One of the most interesting and lively discussions during financial planning is to agree upon estimated future rate of returns on different asset classes, as well as inflation rates over long periods of time.
On every other aspect of the plan, one party or the other has a greater say, and they can back them with numbers or experience. For example, if you take current assets, the financial planner has a greater say in which assets are good or bad based on his experience and knowledge of the market, and there is usually no room for debate on that.
On the other hand, expenses is the domain of the person whose plan is being made, and they have a larger say in determining whether their current expenses should be taken as Rs. 50,000 per month or Rs. 1 lakh.
But whether you take a 6% inflation rate for the next 25 years, or a 7.5% inflation rate is largely a subjective matter, and has to be decided upon in agreement with both parties. One or two percentage points make a world of difference because of the compounding effect, and the portfolio number at the time of retirement can change drastically based on what number you take.
Add to this the fact that you may say that equities will return 12% for the next decade but in reality the market is never smooth, it will be down one year, up another, and the link I shared last week shows the great difference in end portfolio numbers that happens because of this.
In light of all this, how do you ensure that the plan is not wrong or useless?
I feel that there are two ways of doing this.
The first and the simpler one is to be conservative, and ensure that all your assumptions are in line with each other. Take your expenses at the higher end, and ensure that you don’t take a conservative inflation rate and an optimistic equity rate of return.
The second and perhaps more difficult thing to do is to understand that this plan is going to change, and then adjust your plan according to changes in your life or market conditions two or three years down the line.
People who work on project plans in their professional lives can easily identify with this, and how the best laid plans change as soon as you start implementation, and if you don’t change the plan according to reality then it becomes pretty much useless.
I found an excellent quote about this recently which goes as follows:
No battle was ever won according to plan, but no battle was ever won without one. Dwight D. Eisenhower
Another version, which is probably the original goes as follows:
In preparing for battle I have always found that plans are useless, but planning is indispensable. Dwight D. Eisenhower
I think this is a great way to look at any planning process, be it financial or software management. Thinking through what needs to be done to achieve your goals two or three decades from now, what habits you should instill now, where you should invest your money, what are your priorities are far more important than the absolute rate of return that will accrue in those years.
Don’t worry too much about whether inflation will be 7% or 10% in the next decade, focus more on controlling your expenses, ensuring that your asset allocation is right based on your profile and that your money is not stuck in dud investments. These are things under your control, and these are the things where you can make a difference.
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