Every plan has to deal with uncertainty and goals-based investing is no different.
No one can predict the future and even the best laid plans won’t pan out exactly as anticipated. Therefore, it is always important to know the amount of risk associated with your plan.
The good news is we can use a friendly system to help you understand how much uncertainty is right for you – ‘planning with points’. We’ve introduced this idea in a previous post. You can check it out here if you’re not familiar with the concept.
The quick summary is that planning with points is a great way to build a plan that doesn’t require you to become a financial expert.
Every decision you make – how much you can save, how long you’re going to save for, etc. – is assigned a point value that all add up to show you progress toward your goal. Getting 100 points means your plan is on track.
Thus, your plan score – how many points you’ve earned – can quickly help you gauge how on- or off-track you are for your goal. Have 50 points? You still have a ways to go to achieve your goal. Have 98 points? You’re pretty much on track!
Points at Risk
As you gain points in a plan, you are also going to be putting some points at risk. These are the points you could lose over a year if your plan suffers a setback of normal magnitude.
For example, if your plan has 100 points today, it’s expected to succeed. But if 10 of those points are at risk, then next year your plan could have 90 points and you’ll need to make some adjustments to get back on track.
So what exactly puts points at risk? Well, to start, every plan has some inherent risk right off the bat.
Once you set a goal, before you’ve even saved a dollar toward it, there’s some risk that the value of that goal may change in the future.
Let’s take a college tuition goal as an example. Saving for college tuition usually starts over 15 years away from when you will actually pay for that tuition. In those 15+ years, colleges may raise their tuition unexpectedly. This adds some risk to your goal.
For example, you set a goal of being able to pay $50,000 per year for college and are on track. Then a year away from your child starting school, the tuition goes up to $75,000 a year.
Although you are technically still on track for your original goal of $50,000, the actual value of your goal has now changed to $75,000, and you are no longer on track.
Points at Risk Through Your Portfolio
The other way that you can put points at risk is through your portfolio.
When choosing a portfolio, the more stocks, rather than bonds you have, the more plan points you earn. This is because stocks have the potential to go up higher in value than bonds.
But on the flip side, they also have the possibility of losing more value than bonds. That possibility of losing extra value is what puts more points at risk when you add stocks.
There’s no right answer. You may think it’s worth it to earn two points by adding more stocks to your plan, even if it adds one point of risk.
Others may prefer to add $1,000 of annual savings for the same two points and leave the total points at risk at their current level. The good news is that it’s up to you to decide which choices are better.
Understanding Trade Offs when Planning with Points
So there you have it. You can earn points as you build your plan, but at the same time, be aware that certain decisions you make may put some of those points at risk.
You get to determine the right trade offs so that you end up with a plan that meets your needs and does so in a way that feels achievable for you. Points create an easy mechanism to quickly understand what those trade offs might be.
Points are simple, but make no mistake, there’s heavy lifting involved to determine their value.
GBI’s goal is to develop a system – planning with points – so that anyone can build a plan for a financial goal. Points are powerful, simple and don’t require you to become a financial expert.
At the same time, they are a way for us to do the difficult work for you but keep it simple, so you understand how to build a plan that reflects your preferences.
And that’s the key – making sure that your plan works for you in both the good scenarios and the bad ones.
Are you ready to try out the planning with points system? Click here to sign up for early access to the GBI app.