Occam’s – Precision and the Retirement Planning Process

Planning for your retirement is vitally important. You wouldn’t be reading this if you didn’t agree. And with something this important, many of us want a sense of control. We want to know that our retirement income plan covers all the bases, and that it will smoothly take us through to a successful retirement.

But, for most of us, that’s not how it’s going to play out. We simply cannot be that precise in the planning process – and it goes a lot deeper than not being able to predict stock returns into the future. There is simply too much uncertainty around pretty much every aspect of our retirement income plan. How long of a retirement do you need to fund? What will your medical expenses look like? What will you be interested in doing when you’re 80? What’s inflation going to look like?

We can make some guesses (and in a lot of cases they can be solid guesses), but there’s still a huge amount of uncertainty – and that uncertainty compounds on itself.

A good way to visualize this is to think back to your high school science classes. You probably remember the concept of significant figures. Your analysis can only be as precise as the least accurate measurement. If I can only weigh something to the nearest half ounce, I can’t say that something is 8.6 ounces. I can only say that it’s about eight and a half ounces. Trying to be more precise is just not useful. It’s clear in this context – if the scale readout goes 8, 8.5, 9, it would be silly to say that something weighs 8.6 ounces. But in practice, this is where a lot of people get tripped up. So much of the planning process is calculating things based off the guesses we are making layered on top of each other. And it’s easy to just calculate the math, and come up with that precise answer down to the fourth decimal place. That “extra” precision just isn’t meaningful.

But this isn’t a doom and gloom situation. Planning isn’t a house of cards. Done correctly, planning is the opposite. We need to center the planning process on what it’s actually good at – continually improving the likelihood of you having a good retirement. There are two big ideas here. The first is that there is a significant difference between precision and confidence, and the second is that planning is a process of successive approximation.

Exactly Wrong versus Generally Right

For many of us, especially people coming from a quantitative background, we want a specific path to follow that’s meticulously marked. We want a blaze on every other tree. We want to know how much money we “should” have before we retire, or how much we will be spending on groceries when we’re 78. It’s important to make these estimates (though taking it down to itemizing your groceries may be overkill), but it’s also important to recognize that nothing is ever written in stone. Your retirement income plan is trying to model your life. And aside from the point that every useful model is wrong, real life is just messy. Essentially, life happens.

Recognizing this inherent uncertainty opens the door to an even more meaningful analysis. We can move from trying to optimize on precision to optimizing on confidence. This is hugely important. We can move from saying that this will happen unless something goes wrong, to saying that given a set of circumstances here’s what is likely to happen.

With the precision approach, we’re locking ourselves in, and any deviation from that path is a bad thing. It’s a brittle plan, and it will break. As soon as something, anything, happens, the plan is wrong and you need to go back and redo it.

But when you accept the uncertainty, we allow ourselves to build a flexible plan that is useful. We can start thinking about what our plan would look like in different states of the world. What if I live longer than expected? How would I deal with that? What if I pick up hang gliding when I’m 75 (though that might negate the first question)? Just how bad would the markets need to be to put my basic retirement spending at risk? Embracing the uncertainty inherent in retirement planning lets you answer – and deal with – these more meaningful issues.

Retirement Planning is a Walk in the Woods

Very often we treat retirement planning as an event. It’s this massive thing that we do once to get “the answer.” But planning isn’t an event. It’s a continual process. We’re always getting new information – whether that’s just what the financial markets have done over the past few months, or that maybe it’s time to think about moving down south (it’s 3ᵒF here in Maine as I’m writing this) – and we need to incorporate that information into our overall plan. Your plan, just like your life, is always subject to change. And it needs to accommodate these changes. As I said, retirement planning is a process of successive approximation.

A good way to think about this is that planning is a lot like orienteering. You’re in the woods, and you need to get to a certain point a little ways off. The trick is, it’s hard to walk a straight line in the woods. You’re constantly dealing with small obstacles that deflect you this way and that.

So you figure out the best way to go, and then you head off in that direction for a bit. And then you stop and reorient yourself. You take stock of where you are, figure out the best way to get where you want to go, and then head off in that direction. And then you do it again. And again. And you keep doing it until you reach your goal. It’s a process that accepts that precision is, at best, incredibly difficult to achieve and focuses on continual progress instead. Hopefully you never go too far off course, and you’re always moving generally towards your goal – even if those goals might change though time.

Humility and Retirement Planning

So what does all of this mean for your retirement plan? First off, it doesn’t mean that you should throw up your hands and just hope for the best. We may not be able to precisely plot out the next 50 years of our lives, but we can point ourselves in the right direction. We have a general sense of what our future self is likely to look like – even if we can’t predict it exactly. For instance, I enjoy travelling and experiencing new places. That’s unlikely to change. Although I don’t necessarily know how much energy I’ll have to travel when I’m 80, or what types of trips I’ll be interested in taking, I know that I won’t want to just sit at home. Even if you don’t have all the details, you still have the big picture to work from.

This means that you need to approach the retirement planning process from a place of humility. We have a decent picture of what we want to accomplish (that’s subject to change through time), but there are so many sources of uncertainty floating around the system that we need to account for. What will the financial markets do? What’s going to happen with taxes? What will health care look like in 30 years? We can take our best guesses, and wrap them into the plan, but we don’t know. And we need to think about what that would mean for the plan overall.

With these unknowns, we need to build slack into our plans. And the more uncertainty there is in your plan, the more slack that you need to include. Over the course of our retirements, we’re going to end up on the good side of some of this uncertainty, but your plan needs to be able to deal with the negative surprises as well. Your plan needs to be flexible, and able to deal with whatever retirement throws at you.

And the only way to do this is to work with the uncertainty.

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