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Financial Freedom Is Merely Organized Common Sense
Knowing The Future Is Impossible
There is seldom wisdom in a bank’s television commercial. Here is an exception.
Thomas Sargent is a Nobel Prize winning economist. 2011. His specialties are macroeconomics, monetary economics, and time series econometrics. Super-simplified, the study of how money behaves in large economic systems over time.
Since interest is the price of money, it is possible to believe he will know something about future interest rates.
The commercial is brilliant. In only a few seconds it captures the essence of modelling the future.
Interviewer: “Professor Sargent, can you tell me what interest rates will be in 2 years?”
Sargent: “No.”
Interviewer: “If he can’t, nobody can.”
The commercial addresses indirectly the question of parameter uncertainty in dynamic projections and provides no useful answer as to a course of action. There is no real evidence that the bank’s offering will help, but it might.
You cannot know the future and therefore a financial plan must be dynamic (subject to change based on exigent circumstances) in order to have value. At any specific time, some important parameters in respect to the future will be unknown.
For purposes of financial planning the key lessons are these:
- The unknowable essential parameter problem exists, and
- People with the qualifications of Thomas Sargent don’t know how to precisely predict it’s outcome.
So what is the point of planning. They will all be wrong.
People do financial plans with the idea that they can make decisions about their future. A good financial plan probably helps, but its real purpose is to lay down a baseline and establish a process for thinking about how money and time fit together.
Like a quarterly budget. Comparison and reaction to variation is important.
Plan development helps people understand more about themselves and their reaction to money, risk, saving, investment, taxes and the like. The plan, by itself, is not important.
A good financial plan is one that anticipates conditions but allows flexibility and course changes as events overtake it. It informs people as to possible futures and by comparison to that provides insight into new and possibly required, courses of action.
Review and revise is the only part of financial planning that ultimately matters. Be sure that point is emphasized by your advisers.
Financial plans that succeed have evolved to that place. Almost no one hits their original target so avoid static plans. Once done, done forever is thinking that fails.
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Don Shaughnessy is a retired partner in an international public accounting firm and is presently with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario. Contact: don@moneyfyi.com
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