Assumptions: Fact or Fancy?
Merriam Webster defines assumption as follows: “when planning, a fact or statement taken for granted.” My major in college was economics, but if you had told me it would be my major as a college freshman I would have scoffed. In my first economics class, Macro-Economics 101, I was disturbed that every formula contained one or more assumptions; i.e. assume inflation is set at 13%, or interest rates are 12%, or demand will increase by 10% annually, etc. If my assumptions were flawed, what was the point of all the complex calculations? Given my personality, I challenged my professor and suggested that the study of economics was a fruitless endeavor, there could never be a right answer with so many assumptions that were likely inaccurate.
What I learned over the course of time was how the different assumptions changed the outcome. What was important was not the final answer but how the answer changed by altering the assumptions and determining what was the most likely outcome.
The process of financial planning is the same, the assumptions you use in crafting a plan make a vital difference to your future standard of living. Assumptions are merely likely outcomes; they are not facts and should not be taken for granted.
An example of an assumption gone terribly wrong will help illustrate my point. Robert and Mary were married, he retired at age 60 with a full pension and they made the decision that he would outlive his wife and did not opt for survivor benefits. Why did they opt not to leave Mary survivor benefits? He was five years younger, he swam five miles a day, golfed four days a week, ran three days a week, had a healthy diet, and was never sick a day in his life. Mary, however, led a fairly sedentary life, had numerous health problems, and her family history suggested she would likely not outlive her husband. This assumption that Robert would outlive Mary seemed the most likely outcome. Three years later he died suddenly of a heart attack and the pension payments ceased.
When crafting your financial plan beware of your assumptions, they are merely a starting point to allow you to examine future potential outcomes. As you change assumptions, how does your plan change? Start with the most likely scenario and then test your financial resources to determine if those assumptions are flawed. What happens if you die early? What changes if you live longer than expected? What if inflation is higher? What if interest rates are lower? What if you have unexpected medical expenses?
How can you avoid the pitfalls of flawed assumptions? Plan for the worst and hope for the best! If Robert and Mary had opted for survivor pension benefits it would have reduced their original benefits by 18%. They could have altered their retirement lifestyle minimally to make up this difference: dine out 4 nights a week instead of 5, Robert could have played golf 3 times a week instead of 4, and perhaps Mary could have had her nails done every other week instead of once a week. Making these modifications would have provided them better protection. Another option would have been to purchase life insurance on Robert to replace the pension benefits should he die unexpectedly.
In sum, assess where you are financially and determine your goals for the future. Carefully decide on the assumptions you will use to build your plan and then shake it vigorously to determine what could potentially undermine your future. I am not suggesting that you plan for every possible outcome, but you should protect against the catastrophic.
All questions or comments are welcomed.
Suzanne M. Antonelli, CFP®
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