The Variation of Variables

Last week we wrapped up our discussion with quite a funny YouTube video of a grandmother and her toddler grandson baking cookies. You watched as grandma was going step-by-step adding her traditional chocolate chip cookie ingredients, while also wrestling her grandson from devouring the raw ingredients by the fist full. Beyond the humor of it all, it made me think about how each of us has our own grandmothers, and some or most of us, have come accustomed to a particular chocolate chip cookie recipe that we prefer. For some, maybe it is their own mother’s or an aunt’s or a friend’s mother’s recipe, but regardless even right now we can imagine the taste, texture, and uniqueness of those cookies. We broadly address these as “chocolate chip cookies,” but we know in our hearts that this label isn’t sufficient for our own standout favorites.

Not all chocolate chip cookies are the same. Why? Well, there is variation in ingredients, portions, preparation, cook times, etc. For some, even the surrounding environment plays a role – that special couch at grandmas house where you eat your cookies or even the accompanying beverage that plays as the perfect complement. We know that something even as simple as a chocolate chip cookies has a wide dispersion of finished products, coming in all different shapes, sizes, flavor profiles, and consistencies.

Cookie Monster

Financial plans are a lot like chocolate chip cookies. I found myself in a discussion with someone just this week that was telling me about the process his sister was going through to identify the right financial planner to serve her needs. Part of this vetting process for her was to have these advisors mock up some financial forecasts and projections to discuss the viability of her retirement plans. She was astonished by the wide variety of assessment and analysis that she received during this process. Some advisors showed her a financial plan that had her bequeathing significant wealth to her heirs and others were delivering a gloomy message about her potentially outliving her wealth.

This created quite the conundrum. Was she to go with the advisor that painted the greatest looking potential outcome? Was this rosy projection of her future realistic? And, if not, how would she know? Financial planning is both an art and a science, which is why it is so important that both the advisor and the client intimately understands the variables of a financial plan and how those variables impact outcomes.

I can relate to this story because I had a similar experience myself. At the start of my career, I was sent to a week-long training in New York and as part of this process, I was tasked to create a financial plan for a fictitious client. My peers and myself were given the exact same details on the particulars of this fictitious client and I watched as each advisor presented their plans to management. Just like the experience detailed above, these presentations varied widely. At first, this didn’t bother me because I assumed at the culmination of this training that these plans would be graded and some would be deemed as sufficient and others insufficient. No such grading took place and I went home very confused and frustrated with this encounter.

Frustration has often been the fuel in my life for creating change. I used this fuel to read everything I could about the science of financial planning. The further I dug, the more questions I asked, the more theories I challenged, and I did ultimately get to a place where I felt more enlightened on the subject. The varying outcomes of these plans were due to these key variables that acted as leverage points – variables that if tweaked or adjusted slightly could create a drastic difference in the ultimate outcome of the plan. This is where I concluded that financial planning like I mentioned earlier, is indeed both an art and a science. The financial planner, the artist, has the freedom to construct and design these plans in a fashion that matches their own beliefs and preferences. These preferences span from their beliefs on longevity to future economic growth expectations and each of these ingredients will result in a very different cookie… I mean financial plan.

The list of these financial planning variables is much too large to tackle in today’s discussion, but let’s dive into a handful of those high-impact assumptions that I referenced earlier. Also, here is a good place to offer a reminder of why I am writing this. I believe that you – the client, the investor, the shopper-of-advisors – need to know and understand these variables to make sure you are not led astray. There is a reason that patients sometimes seek a second opinion amongst doctors, and that is because even a well-studied doctor who spent hundreds of thousands of dollars and many years in schooling studying the science of medicine can have varying opinions on an injury, an ailment, a treatment plan, etc.

So, let us discuss expenses, rates of return, inflation, longevity, and linear vs. varying assumptions…

At Your Expense

My very first Thoughts On Money post was on the importance of understanding one’s expenses. I was very intentional to not write an article about budgeting, as I am not convinced that budgets are very well followed or adhered to. Budgets are like diets, at the inception a lot of thought and effort is devoted to them, but they are short-lived. Great financial solutions, and for that matter health solutions, are more about creating a lifestyle change than a drastic and temporary adjustment to one’s existing habits. So, that first TOM was all about awareness. Not an encouragement to change how much you spend, but a challenge to know how much you spend. This is not a question that most of us can answer off the cuff, there is a gap between what we assume we spend and what we actually spend. Accurately identifying your expenses in your financial plan will be extremely important. Ideally, when mapping out retirement, one should assume that they live the same lifestyle in the future as they do currently and the plan needs to account for that.

Here’s the problem. Many advisors will make this identifying-the-expenses conversation into one question – how much do you spend? That isn’t sufficient. One must map out total income for the current year, input the appropriate tax assumptions, add in the monthly liability commitments (e.g. mortgage), record the automated saving that are currently in place (e.g. 401(k) contributions), and start to back into some expense assumptions. Much like accounting, which balances debits and credits, one must balance cash flow and assign every dollar earned to some commitment whether that is an expense or money saved. I cannot express how important this is and how often it is done incorrectly. Spend the appropriate time needed to nail down these expense assumptions accurately, your plan depends on it.

To Everything (Turn, Turn, Turn)

What rates of return assumptions does your current financial plan use? Does your plan lean on “historical averages” and are these fitting assumptions? Well, over the last 30 years the annualized return on the 10-year US government treasury is approximately 4.86%. History also tells us that the best predictor of future returns on the 10-year US government treasury is the current yield on the 10-year US government treasury, which currently sits at around 0.63%. The difference between compounding a million dollars at 4.86% vs. 0.63% over the next decade is nearly a $550,000 difference. You can imagine what a difference that would be over a retirement lifespan, and this is just referencing assumptions on government treasuries, not to mention stocks or other components of a diversified portfolio. A lot of financial planning software leans on this historical data in its base assumptions and a lot of financial planners consider these assumptions gospel. Sorry to break it to you Shakespeare, but when it comes to financial planning, the past isn’t always prologue.

We Want to Pump You Up

In the above paragraph, I didn’t provide you with the whole story, as I was referencing historical returns and comparing them to current expectations without contextualizing it all relative to inflation.  As we have discussed in the past here on TOM, inflation is the reality that products and services we intend to purchase in the future are getting more expensive year over year. This increase in price typically goes unnoticed because it is often just a slight uptick and it varies across items – Televisions may be decreasing in prices as technology improves, while education or medical expenses may rise at a higher rate due to the growing demand for these services. An inflation assumption of 3% would mean that expenses double in price every 23 years, which will obviously have an impact on one’s financial plan. So, how about your plan? What rate was assumed for inflation? Was the same rate applied to your expenses also applied to your social security? How about your pension, did you assume a cost of living adjustment here, and is this assumption accurate? All this to say, inflation is one of those variables that will have a big impact on the outcome of your financial plan, so your assumptions here are important.

Live Long and Prosper

The somewhat morbid thing about financial planning is that it also has to map out an assumption for your demise. Longevity assumptions are another one of those variables that need to be thought through prudently. According to the CDC the average life expectancy for an American is somewhere around 78 years old, so is this a good longevity assumption to use in your financial plan? Well, are you average? Maybe this will help to clarify; The US Census Bureau says that the average US household is made up of 2.52 people, have you ever met a “.52” person? Then maybe averages aren’t always the best reference point for longevity. Sure, you could dive into family history and such to try to decipher a more exact assumption for yourself, but it is still very much an unknown. Do you know what assumption I typically use? 100 years old. A majority of my clients will not achieve centenarian status, but if I plan for longer than needed it will result in a more conservative forecast. Remember, financial planning is not a game of darts – you will not be able to hit a bullseye with these assumptions. Financial planning is more like a game of horseshoes where the objective is to get as close as you can. Financial planning is a great arena to under promise and over deliver – use conservative assumptions and then strive to overachieve on these assumptions.

The Long and Winding Road

The last item on our laundry list is to discuss linear vs. varying assumptions. Here’s what I mean by this, so much of our financial planning will be about concluding an assumption for these different variables and then these assumptions will be applied in a linear fashion throughout our planning forecasts. Yes, we can use some modeling techniques to tick some of these assumptions up or down throughout particular years, but in real life will not play out so smoothly and predictable. Imagine trying to predict next year’s spending down to the penny or next year’s returns down to the decimal; it’s just not realistic. Life throws us curve balls all the time; there will be something that happens tomorrow that we would have never assumed yesterday. A financial plan is written in pencil because the plan is intended to be modified as you go. A financial plan is a living document and should be referenced regularly and adjusted, as life-pivots are needed. Why is this important? Because I see too many people putting an elevated level of confidence in the snapshot of a financial plan that was created for one static moment in time. There is a reason we call this profession “financial planning” and not “financial plan,” the gerund form alludes to the profession being a trade that is an active pursuit, not an event.

Take Out The Garbage

Now, as I stated earlier, this is not an exhaustive list of variables, but more of a top-of-mind list from my experience on what are the high-impact variables in financial planning. Your individual financial plan will have its own unique high-impact assumptions and my encouragement to you is to engage your financial plan and your financial planner. Ask lots of questions and get a deep understanding of how the plan was designed and constructed. The Computer Science world coined this term garbage in, garbage out (GIGO) to describe the importance of having clean and reliable data on the input side, so that the outputs would also produce reliable data. This GIGO truth applies to financial planning as well. So much of the financial plan projections and forecasts will depend on the accuracy of the assumptions one puts into the plan.

Maybe the issues I brought up today intimidate you, overwhelm you, or lead you to lose confidence in financial planning – don’t let it. Let this discussion remind you of the importance of dedicating the needed time and focus on the right planner to create a fitting plan for your financial goals and aspirations. As you have heard it said, “failing to plan is planning to fail.”

With that, we wrap up another week of Thoughts On Money. Be sure to listen to the podcast for more insights and discussion on this week’s topic. Please email all questions, comments, and cookie recipes to and I will be back next week with more of my Thoughts On Money.

This is TOM signing off…

The Bahnsen Group is registered with HighTower Securities, LLC, member FINRA and SIPC, and with HighTower Advisors, LLC, a registered investment advisor with the SEC. Securities are offered through HighTower Securities, LLC; advisory services are offered through HighTower Advisors, LLC.

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This document was created for informational purposes only; the opinions expressed are solely those of the team and do not represent those of HighTower Advisors, LLC, or any of its affiliates.

About the Author

Trevor Cummings

Private Wealth Advisor, Partner

Trevor is a Private Wealth Advisor focused on building customized financial plans for his and many clients of the team.

As the author of TOM [Thoughts On Money], Trevor endeavors to write and speak about financial concepts and principles in a kind of “straight” talk demeanor and posture.

He received his Bachelor’s degree in Organizational Leadership from Biola University and his MBA from California State University, Fullerton.