*The title of this post was borrowed from Sam Savage’s excellent book "The Flaw of Averages. Why We Underestimate Risk in the Face of Uncertainty."
Any talk of personal savings, financial planning and the like will quickly and inevitably become a discussion of averages. Average rate of return (ROR), average savings rate, average annual income, average tax rate, etc.
To understand the world, with all its seemingly infinite variables, we look to the past for an idea of what the future will be like. Averages help us make sense of where we have been in the hope that information will shed light on where we are going.
When it comes to average rates of return, however, we must be especially careful about how we use them in the financial planning process. The reason is simple. In hindsight, overestimating or underestimating a future ROR can both be considered errors. But they are not equal, not by a long shot.
If we end up getting a higher ROR than we expect, bully for us! Having more money than we expect never made anyone unhappy. Having more than we planned for is always easy.
On the flip side, if we get a lower ROR than anticipated, life can and likely will become difficult. It can make life hard on us and those we love. Having less than we anticipated is never easy.
The reason I bring this up is that recently a client, who has become a good friend, called my attention to some financial planning videos on YouTube. I think some of them are excellent. Many of the content creators/financial planners who make them appear to have stylized and formalized the planning process in an attractive way. I am taking notes!
For instance, I have noted a disturbing trend across these videos. The sense that I get is one of “telling them what they want to hear.” What do I mean by that?
First, there seems to be a lot of content that focuses on various aspects of “early retirement”. Second, the rate of return projections are sometimes - and I am choosing my words carefully - overly optimistic.
One such video predicted a ROR of 9.4%. To be fair, the presenter made it clear that the 9.4% number was chosen by the client, not himself. However, it was not the client that chose to make the YouTube video I watched, using that estimated rate of return.
My overarching feeling was that these videos and their presenters become popular by selling a dream. The message is, you can stop working and “live your best life.” You’ll have plenty of money to do whatever you like. Work with them and they will make it all possible. The problem is that we cannot know what will happen in the future.
One of my mentors told me back in 1996 that there are three kinds of lies, “lies, damn lies and statistics.” He was right. I often see the “market average rate of return” written or talked about in a way that seems to suggest people should expect that return on their investments. An average is far from a guarantee, however.
Before you quit your job you may want to ask yourself a few questions the YouTube gang seems less eager to take on. Honesty here is crucial.
Will you stay invested or will you need to withdraw some or all of your savings at some point? Will you continue to contribute to your holdings when the market drops, the media begins to howl, and you are gripped by fear?
Will you be invested exclusively in equities over your lifetime, or will you prudently diversify into other asset classes like bonds, insurance, CDs, etc.? What will happen if you or a loved one gets sick, becomes injured or heaven forbid, passes away?
Do you seek value and invest for the long haul, or do you believe that you can outguess the market? Do you believe in making a reasonable plan, one that utilizes a variety of tools to strive toward growing and protecting your money? Or are you a “no guts, no glory” type that puts all their eggs in one basket without regard to risk and volatility?
What will federal and state income tax, capital gains tax, sales tax and property tax be in the future? Given that we have $35 trillion in debt and the government spends $1.4 trillion a year more than it receives in tax revenue - and many states are also running large deficits - my guess is that taxes will be higher. Are you factoring that into your planning?
What will the market average ROR be over the next 30 years? Is it guaranteed that technological advancements will drive similar growth to that which we have seen over the past 30 years? Is it not at least possible that the average rate of return could be less or perhaps even far less?
All of the things which I have mentioned, along with a variety of other factors, will affect your long-term rate of return, perhaps monumentally. Beware of planning based on statistics devoid of context.
Instead, manage your expectations, assume modest future returns, and do not be in such a hurry to quit doing what you have spent your life becoming great at and being compensated for.
I have been in this industry for almost 30 years now. I have heard dozens of retirees express regret at having retired too soon. I have yet to hear one tell me, in hindsight, they wish they had retired sooner. This is not scientific but after three decades of serving people, neither is it insignificant.
If you would like to work with someone who will tell you what you need to know, instead of what he thinks you want to hear, and aid you in discussing, formulating, evaluating, and implementing a plan based on sober estimates and sound judgment, call me at (732) 844-3000. I am here to help.
Scott R. McGimpsey July 31st, 2024
This material was prepared by Scott McGimpsey and does not necessarily represent the views of the presenting party, nor their affiliates. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. Neither Cetera Advisor Networks LLC nor Scott McGimpsey is engaged in rendering legal, accounting, or other professional services. If such assistance is needed, the reader is advised to engage the services of a competent professional. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any federal, state, or municipal tax penalty. Moreover, a diversified portfolio does not assure a profit or assure protection against loss in a declining market. UNIFIED PLANNING GROUP is an independent firm.