If you wrote a financial plan when you were 18, would you expect it to fit perfectly into your life when you’re 40? Probably not. Your life at 40 will likely look drastically different from what you imagined at 18. Moreover, it’s very likely the financial markets didn’t follow your expectations in those 22 years either.
So, then why would you expect to write a financial retirement plan, and then never plan on making any changes? While a retirement plan can provide a great foundation for spending and portfolio adjustments, you should plan on rewriting your strategy over time.
Managing market expectations
Built into your retirement plan is an expected return on your investment portfolio over time. Perhaps you’ve built a well-diversified portfolio to shield you from volatility, but that can only do so much.
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In the first half of 2022, for example, both stocks and bonds fell sharply in value. If you were using bonds to hedge against your stock positions, they didn’t do you much good.
Everyone knows the market doesn’t go up in a pretty exponential curve. It’s a bumpy ride. And it can buck your expectations for a very long time.
You may be familiar with the 4% rule, which says you can safely withdraw 4% of your initial portfolio every year, adjusting for inflation as you go. Throughout any 30-year period in history, the 4% rule has not failed when using a 50/50 stock-to-bond allocation. But it can come really close.
How likely are you to blindly stick with the 4% rule if you’ve seen your retirement portfolio cut by one-half or two-thirds in the first few years of your retirement? You need a contingency on how you’ll change course to ensure you don’t run out of money. Just because 4% has worked in the past, doesn’t mean it will work today.
On the flip side, if you find your wealth exponentially increasing through the early years of retirement, are you going to deny yourself access to that wealth and stick with your planned withdrawals? You could go on more vacations, spoil the grandchildren (or better yet, pay for their education), and so much more if you loosened your purse strings. And if you end the first five or 10 years of your retirement with a lot more money than you started with, you can probably afford to do so.
People are really bad at predicting the future
Just like the 18-year-old you had no idea what you’d actually turn out to be like at 40, 65-year-old you is probably nearly as clueless about what you’ll be like at 80.
Psychologist Dan Gilbert explains that people are really good at looking back and noticing how much they’ve changed, but they fail to predict how much more they’ll change in the future. Here’s what he said in a 2015 interview with NPR:
Time is a powerful force. It transforms our preferences. It reshapes our values. It alters our personalities. … Human beings are works in progress that mistakenly think they’re finished.
So, if you make a plan based on what you think you’ll want and need later in retirement, you’re probably going to be at least a little bit off. That doesn’t mean you shouldn’t plan at all, but just know that you’ll likely want to make a few changes to your plans the farther away you get from making those plans.
“The one constant in our lives is change,” Gilbert said. So why should we expect our financial plans to stay the same?
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