I think a plan is just a list of things that don’t happen.

-Parker, The Way of the Gun

I’m pretty sure that most financial plans are wildly inaccurate. Not even close. It’s not the fault of the software or the calculators – the math is the simple part. The problem is in the assumptions. The user assumes a savings rate or a spending rate, or an asset allocation or rate of inflation or rate of return, etc. Ten or twenty years from now, none of these assumptions are likely to bear any resemblance to reality. Our income will have changed. We will spend money on things yet to be invented. We might adjust asset allocations by our changing perception of risk or value. There are an infinite number of ways for these plans to be wrong vs. one way to be right. With this in mind, is planning worthwhile, or just an exercise in self-delusion?

It’s probably mostly an exercise in self-delusion, but with some potential. To realize the potential however, we first have to acknowledge the big game changer. If the plan does not include a realistic way to manage risk – to limit losses – it is vulnerable to catastrophic failure.

An asset allocation plan by itself is woefully inadequate. Diverse assets have a way of acting alike when trouble strikes. A realistic plan must acknowledge that the idea that all market declines are temporary and will work themselves out with enough patience are a fantasy. Japanese investors have witnessed a market in steady decline for over twenty years. Icelandic investors had a ringside seat for a 94% market collapse. German investors in the 1930s & 40s, Peruvians for most of the 20th century. History is rife with examples of cautionary tales.

The equity markets offer no guarantee of positive returns in exchange for patience. Historically, it is not uncommon for markets to stay depressed for decades. If you have the misfortune of accidentally timing your retirement to coincide with one of these periods, a financial plan that didn’t account for this possibility will survive only as a work of fiction, but without interesting characters or sharp dialog.

In terms of investment priorities, protecting what you’ve accumulated should rank right up there with accumulating it in the first place. A plan that doesn’t emphasize this importance is simply a wishbook.