Financial planning is like taking a long car trip. You plan your route, your schedule, and your eventual destination in advance; but then you have to be prepared to adjust for detours, traffic delays, bad weather, fatigue or other unexpected changes.
When it comes to financial planning, you face this same conflict between sticking to a long-range plan and dealing with the realities of life that occur along the way. The key is being able to distinguish between legitimate reasons to change your plan and simply getting misdirected by new developments until you no longer know where you are heading.
Life happens, and you adjust
Examples of life developments that may warrant a change in your financial plan are:
Getting a raise. As your career starts to take shape, your earnings might change significantly enough to justify raising your lifestyle expectations, but this should be done as part of a plan.
When people get that bump up in pay, they tend to feel like they have a little extra money and can afford to spend more freely. However, a raise should not be a trigger to spend indiscriminately because, in many cases, an increase in income is already an assumption incorporated into your long-term financial plan.
After all, such plans have to account for inflation, and a lot of people plan on doing the bulk of their retirement saving during what they assume will be their peak earning years.
Incorporating a pay raise into your long-term plan will allow you to distinguish between incremental increases that simply keep you on track and more significant jumps that truly accommodate a change in lifestyle.
- Having kids. Even if having kids was part of your long-term thinking all along, you need to anticipate the needs of your growing family and adjust your plan with each child. It can be tough to deny your kids anything if it seems you can afford it, but incorporating spending on the children into your financial plan will help you make sure to preserve your resources to best take care of their long-term needs.
- Financial setbacks. Losing a job, a drop in income, or a significant investment decline needs to be factored into your long-range plan. This can be disheartening; but the sooner you adjust your plan, the less impact it will have because you only compound the impact of a setback if you continue spending at a level based on resources you no longer have.
- Dreams come into focus. It may be a vacation home, a sailboat, or starting a business. It is not financially irresponsible to pursue your dreams as long as you have a plan and, as part of that plan, you can see how that pursuit will affect your other financial goals.
- Retirement vs. lifestyle. The desire to retire early can grow very strong, and long-range financial planning will help you see what impact early retirement would have on your lifestyle. It may be that freedom from work is a more important lifestyle priority to you than being able to afford a few more luxuries.
When to stay the course
If the above are legitimate reasons to change your financial plan, the following are examples of when you should stay on course:
- The urge to buy is not a plan. You may discover new things you want; but unless you incorporate them into your long-term plan before you commit, your spending will get pulled off course.
- Wait for investment windfalls to even out. A big year in the stock market can make people suddenly feel wealthy. Resist the temptation to spend that new wealth, because chances are you will need that extra money to cushion you against disappointing returns sometime in the future.
- Don't make career decisions in the heat of the moment. The emotional impulse to quit a job or retire can be strong, but remember that your career is a centerpiece of your financial plan. Don't take any action until you have measured its impact on your plan.
Having a structure to lean on helps
The key distinction between things that should change your financial plan and those that shouldn't is whether they truly represent a shift in long-term priorities or they're just a short-term impulse. This is where the structure of a financial plan can help. If you think you want to do something that wasn't part of the plan, don't simply act on that impulse. Try incorporating that action into your plan so you can see what long-term impact it will have.
Looking at your decisions as part of a long-term financial plan will allow you to see the trade-offs that will result from changing course, and perhaps force you to think about things a little longer before you act. That extra time to think can make all the difference between a financial mistake and a reasoned change in plan.
Do you have an overall financial plan for your life? How did you become aware that a financial plan would help, and what guides your decisions?
Richard Barrington, CFA, is a 20-year veteran of the financial industry, including having served for over a dozen years as a member of the Executive Committee of Manning & Napier Advisors, Inc.