In my work with clients, assumptions are involved.  There is no avoiding it.

For instance, I have to assume how long a person will live.  I have to assume what asset class returns will be over long periods of time.  And I have to assume values for other things like inflation and taxes.

Certainly, there are circumstances that will impact these assumptions like a family history of longevity or recent economic data or tax legislation.  But in the absence of new information that might impact our assumptions and thereby influence my advice and clients’ decisions, how do you determine if an assumption is too aggressive or too conservative?

In my opinion, there is no clear answer about what is conservative or what’s aggressive.  Risk is most definitely defined and interpreted on a personal level and can vary widely from person to person.  This is one of the reasons why it’s so dangerous to try and pigeonhole people into a “risk category” based on a multiple choice questionnaire.  But that’s another topic for another blog post.

Today, I’d like to talk about the real risk of being too conservative with financial assumptions.

I think we can agree that the risks associated with being too aggressive are pretty obvious and can result in financial disappointment or worse, financial ruin.

But can we be too conservative in our planning and assumptions?  I say that we can.

Let me first say that we each only have one life to live and it would be a shame not to make the most of it.  And that’s where assumptions that are too conservative can have a real impact.

What if you use a number that you consider to be “safe” or “conservative” when planning for your life expectancy?  Or what if you think you’re doing yourself a favor by being conservative with your assumptions for asset class returns, inflation or taxes.  What if you own a business that you plan to sell one day to help fund your retirement needs, but you conservatively use a lower valuation multiple in order to be “cautious” in your planning?

Sure, I think there might be an argument that being too conservative is a better alternative than being too aggressive, but what if you’re being too conservative and you’re wrong?  What is the cost?

The cost is leaving important goals on the table.  The cost is leaving potentially a lot more money in your estate that you planned or wanted.  The cost is living a life of regret — of not making the most of your one, precious life.

The Solution

To be clear, I don’t think that there is a clear definition of what’s conservative or aggressive.  In fact, we’re talking about assumptions which are what we make when there are several possible outcomes for a given situation.  And just like the market itself, these are things we can’t know in advance.

So the answer is to use the best information we have to make what we feel are the best assumptions and then we have to watch those assumptions closely.  In my planning work with clients, we update our clients’ financial advice every 90 days.  This includes a review and discussion of the assumptions we’re applying in our planning and whether or not we agree to adjust them going forward for the next 90 days.

It is only through this proactive, ongoing delivery of advice that we can do our part in helping our clients make the most of their one life.

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