The software used by most financial planners involves a number of variables.
When you have variables, you have to make assumptions.
So the question is: Who is the assumer?
Someone is going to have to make some assumptions about all those variables including:
- What is inflation going to be?
- What rate of return will you assume for stocks, bonds, and cash?
- What will the level of standard deviation (assuming you still believe this is a good proxy for risk) be?
Do you see a problem here? How can anyone expect to have any real idea what the rate of return will be for the next 10 years, let alone get all the assumptions right. In 2007, Alan Greenspan was on with Jon Stewart and said:
….The trouble is we can’t figure that out…I’ve been in the forecasting [assumption] business of for 50 years, more than that actually, I’m no better then I ever was, and nobody else is…forecasting [assuming] 50 years ago was as good or as bad as it is today…
Forecasting is really guessing, and no one is any good at it. The assumptions that go into a financial plan are really forecasts, and in the end, nothing more then guesses. This is only a problem if we don’t recognize it. A financial plan should be seen as nothing more than a starting point. A best guess to get started in the general direction. The plan is worthless without the ongoing relationship with the planner.
We have talked about this before; it is about the planner, not the plan.
Over at the Morningstar Advisor Blog, I wrote about the problem of confusing the map with the landscape and the false sense of precision that comes from being the assumer and not recognizing that you will be WRONG.
If we start by accepting the fact that the assumer will be wrong, then we can move on and understand the real power of the planning process. If you can accept (and find a planner that accepts) that you hire a planner for the ongoing advice. You do not hire a planner to give you a map, but to help you navigate the ever-changing landscape.
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Why not assume the worst historical numbers for the assumptions and then hope for better? You can always retire a bit early if investments go well or have an extra margine of safety for retirement. If things don't go well you should be pretty well prepared.
-Rick Francis
Rick,
There are a couple of problems with assuming the worst historical numbers.
1. What if things were to get much worse than the worst we've experienced?
or,
2. What if, based on use of worst historical numbers, a family concludes that they have to save every last penny and invest more aggressively than they'd like and they have to work longer than they would like and they can't educate their children in the manner they'd prefer and they can't afford to take care of their parents in the event of a long-term illness? And what it, after making all of these “conservative” assumptions, things turn out better than they planned? Every one only gets one shot at life and that scenario potentially leaves a lot of unmet or deferred goals that they might have otherwise wanted to plan for and accomplish.
Regardless of who the “assumer” is, and it's important to know who's filling that role, there is still a balance that needs to be struck between preparing for tomorrow while still enjoying the fruits of your labor today. That, I believe, is the true value of a trusted financial advisor/planner.
I agree with some of what is being said here. But I disagree more than I agree.
To invest, you must make assumptions about the future. So to suggest that assuming is bad is to get on a bad path. The question is — are the assumptions you employ reasonable or not?
I am a critic of Passive Investing. That's because I view the core assumption of the Passive model — that for the first time in history ignoring price will somehow or other work out in the long term — to be so dangerous. My assumption is that price will always matter. I am often criticized by Passive advocates for my assumptions. I don't deny that I make them. What I deny is the idea that the Passive assumptions are somehow “neutral” assumptions and therefore more valid than the assumptions that show why Passive cannot work.
If you want to get out of bed in the morning and accomplish stuff, you have to start with an assumption that gravity is going to continue to apply. I think that the trick is not to avoid making assumptions but to try to be as clear about the assumptions we make as possible so that over time we can make better and better assumptions.
Rob
Well said. I like to think of assumptions as placeholders until more accurate information is available (usually when or after it occurs). As we update assumptions and make new ones, we are making a plan more accurate over time. When we don't the plan becomes less accurate with the passing of time.
I think the involvement of an assumer turns a plan from a simple map to one of those GPS navigation systems that can recalculate your estimated time of arrival and suggest alternative routes as you run in to traffic conditions or traffic patterns that are different than you originally assumed.
@Rob: I think Dylan might have said what I was going to. I am not saying
that you shouldn't make assumptions, I am saying that they will be wrong.
These variables are not like the “law of gravity”. They change and we don't
have the information before the fact, so really the value of assuming
(guessing) is that it puts a stake in the ground (or placeholder as Dylan
said) until we get better info (after the fact) so that we can make course
corrections.
A plan full of guesses is worthless. A plan that serves as a general flight
plan ALONG with regular course corrections is priceless.
Thanks for the comments!
You are right on with this Carl. I remember when we got our first optimizer at our firm back in the early '90s and it was telling us to allocate our clients 100% to “Cable TV”. (Still not sure how that was an asset class to begin with!). My partner and I began putting constraints on the different asset classes until we had so many constraints that we finally looked at each other and said “What's the point?”
Software should be used to show clients what could happen — not will happen, or even will likely happen. It should help clients get in touch with how they would feel if their portfolio experienced certain scenarios so we can get a sense of whether they are emotionally ready for those scenarios. But it should never be sold to the client that we are charting a certain path in clear waters thanks to what the software is spitting out.
Thanks Jack. The optimizer & Cable TV story is great. “
Why not assume the worst historical numbers for the assumptions and then hope for better? You can always retire a bit early if investments go well or have an extra margine of safety for retirement. If things don't go well you should be pretty well prepared.
-Rick Francis
Rick,
There are a couple of problems with assuming the worst historical numbers.
1. What if things were to get much worse than the worst we've experienced?
or,
2. What if, based on use of worst historical numbers, a family concludes that they have to save every last penny and invest more aggressively than they'd like and they have to work longer than they would like and they can't educate their children in the manner they'd prefer and they can't afford to take care of their parents in the event of a long-term illness? And what it, after making all of these “conservative” assumptions, things turn out better than they planned? Every one only gets one shot at life and that scenario potentially leaves a lot of unmet or deferred goals that they might have otherwise wanted to plan for and accomplish.
Regardless of who the “assumer” is, and it's important to know who's filling that role, there is still a balance that needs to be struck between preparing for tomorrow while still enjoying the fruits of your labor today. That, I believe, is the true value of a trusted financial advisor/planner.
I agree with some of what is being said here. But I disagree more than I agree.
To invest, you must make assumptions about the future. So to suggest that assuming is bad is to get on a bad path. The question is — are the assumptions you employ reasonable or not?
I am a critic of Passive Investing. That's because I view the core assumption of the Passive model — that for the first time in history ignoring price will somehow or other work out in the long term — to be so dangerous. My assumption is that price will always matter. I am often criticized by Passive advocates for my assumptions. I don't deny that I make them. What I deny is the idea that the Passive assumptions are somehow “neutral” assumptions and therefore more valid than the assumptions that show why Passive cannot work.
If you want to get out of bed in the morning and accomplish stuff, you have to start with an assumption that gravity is going to continue to apply. I think that the trick is not to avoid making assumptions but to try to be as clear about the assumptions we make as possible so that over time we can make better and better assumptions.
Rob
Well said. I like to think of assumptions as placeholders until more accurate information is available (usually when or after it occurs). As we update assumptions and make new ones, we are making a plan more accurate over time. When we don't the plan becomes less accurate with the passing of time.
I think the involvement of an assumer turns a plan from a simple map to one of those GPS navigation systems that can recalculate your estimated time of arrival and suggest alternative routes as you run in to traffic conditions or traffic patterns that are different than you originally assumed.
@Rob: I think Dylan might have said what I was going to. I am not saying
that you shouldn't make assumptions, I am saying that they will be wrong.
These variables are not like the “law of gravity”. They change and we don't
have the information before the fact, so really the value of assuming
(guessing) is that it puts a stake in the ground (or placeholder as Dylan
said) until we get better info (after the fact) so that we can make course
corrections.
A plan full of guesses is worthless. A plan that serves as a general flight
plan ALONG with regular course corrections is priceless.
Thanks for the comments!
You are right on with this Carl. I remember when we got our first optimizer at our firm back in the early '90s and it was telling us to allocate our clients 100% to “Cable TV”. (Still not sure how that was an asset class to begin with!). My partner and I began putting constraints on the different asset classes until we had so many constraints that we finally looked at each other and said “What's the point?”
Software should be used to show clients what could happen — not will happen, or even will likely happen. It should help clients get in touch with how they would feel if their portfolio experienced certain scenarios so we can get a sense of whether they are emotionally ready for those scenarios. But it should never be sold to the client that we are charting a certain path in clear waters thanks to what the software is spitting out.
Thanks Jack. The optimizer & Cable TV story is great. “
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