Life is full of uncertain experiences, events, and outcomes. It’s what makes life interesting, fulfilling, and fun. To a certain extent, we’re uncertain what our future holds. We can only do so much to further our careers, protect our loved ones, or advance our knowledge. In the end, there will always be a degree of uncertainty in our lives and understanding. The certainty of uncertainty in behavioral financial advice helps us plan for and therefore mitigate the risks these present in order to protect what we value to the best of our ability. This article will explore how behavioral financial advice and the certainty of uncertainty is changing the way traditional financial planning is approached and why it’s important to be aware of its impact on our finances and lives.
4 Areas of Uncertainty
When planning for our futures, we can identify four areas where uncertainty exists. Our health, length of life, markets, and the economy. Each area can’t accurately and consistently be predicted and therefore we have to take action in order to prepare for the worst of circumstances. Failure to plan in any of these areas can have dramatic effects on our lives.
For example, incurring a large medical expense without having health care, or the economy faltering and losing your job without any cash reserves to keep you afloat. While it’s unfortunate there’s a necessity to discuss and be aware of these potentially negative events happening in our lives because it’s only exacerbated if they actually occur without having a strategy in place to deal with it.
Planning for Health Needs
We can do a lot to manage our health. From eating lots of vegetables, sleeping the recommended 8 hours every night, spending time with loved ones, and daily exercise. Yet for all this positive health-inducing behavior, it remains unpredictable whether we experience a debilitating disease or are severely injured and unable to conduct our everyday job.
The mental hardship we’re faced with when we or a loved one faces a life-altering disease or sustains a debilitating injury is hard enough. Failing to plan for these possibilities only makes it harder. Ensuring you’re covered by health insurance, and disability insurance will help mitigate the financial hardship that could befall you in the unfortunate case your health took a downturn.
With healthcare costs today being through the roof, it’s more important than ever to make sure you’re covered. If you’re a young individual with relatively low health care costs and your employer offers an HSA, you should be taking advantage. They allow you to accumulate funds and invest them for future health expenses to be used tax-free. It’s the ONLY triple tax-advantage account available today.
Many employers offer disability insurance to their employees free of charge. However, if you’re not covered, you should look into the private marketplace for coverage. According to the council for disability awareness, one in four of today’s 20-year-olds can expect to be out of work for longer than 1 year before reaching retirement age because of a disabling condition. Being without income for an entire year can dramatically impact our lives and progress towards long-term financial goals. Lastly, to plan for a loss of income due to disability ensure you have an emergency fund with a minimum of 3 months worth of living expenses.
Planning for Length of Life
Along the same lines of planning for our health is the unpredictability of how long we’ll live. Facing our mortality and the inevitable end we’ll eventually all face is a tough subject to confront. But again, failing to plan can have dramatic impacts upon our loved ones should we not prepare for the worst. Life insurance is a tool we use to transfer the financial risk of dying to insurance companies.
For a relatively low cost, we can replace our income and provide for our families should we pass early and unexpectedly. For most young individuals, term insurance is sufficient to provide coverage for this uncertainty. Most employers will also offer insurance up to a particular amount, anything needed on top of that can be bought through private carriers. When evaluating your insurance coverage needs, things to take into account are replacing your income, debt obligations, or potentially being able to finance your children’s education costs.
On the flip side, the longevity of our lives can also impact our finances. Long-term care costs and the expenses associated with assisted living facilities and skilled nursing care continue to increase. While this isn’t something Millennials need to plan for yet, our parents and grandparents will surely be faced with this expense. To give you an idea of how much this costs, in 2016 the U.S department of health and human services estimated the national average monthly cost of assisted living care was $3,628 for a one-bedroom unit and $7,698 for a private room at a skilled nursing facility!
Planning for the Markets
Traditional finance is based upon the notion that investors and consumers act rationally. Yet, in reality, this is far from true. When discussing investments with clients, one thing we always try to cover is how we don’t react to short-term market headlines, corrections (10% downturns in the market), or even recessions (20% downturns in the market).
We know as investors these events are certain, and that long-term they present an opportunity to put more cash to work at a discount. Yet, investors will still behave irrationally when they actually occur because of our emotions. Taking time to divulge the information, reflect, and respond rationally is key.
Planning for the Economy
The last uncertain aspect we need to plan for is the economy. The overall health of the economy and job market can affect our employment status. In 2008, when the economy faltered, many people lost their jobs and sources of income. Being prepared for this by having alternate sources of income, an emergency fund, and investing in yourself through education to make you a desirable employee are all key.
Another aspect of the economy that can be unpredictable is interest rates and inflation. They can erode our purchasing power if we don’t invest. The old phrase “cash is king” couldn’t be more wrong over the past decade where interest rates remained at historical lows. On the contrary, if you’ve been a market participant you’ve enjoyed one of the longest bull markets in history. Greatly improving your purchasing power and providing a buffer against future, unpredictable economic downturns.
The Bottom Line
The certainty of uncertainty brings to light the things we can do to prepare for the worst-case scenarios. While they can be uncomfortable to confront, the fact is failing to plan will only accentuate the problem should an unfortunate event befall you. Put a plan in place and make sure all your bases are covered by scheduling a free consultation today!