If you wrote a financial plan when you were 18, would you expect it to fit right into your life when you were 40? Mostly not. Your life at age 40 is likely to look very different than what you imagined at age 18. Moreover, it is very likely that the financial markets did not follow your expectations in those 22 years either.
So why would you expect to write a financial retirement plan, and then never plan to make any changes? While a retirement plan can provide a great basis for spending and portfolio adjustments, you should plan to rewrite your strategy over time.
Market forecast management
Built into your retirement plan is an expected return on your investment portfolio over time. I might have built a well-Diverse wallet To protect you from the vagaries, but that only does so much.
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In the first half of 2022, for example, the value of both stocks and bonds fell sharply. If you use bonds to hedge your stock trades, they won’t do you much good.
Everyone knows that the market does not rise in an exponential curve to some degree. It’s a bumpy ride. And it can go against your expectations for a very long time.
You may be familiar with 4% base, which states that you can safely withdraw 4% of your initial portfolio each year, adjusting for inflation as you progress. Throughout any 30-year period in history, the 4% rule has not failed when a 50/50 equity-to-bond allocation is used. But it can really come close.
How likely are you to blindly stick to the 4% rule if you see your retirement portfolio shrink by half or two-thirds in the first few years of retirement? You need a contingency on how to change course to ensure you don’t run out of money. Just because 4% worked in the past, doesn’t mean it will work today.
On the flip side, if you find that your wealth increases exponentially during the early years of retirement, will you deny yourself access to that wealth and stick to your planned withdrawals? You can go on more vacations, spoil the grandchildren (or better yet, pay for their education), and so much more if you untie your wallet. And if you end the first five or 10 years of your retirement with a lot more money than you started with, you probably can do it.
People are really bad at predicting the future
Just like an 18-year-old, you had no idea what you would actually be at 40, or 65, you’re probably almost clueless of what you’d be like at 80.
Psychologist Dan Gilbert explains that people are really good at looking back and noticing the extent of change, but they fail to anticipate how much they will change in the future. This is what he said in an interview with him in 2015 NPR:
Time is a powerful force. It changes our preferences. It reshapes our values. It changes our personalities. …humans are a running business that you mistakenly think is over.
So if you make a plan based on what you think you want and need later in retirement, you will likely be at least a little further away. This doesn’t mean you shouldn’t plan at all, just know that you’re likely to want to make some changes to your plans as you move away from making those plans.
“The only thing constant in our lives is change,” Gilbert said. So why do we expect our financial plans to remain the same?
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