How does financial planning happen today?
The typical process of financial planning involves the following steps.
- Identifying your risk type and thus the ability to take Risk
- What are your long term goals usually more than five years into future
- Basis the above you get a plan asking you to invest in various products at various times
But it doesn’t work!!
While there are tons and tons of tools and financial advisors, none of it usually works cause of the fact that our risks keep changing. Our goals are not steady or fixed, and finally, new products keep coming up.
Let’s look at Risk first:
Suppose two people have seen the 2008 crisis. One of them lost his job and took a massive hit on his investments. The other girl was able to retain her job and then invest also at those rock bottom prices.
Fast Forward now: Both of them are working and doing well, have similar salaries and similar lifestyles. All tools will tell you that their risk-taking ability is of the same type. However, that 2008 event changed everything which no advisor or a tool can detect.
Next lets at goals:
Long-term goals are hard to implement because they are a collection of short term goals. These have to be managed, marketed, and used as information to gauge whether a long-goal reward still exists.
What this implies that long term goals look great on spreadsheets, but what matters is managing the short term goals consistently to make the long term goals happen.
Long term thinking will say keep investing for ten years without telling that in between you would be asked to invest even when your portfolio is down 50%.
As you can see its almost impossible to have a stable financial plan when all the components underlying the idea keep moving
The emergence of Financial Pornography!!
Coined by Nick Maggiulli, it tells that how financial apps and advisors use beautiful looking charts, engaging tools, quizzes to portray a future that seems highly achievable. Unfortunately, they usually have no resemblance to reality. Like in our post on goals we looked that the same
Looking at these tools and charts will make you think you are doing well only to release that goal don’t move that linearly and bad things happen
The Financial Turing test
We borrow this concept from the Blog https://ofdollarsanddata.com/the-financial-turing-test/
Imagine you meet someone new or use an app which claims to be a “financial expert.”
If you could only ask them one question to determine if they are legit, what would you ask? We call this the Financial Turing Test.
The original Turing Test was a thought experiment designed to determine whether artificial intelligence (AI) had been invented. The idea was simple. You sit down at a computer terminal where you message back and forth with some “entity” (either a human or a computer program, but you don’t know which).
Assuming you can ask any questions you want, could you determine whether the entity you were chatting with was a human or a computer more than 50% of the time? If you can tell the difference, then AI doesn’t exist. Otherwise, the Turing Test has been passed, and AI exists.
Instead of identifying whether an entity is a computer or a human, the Financial Turing Test differentiates financial sages from financial charlatans.
So what is the Turning test question for alls such tools and advisors?
Ask if the tool/advisor helps you answer this question.
How do you get rich without getting lucky?
If they tell you to invest on goals or ask you to save here you know well they are failing the test. Cause they are implicitly telling you that the three components of financial planning Risk, Goals and Product all have no luck involved. That is so far away from the truth
The 2-minute Financial Planning checklist
So yes we have criticised everything till this point. How do we then address this?
We do it in a straight forward manner.
All your financial decisions have to do two things
1) Ensure that you remain anti-fragile
We leverage the concept of Anti- Fragile by Nasim Taleb
What that means that If bad things happen, you are ready to benefit rather than getting destroyed. While the probability of this low if it happens, it will ruin all wealth creation. A lot to times when things are doing good, you would think there is no risk, but Risk is always there. Pablo Escobar expected 10% of the cash he stored in warehouses to be eaten by rats or spoiled by mold. That was if everything went well.
Some downsides are unavoidable. You can push back, but they’ll never die. They’re part of life, and you might as well learn to accept them than pretend perfection exists.
What matters is how you plan for them!!
2) Allow compounding to work
To do this decouple all your investment from goals. The only goal which you have is creating wealth. And the simplest way to build wealth is that let money create money whenever you take out cash or break this pattern your set your self back.
With these two as foundations below is the 2-minute financial planning tool. Answer these questions every quarter to be on track
If I or someone in my family gets hospitalised for 15 days, do I have to break my investments or savings?
Do I have enough savings if my parents to get hospitalised to take care of them?
If I am not able to work or lose my job, can I manage my expense for next three months OR will I have to break my investments/ savings?
In case of n urgent requirement of funds ( Wedding, Brothers College Fees etc) can I borrow money at low costs
If I die, can my family survive for the next ten years?
Is there a goal/ desire in the next three months, which will lead to me breaking my investments?
Am I able to save 30% of my salary each month
Do I think that my finances will beat real inflation comfortably?
That s it!! Any time you hit a NO against any of these questions, you know you need to do something. Whatever financial instruments you are using need to be adjusted or calibrated.