Recent developments in artificial intelligence (AI) technology once again have the world asking about the state of our future. For some, the future looks much brighter with enhanced accuracy and efficiency. For others, the future looks like scenes from the Terminator franchise where Skynet has taken over the world.
The truth, though, is that the future is unknown. In a world of constant change and an infinite number of variables, what can you do? The answer may lie in the origin of the word “future” itself. It comes from the Latin word ‘fu’, meaning “to grow or become” and ‘esse’ meaning “be”. Although life is filled with unexpected events, you do exercise a certain amount of control in determining how things grow or become. Wendell Berry, an American novelist and farmer, said, “…the only possible guarantee of the future is responsible behavior in the present.” At every age and every season of life, it is important to focus on what you control. So, what are some responsible financial behaviors you can implement to work toward a secure future?
1. Establish an emergency fund.
As the Boy Scouts say, “Be prepared.” If income is only allocated with current monthly expenses in mind, how will an unforeseen expense be handled? These events can take many forms, such as job loss, home or vehicle repairs, medical emergencies, or the death of a loved one. Without savings set aside specifically for the unexpected, you may be forced to utilize a high-interest credit card or withdraw money from assets earmarked for retirement or college funding. Ideally, you should have 3 to 6 months of your expenses set aside in a separate, liquid savings account.
2. Live within your means.
During your working years, this simply means do not spend more than your income. In retirement, the principle still applies but in a different way as your income sources shift to pensions, social security, and portfolio withdrawals. In general, various studies indicate a 4% initial withdrawal rate (annually increasing with an assumed inflation rate – generally in the range of 2.5% to 3.5%) from a well-diversified portfolio in retirement sustains that portfolio for approximately 30-34 years, while a 5% withdrawal rate depletes the portfolio after 21-25 years1.
In addition, it is important to “give every dollar a job”. In other words, do you know how your money is being spent, saved, or gifted? Those are the three things you can do with money, and your value and goals will dictate the right allocation to each for you.
3. Don’t put all your eggs in one basket.
Diversification is one of the best ways to account for all the things we do not know, and it applies to a variety of areas. Within your investment portfolio, diversification of asset classes provides access to various sources of returns. You can also diversify your taxation by utilizing multiple account types (tax-deferred, taxable, tax-free). Ultimately, diversification means flexibility, a key benefit when facing the unknown.
4. Manage your risks.
Whether you realize it or not, you make decisions about risk management every day. When you drive a car, there is the possibility that you could be in an accident. You could avoid this risk altogether, but then you must determine another way to reach your destination. You can reduce the risk of an accident by not texting and driving. Financially, most individuals decide to transfer the risk of monetary loss associated with a wreck to an insurance company rather than retain it.
Peter Bernstein states, “The essence of risk management lies in maximizing the areas where we have some control over the outcome while minimizing the areas where we have absolutely no control over the outcome and the linkage between effect and cause is hidden from us.”2 It is also helpful to consider the probability of an event happening (low versus high) and the financial impact (low versus high). For example, consider a young married couple with children where one spouse works and the other does not. The probability of an early death for the working spouse is likely low, but the financial impact to the non-working spouse would be high. Other high impact events include health problems and disability. Recognizing and managing these risks is responsible behavior.
For additional insight on risk and how it plays into financial decision making, see this July 2023 blog post by Bridgeworth Chief Investment Strategist, Zach Ivey, CFA, CFP®, ChFC® .
5. Consider what would happen in your absence.
Despite the certainty of our mortality, many individuals fail to make a plan. Unfortunately, avoiding these decisions does not alleviate the pain associated with premature death or disability, but often creates additional heartache and complexity. Executing estate documents (Will, Power of Attorney, and Advanced Healthcare Directive) eliminates the guesswork of your wishes.
Yes, the future is unknown, but thankfully you have the ability to influence it. Henry Ford II said, “Nobody can really guarantee the future. The best we can do is size up the chances, calculate the risks involved, estimate our ability to deal with them, and then make our plans with confidence.” Borrowing a line from another classic movie franchise, Doc Brown tells Marty McFly in Back to the Future III, “…your future hasn’t been written yet. No one’s has! So make it a good one!” If you need help taking the necessary steps today to ‘make it a good one’ and ‘plan with confidence’, reach out to a Bridgeworth advisor today.
1 For illustrative purposes only. Sources: Bengen, William P., 1994. Determining Withdrawal Rates Using Historical Data. Journal of Financial Planning 7(4): 171–180. Cooley, Philip L., Carl M. Hubbard, and Daniel T. Walz, 1998. Retirement Savings: Choosing a Withdrawal Rate That Is Sustainable. AAII Journal 20(2): 16–21. Henry-Moreland, Ben, 2022. Why High Equity Valuations And Low Bond Yields Won’t (Necessarily) Break The 4% Rule. Kitces.com
2 For detailed reading on the history of risk management, consider Bernstein’s book, “Against the Gods: The Remarkable Story of Risk”.
Bridgeworth Wealth Management is a Registered Investment Adviser.
There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not ensure against market risk.
The information and material presented in this commentary are for general information only and do not specifically address individual investment objectives, financial situations, or the particular needs of any specific person who may receive this commentary. Investing in any security or investment strategies discussed herein may not be suitable for you, and you may want to consult a financial advisor. Nothing in this material constitutes individual investment, legal or tax advice. Investments involve risk and an investor may incur either profits or losses. Past performance should not be taken as an indication or guarantee of future performance.