While reading the title, you’re probably thinking “the use of the word plan seems unnecessarily redundant.” To that I say, exactly, and now I have your attention. Unfortunately, many in society view redundancy as a bad thing (more on this later).
First, let’s explore the premise of planning. Financial planning is an essential aspect of achieving long-term goals and securing your vision of financial freedom. Planning often involves setting clear objectives, managing income and expenses, and making informed decisions along the way to help reach each financial milestone. Unfortunately, the road to financial success is not a smooth one. Life is full of unexpected twists and turns, yet we as humans often overlook these variables as improbable “What ifs”. When it comes to money, we are victims of our predisposition to being certain and precise rather than acknowledging that uncertainty, randomness, and chance exists in everyday life. This presents very real challenges in planning. It also presents the reality that room for error is the only effective way to navigate a world that is governed by odds not certainty.
The Wisdom of Redundancy
Now, let’s revisit the idea of redundancy. What we overlook is that redundancy exists around us every day, for good reason. Take air travel for example. A modern airplane has many redundant systems in the event there is a failure onboard. This redundancy is in the name of safety. It provides room for error and a level of planning that considers risks that are so crazy, they do not even cross most of our minds when booking a flight. They assume that if something can go wrong, it eventually will. To avoid disaster, they steer clear of single points of failure. In financial planning an example of a single point of failure is the sole reliance on a paycheck to fund short-term spending with no savings to create a gap between what you think expenses are and what they might be in the future.
Understanding the importance of Room for Error
Financial Planning is most certainly a delicate balance of art and science. It involves estimating income, expenses, investment returns, and many other financial variables. In many cases, plans use these data points to make mathematical predictions. However, life rarely adheres strictly to your calculations. Unexpected events such as medical emergencies, job loss, economic downturns can disrupt even the most meticulously crafted financial plans. This is where room for error becomes invaluable.
Uncertainty Is Inevitable
It’s important to recognize that life is inherently uncertain. No one can predict all the financial challenges that might come their way. By creating room for error, you acknowledge this uncertainty and prepare for the unexpected. This buffer ensures that you can adapt to unforeseen circumstances without jeopardizing your long-term financial goals. This is not to be confused with being overly conservative. This is a simple acknowledgment that life and money are not always black and white. Sometimes, living in the grey can have its advantages.
Mitigate Stress and Anxiety
By overlooking room for error, a single financial setback can lead to stress and anxiety. This stress will not only affect financial outcomes, but also your overall well-being and could impair decision-making abilities. A financial cushion provides peace of mind, knowing that there is a safety net to fall back on when faced with unexpected challenges.
Avoid High-Risk Strategies
Some individuals may be tempted to take on excessively high levels of risk in their planning. Some view this as a fast lane to success, while others may view this as freedom to save less toward eventual goals. Excessive risk can lead to significant losses that can not only affect the present situation, but also future opportunities. Take for example, someone who was overleveraged during the financial crises in 2008-2009. After experiencing financial catastrophe, they were unable to take advantage of the subsequent favorable low mortgage rate environment. Pushing risk and exposure too far ultimately limited their opportunities for recovery in the near term. Pursuing overly aggressive strategies for upside potential with a downside risk of total loss is typically not a worthwhile tradeoff.
Incorporating Room for Error in Your Planning
Build an Emergency Fund
One of the most effective ways to create room for error is by establishing an emergency fund. This can cover three to six months’ worth of living expenses and should be easily accessible. This can act as a financial safety net in case of job loss, unexpected medical bills, or other emergencies.
Diversification is a key strategy in financial planning. By spreading your investments across different asset classes, you can reduce your exposure to concentrated financial risks. This can help mitigate the impact of market volatility on your portfolio.
This is less about the type of account and more about acting. There is power in realizing you don’t always need a specific reason to save. It’s logical to save for a home or retirement, but it is equally important to save for the things you can’t possibly predict. Predicting exactly what you’ll use savings for suggests a precise understanding of your future self and future expenses. This something I think we can all agree is impossible to know.
Review and Adjust Your Plan Regularly
Financial planning isn’t a one-time task. It’s also not a sprint to an eventual end. A marathon is a more appropriate analogy. Regular reviews and adjustments are needed and are great exercises to build endurance for the plan. Being prepared to make changes when circumstances change is key.
Some may read this and think creating room for error is an admission of defeat. Financial planning is not a competition that must be won. It’s a journey we must endure, much like a marathon. It’s a race we’re running against ourselves, and our only measure of success is the eventual finish. Embracing uncertainty, we are giving ourselves the capacity to push through the challenges along the way and ensure we stay on track to finish the race. Remember, financial planning is about more than just numbers; it’s about securing a future of financial well-being and more importantly, peace of mind.