Math is not an easy subject for everyone to grasp, but most people understand the concept of a basic mathematical formula. The simplest math equation might be a + b = c. It always works. We can use any type of computation – addition, subtraction, multiplication, or division – and solve for unknown variables, provided we know the others.
Often, we hear of people taking this approach to plan their financial future. They view it as a mathematical formula:
However, there are numerous problems in trying to use mathematics to plan your life, particularly when it comes to variables that we do not have control over to assume a future outcome. And the truth is we can prove the math to be true all day, but sometimes, life will get in the way and market cycles and unexpected life events will throw wrenches into our projected, linear future.
The biggest assumption we make when trying to plan our lives around a formula is that we know what the financial goal is or we try to put a specific number on it. However, we do not know the actual amount of money it will take to fund retirement or college tuition, or whatever the specific goal is. We can use our best educated guess factoring in some inflation rate, but the truth is that the further into the future we plan, the less we really know what it will take to achieve that goal.
Life can get in the way, too. What if you wanted to have a family and instead of one child, you have two or three or more? What does that do to the mathematical formula? What if you have kids that you are still taking care of and you have parents who have become sick or frail over time who need assistance, both physically and financially? That’s called the sandwich generation that we see a lot successful people who are raising kids that are still at home and caring for parents who need them, too.
So what if the best possible outcome happens? What if we actually do hit our goal? What if, somehow, some way those variables over time have the cumulative effect of getting us to our goal? There’s still a chance that wouldn’t be enough!
Another assumption that we often see is that our goals will never change. Particularly for retirement planning, maybe the ideal amount of money our 35 year old selves wanted to have in retirement changed over those 30 years, and it isn’t enough support the lifestyle we grew accustomed to, charitable causes we want to support, or family members who rely on us. Life may have changed so much that we could not have guessed and never could have accounted for it when we were 35 years old.
There are also economic variables to consider, the two most obvious being inflation and taxes. Inflation is simply the value of a dollar and what it will provide for us. There is the national inflation rate that the government monitors, but there is also your personal inflation rate to consider. In working with families, I often see if you were to put a rate on their personal expenditures as they move through life stages – growing their family, building their careers, and having their children grow up - their expenditures often increase more than the 1.5% per year1 that is currently the national inflation rate. When their incomes grow, their taxes also grow. In 2015, we are continuing a period of historically low marginal taxes. Tax rates may not climb as high as they were in 1944, when the highest marginal tax bracket was 94%, but there is the possibility that taxes will increase between now and the age you plan to retire.2
1U.S. Bureau of Labor Statistics, CPI Detailed Report – January 2015
2U.S. Federal Individual Income Tax Rates History, 1862-2013 (Nominal Dollars)