29 May What do battle plans and retirement plans have in common?
In the early 1910s, as part of its training programme, the US military used some maps of the Alsace-Lorraine and Champagne areas in France. Some education reformers protested that the locations were not relevant to US forces and that it was silly for the US Army to use such maps. Instead they proposed using maps of areas in the US for the training programme where the US Army was more likely to fight a war.
About two years after the maps were switched to a new location within the US, World War broke out and the US military was deployed to fight in Alsace-Lorraine!
Former army general and 34th US president Dwight D. Eisenhower later cited this story to illustrate an important lesson on planning, noting ‘I tell this story to illustrate the truth of the statement I heard long ago in the Army: plans are worthless, but planning is everything. There is a very great distinction because when you are planning for an emergency you must start with this one thing: the very definition of “emergency” is that it is unexpected, therefore it is not going to happen the way you are planning. So, the first thing you do is to take all the plans off the top shelf and throw them out the window and start once more. But if you haven’t been planning you can’t start to work, intelligently at least. That is the reason it is so important to plan, to keep yourselves steeped in the character of the problem that you may one day be called upon to solve — or to help to solve’
To plan effectively, we often feel that there are an infinite number of questions we need answer. Will it rain tomorrow, or won’t it? Will there be a World War III this year or next? Will I run out of money in retirement? The problem is we simply won’t know for sure until the event has happened, by which time it’s too late to plan.
Without the proverbial crystal ball, it’s impossible to come up with a perfect answer to these questions here and now. This is because the future is inherently unknown. The appropriate term for anyone who claims to know exactly what the future holds is a fortune teller or a conman.
So, if we are unable to predict the future, how can we make decisions about the future? The answer is that we think in terms of probabilities or odds.
As Canadian Author Shane Parish puts it, ‘probabilistic thinking is essentially trying to estimate, using some tools of math and logic, the likelihood of any specific outcome coming to pass. It is one of the best tools we have to improve the accuracy of our decisions. In a world where each moment is determined by an infinitely complex set of factors, probabilistic thinking helps us identify the most likely outcomes. When we know these our decisions can be more precise and effective.
Successfully thinking in shades of probability means roughly identifying what matters, coming up with a sense of the odds, doing a check on our assumptions, and then making a decision. We can act with a higher level of certainty in complex, unpredictable situations. We can never know the future with exact precision. Probabilistic thinking is an extremely useful tool to evaluate how the world will most likely look so that we can effectively strategise.’
While we don’t know for sure if it will rain tomorrow or not, there is extensive data on weather conditions that informs us of the chances that there might be rain. Likewise, we cannot say with absolute certainty whether you will run out of money in retirement because:
a) We do not know for sure how long you will live for
b) We do not know what future investment returns or inflation will be.
However, there is extensive data on longevity, historical returns and inflation, which can help us create a plan to improve your chances of success.
- For instance, suppose James plans to withdrawal £3,500 per year (adjusted for inflation) from a £100,000 portfolio for a 30-year period. How do we know if this plan is likely to work? We can look at extensive historical data for some insight. We know that there are 88 rolling 30-year periods between 1900 and 2017. A withdrawal of £3,500 per year from a £100,000 portfolio invested in an equal split of global shares and global bonds for a 30-year period would have lasted for a full 30-year period in 70 out of those 88-rolling periods. This is a probability of 80%. That is after accounting for a fee of 1% per annum.
While we cannot offer iron-cast guarantee, we know that the odds of success in this case are good.
- But suppose James plans to take £5,000 per year (adjusted for inflation) from his £100,000, and also wants to leave a legacy of £25,000 to his estate after 30 years? Using the same data as above, the probability of success is now only 30%. In other words, this plan has not worked in 7 out 10 historical scenarios. This suggests the odds are much worse that a coin toss, and it is unlikely to work.
Of course, probability only informs us of where to start. We still must monitor the plan to reflect how things change along the way and adjust our plans accordingly.
The famous saying that “no battle plan ever survives contact with the enemy” rings true here. In the military context, battle plans are recognised as essential and so is a ‘financial plan’ in the context of retirement. This is because the process of engaging the plan, progressing towards the goals and seeing what happens once the enemy is engaged, will itself change and alter what the next step should be.
In a sense, retirement income plans should be viewed as battle plans. When plans meet the real world, the real world doesn’t yield to your plan. You must adapt whatever you’re doing to reality. This is where Tandem Financial can help.