill

So what if we are wrong now? we can repeat this process and adjust what we do in the present as more information becomes available. We may still be wrong, but with each adjustment, the margin of error in our placeholders becomes progressively smaller until we arrive at the certain information.

This process is known and trial and error, and we rely on it almost everyday, from figuring out what time to leave the house to get someplace on-time to how much food to plan for dinner. It starts with a trial, and even if most of our assumptions are wrong, we have a starting point from which we may continuously improve.

The more we use trial and error to solve a problem, the better we get at it. Just like planning meals, travel, and projects, financial planning has a skill set that is ultimately refined through trial and error. Even medicine uses trial and error. How does a doctor know what dose of a medication will get a patient’s high cholesterol under control? Uncertainty is found everywhere, yet we still get things done.