Last week, I watched a great little bit of YouTube on how uncertain and chaotic life is and how much can go wrong. And no, I didn’t enjoy it because I am manic depressive or am a typical economist, and hence representative of the dismal science: I value it because it reminded me that, ‘The most important part of every plan is planning for things to not go according to plan.’
What I’m talking about here is that it’s actually better to be a financial pessimist than an optimist. There’s nothing worse than always assuming, Mr Micawber style, that ‘something will turn up’; it won’t. Empires collapse, wars break out, idiots get elected across the entire political spectrum, crazy computers wreck the market.
That means you absolutely, absolutely need to build in what psychologists call room for error in any set of long-term financial assumptions. Many people in the financial planning game tip their hat here to a very insightful chap called Morgan Housel—a former columnist at The Motley Fool and The Wall Street Journal whose 2020 bestseller The Psychology of Money opened the eyes of many of us to just how important human emotions are to us getting the right orientation around being comfortable with getting our futures right.
When I say ‘comfortable’, btw, I mean that in the human, not the fiscal, sense. We already knew personal beliefs, behaviours, and emotions shape financial decisions more than technical knowledge or income level. What Housel surfaces so well, I think, is that ultimately success with money is not just about intelligence, but about temperament—our individual proportions of patience, discipline, and the ability to manage fear and greed.
He also stresses the risk to your long-term position of overconfidence and chasing short-term gains, stressing that avoiding financial ruin and staying in the game is more important than chasing any possible big wins. He also highlights the role of luck and risk, suggesting humility in both success and failure and the rewards you can get on building wealth slowly and sustainably through behaviour rooted in self-awareness, long-term thinking, and resilience.
Making caution and a safety net your SOP
Fascinating stuff—but what does it have to do with you and your financial future? It all comes down to building in a safety margin. Housel’s model is based on always looking at the dark, not the sunny, side of the street and being cautious and canny.
And I absolutely agree. That’s because a good independent financial adviser will always strive to try and forecast the future as best all parties can, based on certain assumptions with as many probabilities and trendlines in there as we can. What we both want is for a date, based on this data and set of variables, that, yes, Q2 2033 (say) is the timeframe for you to safely and comfortably get on with something different than the 9 to 5.
But by definition, we’re dealing with some predictions and, to some extent, hopes here. We could be wrong—which is why you need to be cautious and deliberately engineer in some room for error. The data suggests x% return on investment over n years (well, pre-Trump 2.0, maybe, but things do tend to even out over the mid-term); so, let’s play safe and not assume very high returns on your investments, but keep it modest and figure only 1.5-2% above inflation.
A good IFA will also factor inflation into your spending every year; the thinking here is that even though your spending in retirement doesn’t always rise with inflation, sometimes there’s a lag, so let’s err on the side of caution. Again, you may pop off to the big board meeting in the sky in your 60s (so, stop living like Iggy Pop, maybe), but to ensure you don’t run out of money and end up on cat food à deux, the model that lives in our cloud about you assumes you will live well past your century, so let’s make sure there are funds for that.
Similarly, we don’t assume that you will sell up and radically downsize, so we try to keep your projected outgoings total constant (silently figuring those fixed costs will go down over time but not expect them to). We also regularly run through scenarios where the market crashes and see how it affects your plans, and so forth; I have a couple of little scenarios that I also run from time to time to even further stress test my predictions for you.
Let’s make uncertainty work for us
I hope you agree that all this is eminently sensible and good, cautious long-term thinking. But as we may be entering some more, shall we say, unpredictable times in the next few years, you can’t be blamed for looking for a little bit more psychological buffer than our secret spreadsheets put in place to make sure you can indeed cash out in 2025.
The good news is that, absolutely, there are other things to do to shore up your defences short- to mid-term, reinforcing all this good long-term caution and over-protection. Table stakes here should be:
Cash in the bank
You want, as your first stop, at least 3 to 6 months of living expenses easily accessible in case, but it’s really sensible to reserve as much of the folding stuff as you can if you have a big purchase to make. To be honest with you, I think you’re going to sleep easier at night if you can make that rainy day fund more like 12- or 24-months’ worth—essentially, as much as you are comfortable with. The peace of mind this can give you if certain random decisions end up tipping up the apple care will be more than worth it, believe you me.
Boring? Nah, bonds are bussin’
Really do have a place in your heart and investment portfolio for a Government IOU or two. If you steer clear of the very long-dated ones, bonds are less volatile than stocks, and if we enter a global recession, everybody will be trying to buy them off you because interest rates go to zero, but these go up! That’s what it says on the tin; they are a hedge, plus give you a nice bit of extra yield and a wee bit of welcome quiet certainty.
Curb your enthusiasm
We’ve already talked about lifestyle creep, and this is why: be a bit boring, spend less than you earn, and avoid lifestyle creep. By steering clear of getting too attached to shiny things, you will secretly be that much more reassured that if things get real or some disaster (personal/emotional/career) comes long you won’t be spending beyond your means and so could come unstuck. Always try and have a bit left over from your monthly spending, for example, to invest, or make a resolution that from now on you will never spend your annual bonus or stock-related compensation, but sock that aside and just live on your regular salary.
Income: always worth protecting
You should have life insurance anyway, but there’s always room for a bit of a safety net with another form of the stuff—income protection and other products deliberately built for shoring your income up if you can’t work for a spell, and so on. Look into if your employer offers this as a benefit (along with medical, if you haven’t yet), or talk to someone like us to get this into the safety net, too. What’s the harm?
A gold-plated clock is better than none
Last but not least, have you paid enough ‘stamp’ to get that full state pension ready to come on stream at 67 or whatever your date is? It may seem like a modest amount if you’ve done really well in other parts of your life, but you paid into the system, you deserve it, and it’s a great safety net—might even cover some expenses you haven’t planned for later in life. So why not check on your payments and get this last bit of psychological safety cladding put in.
Conclusion
As with all I’ve said, building in room for error and looking for the safe way to get to your desired monetary and personal destination is a psychological approach to money your future self will thank you for. If you agree, drop me a mail today and we’ll see what we can do with you and your spouse to do the same.
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The value of investments and the income derived from them can go down as well as up and you may not get back the amount originally invested.
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Past performance is not a reliable indicator of future performance.
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Tax treatment varies according to individual circumstances and is subject to change.
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The Financial Conduct Authority does not regulate cashflow modelling, tax advice or estate planning.
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Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.
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Gilts and bonds carry an element of risk which may impact the value of capital and/or income.
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The contents of this newsletter do not constitute advice and should not be construed as a personal recommendation.