The Need For A Theory of Financial Planning

Financial should be like science. At least in terms of its aim.

The grand aim of science is to cover the greatest number of empirical facts by logical deductions from the smallest number of hypotheses and axioms.  – Albert Einstein.

Financial practitioners and their clients alike would benefit from that approach.

Complexity conflicts with Einstein’s idea

Like science describes our universe and its effects on our lives, financial planning should describe our financial world and its effects on our lives. No financial planning approach, to my knowledge, starts with the fewest hypotheses and axioms and from there builds an overarching description of the process.

What is the general case?

Financial plans should rely on an overarching condition and deliver outputs predictably. Science is very good at creating artifices that work. Like lasers, cellphones, computer chips, fuel injection and instant rice. Financial planning has many tools too. Life insurance, investment funds, casualty insurance, tax advantaged funds, and hundreds of specific tools.

I know little about the detail of how any of the science based ones work, but expect them to do so and in very narrow ways. My role is to use them to create outcomes that meet my needs. Pleasant music.  A game. A comfortable drive.  They become objects in my life program. They achieve specific things as needed by the broader program. And in a general way, I know what that is.

Financial planing is usually backwards

We typically start with a complex product and then add another and another. Insurance, retirement plan, educational plan, budgets, wills, powers of attorney and debt management are all components of a life plan and its attendant financial plan, but a vast stack of product is incoherent to many.

Working from the particular to the general usually fails.

Why does it fail?

Because the insight is in the general case. Financial plans envelope decades. If there is no deep insight to purpose and outcome, people get lost. They buy solutions tactically instead of strategically. Eventually they make a mistake. In very long plans powered by compound interest, time lost to a mistake matters.

People who have sound axioms and hypotheses behind their plan make fewer mistakes and find those they make more quickly.

Some axioms that help.

  1. Everyone dies. No one knows when, but they can use the fact to assist their planning. Insurance replaces lost earnings or provides an orderly and inexpensive way to meet end of life obligations.
  2. If you consume all of your money, you will have too little when you stop earning. The ant and the grasshopper of Aesop’s Fables fame. You must transfer some of your earnings to the future so you can spend them then. Saving is just deferred groceries.
  3. Debt means choosing a reduction of future consumption and savings. Just as savings are money you have earned and not spent yet, debt is money you have spent before you earn it. The joy of spending now may be offset by the not-so-joyous payments.
  4. The income tax system harms you. It is designed as a game with three rules. You cannot win, you cannot break even and you cannot refuse to play. With care, you can minimize the effects.
  5. Time exists so you don’t have to do everything at once.

Hypotheses

  1. Investing and debt are time machines that move what you earn to a time of spending. Both have a price to operate. Investing pays you and debt costs.
  2. Large markets like the stock and bond market are created to provide liquidity so that people can trade non-money things. Without a market it would be very hard to buy or to sell the debt of a government or a share of a business.
  3. Market prices are for purposes of liquidity only. They do not speak to the value of any security, only to the price that allows the security to trade now. Business valuation and market prices are only slightly connected in the short term. The real value only shows up over a long time and only then for the people who are not interested in fashion, band wagons and the excitement of the pundits.
  4. Money is not valuable by itself. It is only valuable when you use it. Theoretically it is a store of value, a unit of exchange and way to keep financial accounts. Money should be held for a purpose. Future consumption, opportunity, security against adversity and liquidation of obligations arising in the future.

You will not get it right, so evolve answers

A life plan and its financial winger, cover a long time and we cannot see the future clearly enough to get it right at the beginning. The real skill is changing as you go along. Your circumstances change, the world around you changes, and your attitude and approaches change. You must learn to apply new skills and find new resources to be successful.

Adaptation is key to success.

Fortunately humans are very good at adapting. The problems arise only for those who do not know they must adapt or who fear to admit they must change.

If you can have just one strong skill, choose adaptability.

Don Shaughnessy arranges life insurance for people who understand the value of a life insured estate. He can be reached at The Protectors Group, a large insurance, employee benefits, and investment agency in Peterborough, Ontario.  In previous careers, he has been a partner in a large international public accounting firm, CEO of a software start-up, a partner in an energy management system importer, and briefly in the restaurant business.

Please be in touch if I can help you.  don@moneyfyi.com  866-285-7772

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