How The Curse Of The Average Leads To Failed Retirement Plans

Many financial plans are based on one very simple foundation. Unfortunately, using this foundation often is a mistake. The mistake is made in broad-based financial and retirement planning as well as investment planning.

I call this mistake the Curse of the Average.

A lot of data is available to us these days. Cheap, fast computing power and memory also are readily available to sort and manipulate the data.

It’s easy to find the average return of different investments over long periods of time. We also can mix those investments into any portfolio we want and look at the long-term results. We can develop investment strategies and see the returns they would generate over the long term.

Inflation rates over the years are readily available. Life expectancy can be estimated either for a person’s age group as a whole or by those in the age group who share variables such as lifestyle habits, education, income, and others.

The problem is that all these data points are only averages. Some of them are averages using many years of data. Other data points are the result of manipulating data and correlations that seemed to matter in the past and using them to project the future.

The data can be very helpful for policymakers. They also can be a good starting point for planning your finances. But for an individual, they should be only a starting point. Too many plans assume that the average long-term results will be the result in their cases. The problem is that the averages are composed of individual results that differ quite a bit from the average.

Stock market returns are a good example. The average annualized return of the major U.S. stock market indexes is around 9%, depending on the stock index and time period. But it’s a very rare year when the indexes register a return at or near the historic average. Instead, the annual returns tend to be very different from the average. Plus, there tend to be long periods when the annual returns are well above the average (bull markets) or well below the average (bear markets).

The fate of your retirement plan doesn’t depend on the long-term average return of investments. It depends more on whether you retire early in a bear market, a bull market or some other type of market.

Life expectancy is another good example. Not many people live the average life expectancy for people born the same year. Because of inherited traits, lifestyle, environment, and luck, most people live either shorter or longer lives than the average expectancy.

As I said, the long-term averages are good starting points. You also need to ask what is different now or could be different in the coming years that would cause your experience to deviate from the average.

For some factors, you have to plan with some flexibility. Consider that a range of outcomes are possible and estimate how those outcomes would affect your plan and its results. Assign probabilities to different scenarios. Plan for the most likely scenario, but also have enough flexibility that you can adjust to results that are either better or worse than the most likely scenario.

Retirement planning is the process of determining retirement income goals and the actions and decisions necessary to achieve those goals. Retirement planning includes identifying sources of income, estimating expenses, implementing a savings program, and managing assets and risk.

Capitalstars is a SEBI registered investment advisor. Schedule a call with Capitalstars investment consultant or drop a mail at backoffice@capiltalstars.in and we will get in touch with you. You may also call us on 9977499927.

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