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In a Financial Plan, How Much Flexibility Is Too Much?

When it comes to flexibility in a financial plan, it’s a delicate balancing act: it is important to maintain enough flexibility that your financial plan can accommodate unexpected events that are out of your control. On the other hand, a sound financial plan needs to be firmly grounded by factors you can control so that even in the face of unexpected events, following your financial plan gets you to where you want to be.

When you develop a financial plan, you have to make certain assumptions, many of which are out of your control. Yet you can develop a financial plan with assumptions about these factors even in the absence of a crystal ball.

Taxes ─ The notoriously complicated U.S. tax code will affect your financial plan in a number of ways. For one, your effective tax rate will change as your income changes. Also, changes to the tax code itself can affect your financial plan, often dramatically. Fortunately, changes aren’t typically made every year; and because Congress sets tax policy, most changes in the tax code are announced in advance of taking effect ─ allowing you time to plan how those changes might impact your financial plan.

Income ─ We all hope, of course, that our income will rise as we move forward in our careers. Typically, those kinds of income changes are predictable. More dramatic yet still predictable income changes can happen when one spouse voluntarily stops or starts working. The loss of a job or dramatic decrease in work hours can cause unexpected changes in income.

Health ─ Your health and the health of your spouse is a significant factor in your financial plan for two reasons: first, because health is a big determinant of one’s ability to earn income; and second, because health care costs are often one of the largest expenses, especially for older people. As you age, it’s important to think about changing your assumptions about your health. Maybe you reduce the income you expect because you won’t be able to work long hours. Or you increase the health care-related expenses you plan for. You can also take steps to mitigate the impact of health changes.

Life ─ Beyond job losses and health events that can affect your financial plan, other major life events can have a big impact as well. Whether it’s good or bad, expected or unexpected, events like the birth of a child, marriage or divorce, a spouse’s death, or a relocation will affect your financial plan. Some you can plan for, some you can’t; the point is to be aware that these kinds of events will impact your financial plan.

Economy ─ For most of us, our financial plans are based on the assumption that our investments will earn a certain average return in the market. Those assumptions affect decisions we make about our plans, for example, the amount you need to save every month to retire at age 70 may be larger or smaller the higher or lower your assumption about investment returns. The best way to make these assumptions is to base them on long-term historical returns in relevant market indices.

Live within your means ─  When you keep your expenses (including savings and investments) less than your income, you give yourself more flexibility to accommodate unexpected changes that you can’t control. If you have some breathing space in your budget every month, you can more easily accommodate, for example, a higher tax rate or economic downturn without having to alter your financial plan.

Have a rainy day fund ─ Have at least three to six months worth of living expenses in an easily accessible, liquid fund that you can draw upon in the event of a rainy day ─ an emergency or unexpected situation. This savings should be set aside from all other savings and investments and only used for true emergency expenses ─ like in the case of a job loss or illness. With an adequate rainy day fund, you can deal with unexpected events without having to erode your financial plan.

Revisit your plan regularly ─ The number-one key to achieving your financial goals is to review and, if necessary, revise your financial plan regularly ─ at least once a year. That way, you can make adjustments for all the factors out of your control that have changed for better or worse. If you haven’t revisited your financial plan in the last year or if you need to develop one, please call.

Copyright © Integrated Concepts 2012. Some articles in this newsletter were prepared by Integrated Concepts, a separate, nonaffiliated business entity. This newsletter intends to offer factual and up-to-date information on the subjects discussed, but should not be regarded as a complete analysis of these subjects. The appropriate professional advisers should be consulted before implementing any options presented. No party assumes liability for any loss or damage resulting from errors or omissions or reliance on or use of this material.

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