"Everybody has a plan 'till they get punched in the mouth." - Mike Tyson
Mike Tyson’s cogent remark applies to financial planning as well. We all have a plan until something unexpected happens. A boxer should expect to get punched in the face (more than once), but what this means is that sometimes we need to adjust our plan based on surprise events.
Individuals can expect unforeseen events to impact their financial lives. We should revisit our financial plans during these times, but a well-constructed plan should not need to change drastically due to expected market volatility.
Unfortunately for boxers, they do not have time to integrate potential causes and effects to visualize what kind of shape they will be in by the later rounds. Financial planning, however, does have the benefit of foresight. Boxers must react instinctively. Financial advisors can use more forward-looking tools.
Monte Carlo simulation is a tool advisors use to predict how an investment portfolio will perform through time, incorporating thousands of positive and negative scenarios. The output shows how long an individual’s financial assets should last and the expected level each year. It is a useful, probabilistic, framework providing insight as to where adjustments can extend the life of the portfolio, or conversely, potentially increase spending if there is sufficient probability of excess assets.
A financial plan is the result of various inputs, assumptions, and expectations. It incorporates market volatility, tax rates, income and expense variability, life changes, and many other situations that could arise. Unfortunately, we cannot predict when these variables will change.
Make sure your plan can withstand a punch to mouth (metaphorically speaking of course). Watch this short video from our partners at eMoney to get you started.
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