Is Your Current Financial Plan Dangerous? Here Are Five Reasons Why It Might Be

Author: Eric Cramer, CFP®, CFA®

If you’ve ever gone through the financial and investment planning process, you might remember that it took some effort. But you might look back at that investment in time and feel some sense of satisfaction that you did something for yourself and your family. Unfortunately, investment planning may be extremely dangerous to your financial health. Here are the top five reasons why:

One: Your Future Earnings Are Tough to Predict.

How many working people can look back a decade and say that they would have accurately predicted their current income level? Fortunes change, people lose their jobs, people get promoted, and the future is unknown for most of us. Because of this, future earnings become one of the biggest financial planning mistakes people may make. If your financial plan assumes you have a healthy income for decades into the future, but that doesn’t happen, do you expect your retirement lifestyle to be the same? Anyone more than ten years from their planned retirement needs to understand why a certain income figure was used in their plan, and they might want to make their income estimates extremely conservative just to test for problems with their plan. A good advisor may even run more than one plan, using different income levels, to examine the sensitivity of the plan to this input. Another technique used for people approaching retirement is to assume that all income ends in the current year. This helps establish what your “worst-case scenario” may look like and every year of additional income just makes things better. 

Two: You May Not Die on Schedule. 

Life expectancy is a tricky thing for anyone to predict. The best investment planning probably assumes a very long life expectancy, because outliving your money is the biggest risk most people face. Avoiding “superannuation” is the main motivation for many people to engage in investment planning, which is why some planners may suggest using a life expectancy that you only have a 10% chance of achieving. This doesn’t mean that this estimate is more accurate, it simply provides a more prudent way to think about how to plan. 

Three: Your Investment Expenses May Be Too High.

If your investment planning doesn’t address the concept of investment expenses, then you may need to ask some questions. Another big financial planning mistake you can make is not taking into consideration what you’re paying in fees and even taxes on investments. For example, your stock broker may start to crank out financial plans that use index returns to predict portfolio returns. But the reality may be that your investment accounts become full of high-cost mutual funds, annuities, and other fee-laden investment products that may not be able to quickly adjust to market shifts. It isn’t unheard of for an investor to pay more than 2% in total investment expenses (and sometimes much higher) while relying on a financial plan that assumes there are zero investment expenses. For a $1 million portfolio, that’s $20K per year that doesn’t compound. If you don’t think investment expenses are a big deal then consider this: at the end of 2017, the average annual return of the MSCI ACWI IMI Global Equity Index for the prior ten years was only 4.97. And the Bloomberg-Barclays U.S. Aggregate Fixed Income Index return over that decade was only 4.01%. If your portfolio was paying an extra 2% in fees then, depending on your allocation, you may have barely kept half of your returns. At the end of the day, your investment expenses really do matter.

Four: You May Pay High Taxes On Investments.

Taxes are boring, yes, so let us tease you with this idea: if you own an actively traded mutual fund, and it realizes short-term capital gains (from selling stock it owned less than a year), then the fund has to distribute those gains to you along with a tax on the investments. Your investment planning advisor may not see it coming, and there may be little you can do to stop it. To make matters worse, the distribution that hits your account will now be taxed at your highest marginal rate (because it’s a short-term gain). On top of this, distributed short-term capital gains cannot be offset with realized capital losses. So, if your super stock-picking mutual fund was up 20% in a big year, but sold most of its holdings to reposition, maybe you had 10% distributed to you at a tax cost of around 4-5%. Suddenly that terrific 20% turns into only 15%. The big pothole here is when a fund has a down year, but still sells some winners, and you pay investment taxes on a negative return! It’s happened before and it will surely happen again. Will you make this common financial planning mistake?

Five: You Count Too Much on Social Security.

Some investors won’t need Social Security to have a terrific retirement, but for most of us, it will at least play an important role. And here’s the thing: Social Security has its risks. It’s not hard to be cynical about this program run by the Federal Government, but in the interest of giving respect where it’s due, the Trustees responsible for running this giant entitlement program write some of the best financial reports you will ever read. They have been telling us for years that there are major Social Security risks ahead, and it’s getting closer to reality. In the 2023 Annual Report, it was estimated that in all likelihood the program will exhaust itself by 2033. At that point, they estimate, benefits will have to be cut by 23% to match annual tax collections. We can’t know how our current and future politicians will address this problem, but if your investment planning isn’t assuming a cut to your currently legislated benefits, you may be counting on money that you will never receive.

At BIP Wealth, we focus on holistic wealth management to help our clients fortify long-term success and avoid the common financial planning mistakes you read about above. To learn more about our services, check out our What We Do page. If you’d like to get in touch with one of our wealth advisors, feel free to contact us!

Investment Planning FAQs

How do I estimate future earnings?

Although it is very difficult to accurately predict your future earnings, it may be helpful to create more than one investment plan to determine what your financial situation could look like in different scenarios.

What is superannuation?

Superannuation refers to a retirement savings system in which individuals set aside a portion of their income during their working years to fund their retirement. It is commonly known as a pension or retirement fund.

What is an investment expense?

Investment expenses refer to the costs associated with managing and maintaining an investment portfolio. These could include advisor fees, taxes, and operating expenses.

When do you pay taxes on stocks?

Taxes on investments like stocks are typically realized when you sell them for a net gain or loss.

Is Social Security at risk?

In a recent estimation, it was said that Social Security could exhaust itself by 2033, resulting in a 23% benefits cut.

This communication contains general investing information that is not suitable for everyone and is subject to change without notice. Past performance is no guarantee of future results and there is no guarantee that any views and opinions expressed will come to pass. The information contained herein should not be construed as personalized investment advice, tax advice, or financial planning advice, and should not be considered a solicitation to buy or sell any security. Investing in the stock market and the bond market involves gains and losses and may not be suitable for all investors. Indices are not available for direct investment.