Mark Riepe: Welcome to Financial Decoder, an original podcast from Charles Schwab. I’m your host, Mark Riepe.
This show is a companion to Schwab’s Choiceology podcast, which shares stories of irrational decision making from a variety of fields.
Decoder is different. We break down the cognitive and emotional biases that influence your financial decisions and offer strategies to help mitigate those biases and improve your financial outcomes.
We all have goals in life. Maybe your goal is to purchase an RV and spend your retirement visiting all 60 U.S. national parks.
Maybe your goal is to pay for every expense of your twins’ Ivy League educations.
Maybe you want to go to a yoga retreat for a month in Costa Rica.
So let me ask you a question: Whatever your dream, can you, right now, identify the concrete steps that you need to take in order to actually achieve it?
If not, it’s probably because you’ve never taken the time to document your goals and how you intend to accomplish them.
There’s clear evidence that the best way to achieve your financial goals is by starting with a plan. Think of it like a roadmap to your goals.
Unfortunately, planning isn’t popular.
Among respondents to Schwab’s Modern Wealth Index survey, only 34% of Millennials have a written financial plan.
That’s a low number, but believe it or not Millennials score much better than Gen Xers and Baby Boomers, who only managed to clock in at
In this episode, we’ll look at several of the biases that can prevent you from creating—and sticking to—a plan even though it’s in your best interest to do so.
I live a half-mile from a grocery store. Now, given how close it is I don’t spend a lot of time planning my trips there because the cost of forgetting something and having to go back isn’t a big deal.
I also have a Costco membership.
With zero traffic it takes 30 minutes to get there, and the Bay Area never has zero traffic. When someone in the family is making a Costco run, there’s absolutely some planning involved to make sure we maximize the usefulness of that trip.
That’s a trivial example, but planning for your financial future is not trivial.
Suppose you overestimate the amount of extra money you’ll have in the future.
Then you might be likely to buy a more expensive house or car now and saddle yourself with extra debt and the payments that come along with it.
The first reason that planning matters is that it tends to work. By that I mean there’s empirical evidence that the willingness to engage in planning leads to greater wealth accumulation.
Why is that? Well, people who plan tend to do a better job of budgeting, which in turn leads to better control of their spending and saving. People who plan also notice problems earlier and are able to correct them more effectively, compared to people who don’t have a plan.
The second reason that planning matters is that it helps mitigate the bias of narrow framing.
Think of framing as the way a decision is presented. When using narrow frames, people tend to look at just one piece of the puzzle. Adopting a broader frame makes it easier to see the big picture.
A good plan takes a comprehensive view of your entire financial life, and by its very nature will look at tradeoffs between multiple goals. For example:
- Saving for retirement down the road vs. paying for college now
- Spending on an elaborate vacation vs. short getaways or other entertainment
- Investing in a home remodel vs. replacing a car still in good condition
Planning’s a good thing, and you can’t plan unless you get started, but planning effectively is a great thing.
Unfortunately, there are additional mental biases that cause people who are in the midst of planning their financial futures to create plans that aren’t nearly as helpful as they could be.
Optimism bias refers to a tendency to have a rosier view than is warranted when it comes to thinking about the future. Think of optimism bias as a general sense that things will be just fine even if the facts suggest otherwise.
How many times have you been told by someone “Relax, it’ll all work out in the end”?
Maybe they didn’t really believe that everything would work out, but in most cases I think that they were being sincere in their advice.
Some of that sincerity is fact-based, but some of it is colored by an innate sense towards the positive when we think about the future.
This tendency towards optimism extends into the realm of personal finance as well. And research studies bear this out.
From 1978 to 2015 a cross-section of Americans were surveyed every month about how they expected they would do financially over the next year.
In 435 out of 456 months, the majority of respondents believed that their financial fortunes would improve.
In particular, these researchers find that individuals tend to underestimate the future growth of their expenses.
When planning, this matters because if you pay too much attention to just your personal income statement—and not the expense side of the ledger—then you could run into a problem.
This inherent optimism also can intersect with something called the planning fallacy.
That’s our tendency to underestimate the time it will take to complete a task despite knowing that similar tasks have, in the past, taken much longer.
For example, I’m not a golfer, but I know enough about golf to know that each club in the golfer’s bag is optimized to hit the ball in a certain way from a certain distance.
One of the decisions you face when playing golf is picking the correct club for the shot that you’re about to take.
It turns out that golfers routinely pick the wrong club. That’s not news.
What is news is that they’re making a mistake when it comes to club selection in a systematic manner. In other words, there’s a consistent pattern to the mistake.
When deciding which club to select, golfers appear to think about the best and longest distance they’ve ever hit with that club and assume they’ll do it for the shot they’re about to take.
But how often do we perform a task perfectly? Maybe you’re different, but for me it’s not that often.
And golfers are no different and so golfers routinely end up hitting the ball short of where they want it to be. What they should do is pick the club based on the average distance that they usually hit with that club.
The applicability of all this to planning is you need to be realistic when sitting down to chart out your future.
Fantasies are nice, but a plan built on fantasies isn’t so nice when reality starts to intrude.
I’m joined now by Chris Thom. Chris is a Certified Financial PlannerTM who heads up Schwab’s Planning & Portfolio Group, which advises on $110 billion worth of assets in offers like Schwab Private Client and some additional planning specialist teams. Chris, welcome to Financial Decoder.
Chris Thom: Thanks, Mark. It’s great to be here with you talking about this important subject, one that I’m particularly close to with our employees who serve clients.
Mark: So, Chris, we started off this episode talking about how investing is a means to an end, achieving specific financial goals, but not an end in and of itself. You live that reality every day. Is this interconnectedness, is that a new concept with most of the clients that your team is working with?
Chris: You know, Mark, I think it is. It’s relatively new just over the last five years. And if you think about the industry context and where we’ve come from, we’ve come from a world that’s really been focused on investment acumen first. And stock selection is primary value-add activities, and the real transition that’s happening is … and, quite frankly, what you describe in your opening, is this new reality that helping our clients achieve customized goals is the way that we’ll be adding value into the future.
Mark: So the days of the kind of the cookie-cutter financial plan, those are gone. Really, it’s now about coming up with specific solutions for specific people.
Chris: That’s exactly right. We’re seeing the change towards being able to add really credentialed advisors and putting them in positions to provide that specific advice is really what our clients are asking for.
Mark: We talked a lot about planning just sort of in general and we gave some examples of planning elements, but give us a little bit more complete picture of what constitutes a plan, what are sort of those foundational elements that every plan should have?
Chris: Sure, Mark. A basic foundational plan should always include five key areas. Number one, an overview of the client’s net worth, essentially their assets minus their liabilities. Number two, it should include an overview of the client’s cash flow. For example, do they spend less than they make? How much is being saved? How much are they paying in taxes? Number three is an overview of the client’s goals, such as their investment portfolio, buying a home, saving for college, planning for retirement, etc. Number four would be a probability analysis to see how are varying market returns going to impact the client’s likelihood of achieving their success? And then last but not least, a customized action plan that outlines specific recommendations that help the client improve their overall financial security. So that would be the foundational level of planning.
Mark: Well, I’m going to try to grossly simplify this even further. So where you’re trying to go, what resources do you have right now, and how are you going to get there.
Mark: So what do you think, in your experience, what are the barriers to kind of getting going? Why aren’t more people making this happen?
Chris: Mark, we see two key barriers really preventing clients from beginning this process. I think, number one, is the reluctance, the feeling of “I haven’t done enough.” And so maybe at some form that’s embarrassment of “What decisions have I made in the past?” and “Am I going to be OK?” and “Do I really want to share my personal situation with somebody outside of, you know, myself or my spouse, our family?” and having that transparent conversation with someone who can help. The second barrier that we see is oftentimes a fear of cost, and sometimes clients will perceive that the financial-planning process is like going to a very high-priced estate planning attorney. And the reality is there are so many very, very low-cost and affordable ways to conduct financial planning at Schwab that that really shouldn’t be a barrier either.
Mark: So some of these items that you just mentioned, presumably some of these goals and some details of their situation are more important than others. So how do you … do you just try to tackle everything all at once or do you try to rank-order these things in terms of probabilities, or priorities, and then address them?
Chris: Yeah. So from our perspective, the way we look at a client situation is, Mark, we’re trying to evaluate how do we improve the client’s overall financial security? So, to us, what that means is “What are the issues that are most significant to that client?” And we use a framework. We call them the wealth management issues. We’ve used this framework of wealth management issues to prioritize. So to give the listeners some examples of what that could look like: investment planning, risk management insurance planning, retirement planning, estate planning, etc. And we try to look at what are the risks that maybe aren’t addressed, and present the client with the most risk upfront, and we tackle those first. I think one of the things that we’ve seen throughout time is that clients can’t process an action plan that includes 15 or 20 things on that list, and we can overwhelm them through the financial-planning process. And so our goal in creating customized advice is to rank-order and prioritize those issues and tackle two to three a time.
Mark: And how specific do you get in those discussions? You know, does it … how customized, I guess, is maybe my question, how customized does that have to be in order to really be useful?
Chris: We’re on a mission right now to make our advice even more customized and actionable. So I’ll give you a couple of specific examples.
First and foremost, a lot of the financial-planning technology that exists today really uses general rules of thumb. Consider having an emergency fund. Consider life insurance. Consider having an estate plan. And we want to take that one step deeper, and if we’ve done an effective job of discovering what our clients’ current situations, goals, feelings, future, family, business dynamics, if we understand those, then there should be no reason why we couldn’t provide a specific recommendation. So, as an example, if I was talking to a client and I had done an effective discovery meeting with her and really understood her needs, and I uncovered that she needed more life insurance, I would say, “Ms. Client, I strongly recommend, based on all that you shared with me, that you purchase an additional $500,000 of life insurance. Why? Because your goals necessitate that, and your premature demise could really, you know, land your family in a difficult financial predicament. And so based on that need, I recommend that you go purchase the coverage.” Now, thankfully, we at Schwab have opportunities and ways to resource that out to help the client find a life insurance solution in that specific case, but we want to at least call out that specific amount and address that need.
A next one might be if a client has never seen an estate attorney and never created a basic estate plan to include a will, living will, powers of attorney, etc., we would recommend that they go do that. There’s no interconnection with Schwab in that case, but it’s the right thing for the client’s overall financial security.
So those were a couple of quick examples of how we’re trying to be more specific.
And then how that plays out is we want to put that in writing to the clients. So in some ways we’re able to post that on Schwab.com for clients, and sometimes it could be as simple as an email to the client, saying “These are the two to three things we strongly recommend you go consider pursuing first.”
Mark: So how do you avoid the situation … because I think we’ve all been in situations where we’ve worked with a professional, whether it’s … you know, it’s like an attorney or a doctor or somebody, a landscape specialist, we get a list of to-dos, we go home and we implement, you know, a tiny fraction of what’s on that list. So how do you prevent that?
Chris: Yeah, it’s a terrific point, and the planning process can feel overwhelming at first. So the real science and the art behind how we operate within our teams is to make it digestible, so to focus it with priority on what are the items that present the most risk, address those, and then we have to use the remaining items that we’ve haven’t been able … so as an example, if we tackled life insurance, and we tackled, you know, overall risk management insurance issues with the client, but now it’s time to move forward and really talk about college planning, and now it’s time to talk about beneficiary designations, etc., with those types of topics after we’ve had success getting the first couple knocked out, now these remaining items can really serve as the agenda topics for future meetings. And so the goal for our team is to keep a running list of what work has been accomplished towards helping improve that client’s overall financial security, knowing that it will take time to do that.
Mark: So rather than, you know, start with this laundry list of everything, it’s much better to focus on a few things that are, you know, sort of quick wins that we can get done right now, and then gradually, almost kind of spoon-feed in all these additional … these additional needs.
Chris: That’s exactly right.
Mark: We’ve got thousands of planning conversations going on right now with different types of clients. Inevitably, there’s going to be some tradeoffs that need to be made. You know, people can have a really long list of goals, but, you know, limited resources. So what are the most common tradeoffs that sort of real people struggle with?
Chris: There are a number, and we serve a wide variety of clients with … whether they have a simple, or a complex, or somewhere in-between type of scenario. I would tell you that one of the things that we enjoy the most as planners is being able to help clients really evaluate pros and cons of different types of scenarios. And so, inevitably, we will present two or three possible scenarios based on what we’ve learned from the client and try to help them decide. But some of the really common questions and tradeoffs that pop up are, “Chris, can I retire two years earlier than I was expecting? And if I’m going to retire less, maybe we’ll actually take retirement distributions that are a little bit less than we first projected so that we could achieve that goal.” So that’s definitely one.
One of the other tradeoffs, and this is one that we see quite frequently, is “What kind of school can my child or grandchild attend?” And so the evaluation of 529 savings and other types of education savings for a public institution versus a private that are tremendous differences and impact to a financial plan.
And I think one of the … one of the other areas, one of the other tradeoffs that’s really coming up even more frequently, especially over the last decade, is clients purchasing a second residence, a vacation home, and really thinking about, you know, “Could I do this?”
Now, it’s not necessarily a tradeoff, but there are also some other impacts to a financial plan that clients maybe aren’t thinking of that we really want to bring to the forefront. So a perfect example would be how to plan for healthcare in retirement. And so clients often come to us and say, “Should I buy long-term care insurance?” And what we try to help our clients do is to inform them as to, “Well, if we don’t buy the insurance we could have a $300,000 to $600,000 expense that happens at some undetermined point in your future.” And you’re right—if you qualified medically, you could purchase a long-term care policy that would prevent having to dip into that portfolio. And so really trying to illustrate those types of tradeoffs, as well, so clients can understand them.
Mark: No, that’s a nice lead into my next question. Earlier, we were taking about people generally are prone to optimism, and one consequence of that is they may have some blind spots and not really thinking about some … you know, some negative events that might happen. Are there some … are there some other … you know, in addition to healthcare, are there other blind spots that come up again and again that are important, but people haven’t really thought about on their own?
Chris: Absolutely. We’ve alluded to a couple of these already, but first and foremost, so many clients come to us, and particularly higher-affluent and high-net-worth clients, they come to us and they’ve been extremely focused on portfolio returns. And, quite frankly, that’s what the industry, that’s what we as an industry, combined industry, have really led our clients to over the last several decades. And the real change now is to be thinking about what are the areas that present risk to an overall situation? So as example, does it matter if you’ve got a 10% or a 12% portfolio return, but yet didn’t have a life insurance strategy in place, or didn’t have an estate plan in place to help with the transition of assets at death? And so many times clients have not addressed those two key issues. And so as our advisors meets with clients, right upfront they’re saying, “Hey, you know, we can… we’ll talk about allocating the portfolio, and we’ll talk about some of the aspects of diversification and managing your aggregate asset allocation, but we have to start here first with these protection issues, because without those in place, your family is at risk.” And a lot of times, particularly with mid-career professionals, they’re very surprised at what the risk is from a life insurance perspective. A single income family, they’re most at risk. Dual income, a little bit less risk, but it’s still an important issue to tackle. And I would say across the industry, the ability to really assess a client’s needs in the realm of insurance is … that expertise is lacking. And so as financial planners, as advisors at Schwab, we want to help just illuminate those issues for clients, so they could just better understand the risks. But those are the two biggest surprises.
Mark: You earlier talked about … you know, you tried to kind of lay out, you know, kind of the high priorities and then you sort of moved down the … moved down the list. How frequently are you kind of getting back to clients and are having these conversations? Is this an annual thing, is it biannual, or is it on an as-needed basis?
Chris: So, first and foremost, there’s a macro trend that’s happening across the industry, and, thankfully, it’s impacting technology and, you know, providers of financial planning have really helped us with this, but planning is no longer static. The transition we’ve seen is it’s now a dynamic process, and we want planning to be even more dynamic.
So to illustrate, in times past, and if I think back to when I was an entry-level financial planner, we actually presented a book, Mark. And it actually had … it had gold … it had gold pages, it had three … it had three rings, and it had content that was immediately obsolete as soon as we hit print, and we used to charge quite a bit for it. Today’s conversation, and thanks to technology, we’re able to aggregate a client’s overall, you know, portfolio, assets from … you know, at Schwab, outside of Schwab. We can pull that all into one picture, and it can help us to update the plan very, very quickly just by asking the client some additional questions.
So if you remember our framework of simple to complex with a client’s overall situation or somewhere in between, that could really drive when planning conversations could be needed or a plan update could be … could be needed. As a general rule, I think every one to two years would be a great opportunity for clients to update a plan. But as clients go through different life events, especially … and it seems like, Mark, you know, you and I have talked about family in the past, that life events can come in twos and threes. It’s very rarely just one life event at a time. And so if there’s a birth or a death, or all of a sudden there’s a need to stop working, or if there’s, you know, any number of situations that could pop up, we want to talk with that client and really help them understand the impact to their situation.
So when in doubt, reach out to us and we can help to do that. But I think at least once … one to two years would be a great general rule of thumb to keep in mind.
Mark: Right. But thanks to the technology, really, there’s … it’s almost like so many things in life, it’s moving to more of a real-time basis, deal with the situation as it arise … as it arises, as opposed to some, you know, kind of somewhat arbitrary review cycle.
Chris: That’s exactly right. You know, we’ve really tried to look at planning through the client’s eyes, and one of the things that our clients have told us is they want to have more control in that planning process. And so for a lot of our clients, they actually have access to tools where they can go create scenarios themselves, and go into the financial-planning software, and … we call it the play zone. And they can look at different scenarios and see, “Gosh, what if I wanted to adjust my retirement age?” or “What if I added a wedding savings goal?” And as a dad of three kids and two daughters I think about that all the time, you know, having specialized goals like that. And you can actually go do it and model that without ever having to talk to anybody at Schwab. And so I think it’s that combination of the self-directed nature, giving clients a lot of autonomy on how to think about planning on their terms, but then we want to be that trusted advisor to help them navigate those decisions.
Mark: Chris, this has been fantastic. I mean, so often discussions about planning are, you know, kind of either, you know, the 100,000-foot level, or they’re sort of very touchy-feely and they’re not, you know, really … really concrete. So it’s great to be able to talk to someone who is actually in the trenches on a daily basis working with real people with real problems.
Chris: Well, thanks for the opportunity to be with you, Mark. I think all of our clients can benefit from a planning conversation of some kind, no matter the complexity of your scenario. And we’ve got professionals here serving in a fiduciary capacity who can help to really provide that specific guidance, and we look forward to doing that however we can.
Mark: Great. Thanks a lot.
Chris: Thanks, Mark.
Mark: At the beginning of this episode, we talked about how so few people have documented financial plans. Now, let’s consider why that might be, and what you can do to overcome barriers to effective planning.
In many cases, people are either just not intuitively thinking about the long term, or they have a hard time visualizing their future beyond a year, and so planning doesn’t happen. This is a great example of present bias. The costs of the time and effort to prepare are immediate and real, but for many people the benefit is far off and vague, so often, the challenge is just getting started.
One technique that has been shown to help in other areas is to break the task into clear, discrete pieces that aren’t too complicated and to find a way to create specific reminders to complete each of these tasks. For example, instead of the task being Create a Financial Plan, instead, break it into pieces like List and Rank My Goals, Attach a Price Tag to Each Goal, Determine Where My Money Goes Each Month, Find An Online Resource That Can Suggest the Savings Rate I Should Have. You don’t need to do it all at once. In fact, it’s probably better if you don’t do it all at once because it will seem overwhelming and you’ll never get around to it. Instead, set aside a small amount of time each week and work on one part. Use a reminder tool, and don’t forget to reward yourself a bit as you complete each task.
Another way to stay grounded in reality is to pay attention to base rates. Use them instead of overly optimistic projections for things like your investment returns or likely expenses. Think of a base rate as the normal or average rate at which something happens. For example, let’s imagine you’re planning to take a vacation three months from now to a place you’ve never been to. What are you going to wear? That depends in part on the temperature. You probably have weather forecasting app on your phone, but those usually don’t go out more than 10 days or so. One approach is to find a resource like Wikipedia and look up the average temperature and weather based on historical statistics. It isn’t a forecast, exactly, but it helps ground your expectations in some sort of an objective reality. It gives you a starting point, and you can refine your forecast with more detailed information as you get closer and more information becomes available.
Retirement is the number one goal for most people, so let’s think about base rates with respect to retirement planning. For instance, how much should you plan to spend on travel? One approach is just to think about it yourself and then make a prediction. Another approach is to start with the base rate for retiree travel and then adjust it based on your own circumstances. Many people don’t plan on retiring completely, they want to continue to work some, and that’s a great idea. But rather than just assuming that will happen, do a little research into how often retirees actually work. Doing so will give you a bit of a reality check. I like using base rates because they help to mitigate a whole bunch of biases that plague people when they’re forced to make these kinds of predictions.
I also like using base rates because they work. One study asks subjects to make long-term predictions about their future, such as whether they would likely change careers, or change political views, or pursue future education. It turns out that the subjects could have vastly improved their forecasting accuracy if they paid attention to base rates.
The final tip I want to share about making plans as effective as they can be is to ensure that your plans and goals are specific. Specificity helps because it makes plans easier to monitor and easier to complete. For example, losing weight is a goal many, many people have, but vaguely intending to lose weight isn’t the same as an actual plan for doing so. A better goal and plan is to lose five pounds in the next six weeks with, say, particular dietary changes that are realistic. It’s clear, it’s specific, and you can get unmistakably accurate feedback as to where you are on a frequent and regular basis. Planning is hard when the goals are vague. People tell me all the time that their goal is to live comfortably in retirement. What does that really mean? It’s a nice vision, but you need to put some meat on those bones.
Let’s face it, most plans are going to require time and effort to make achieving the goals possible. The elite athletes don’t achieve their lofty status without thousands of hours of often lonely practice. They put in the time because they have a vision of future success. Similarly, the more effort you put into visualizing your financial future and your specific financial goals, the more connected you’ll feel to your future. That degree of connectedness will drive you to develop a workable plan and commit to your plan in order for a payoff down the road.
Thanks for listening.
We have more information about getting started planning at schwab.com/ChartYourFuture.
If you want to learn more about the details of planning and how you can achieve your goals, there are retirement calculators and other helpful tools available at schwab.com/planning.
And you can talk to Schwab about creating—and sticking to—a financial plan. Call us at 800-355-2162 or visit a branch near you.
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For important disclosures and a transcript, see the show notes and schwab.com/financialdecoder.