Collisions in personal financial planning occur when competing priorities or circumstances force difficult trade offs in the allocation of resources. They can, however, be reduced by paying careful attention to the unique backgrounds of group members, by planning well, and by taking a collaborative approach to create a solution that all parties can live with and support.
Examples of collisions in financial planning are spending on immediate essentials like food and housing against long term savings for retirement; discretionary spending like a vacation against reducing a debt; incurring debt against investing or saving; and spending on children’s tertiary education against buying an additional asset.
Although financial planning collisions occur in groups, notably families, they also occur in the lives of individuals. Thus, there may be some differences in how they can be avoided and remedied.
In the case of individuals, their short term goals may collide with their long term goals. Spending to satisfy the desire for immediate satisfaction, for example, may lead to the incurring of debt, including expensive credit card debt, which can seriously compromise the ability to achieve long term goals.
Unforeseen circumstances – job loss, medical emergencies – may make it necessary to divert funds earmarked for long term benefits like education and investments, in the absence of adequate savings and funds for emergencies. Though not fatal, these may stall the achievement of important investment goals. At the other end, optimism bias may cause losses due to over exposure to too much risk.
Behavioural and emotional biases may also lead to decision making that conflicts with the best interest of the individual. For example, loss aversion may cause a delay in selling under performing assets.
Individuals who recognise the disconnect between aspects of their financial plan can still make changes to it to make it coherent.
Financial disagreements happen between individuals in groups for several reasons: differences in financial values and emotional connections to money; different communication styles, such as one talking openly about money and the other being reticent; one worrying while the other does not; each having a different background and family culture; and preferring different types of debt – short term against long term, or debt to fund investment against debt to acquire personal items.
Given the above differences, personal goals often collide with the goals of the group, which may cause ongoing conflicts if they are not brought into alignment. Collisions also come about due to differences between short term goals and long term goals.
Plan together
To reduce the risk of collisions in relating to money, it is worthwhile for the parties to talk about their background, plan together, identify shared goals, and check in regularly – for example, having a financial fun night, which would combine fun activities with practical money discussions.
Within the family, the following may be done to reduce the risk of collision: have regular discussions to discuss priorities; focus on shared goals; set spending thresholds; set timelines for accountability; categorise expenses; and separate needs from wants.
Through discussion, the family unit can establish financial priorities by recognising shared values, and arrive at a unified budget to provide for essential family support while advancing its long term objectives. Discussions must be ongoing to assess progress and make adjustments where necessary.
Financial planning is about trade offs between competing financial priorities. Trade offs are necessary because there are competing priorities for finite financial resources, and giving priority to current needs can reduce future security. The end game is to make the most satisfactory choices in each situation. This is why collaboration is so important.
A financial plan is more than money management, investments, and budgeting. It is also about insurance, estate planning, retirement planning, and tax planning, so they should be managed to avoid collisions.
Collisions should be avoided in life insurance by selecting the type of policy that best meets the needs of the insured and the beneficiary. Term insurance, though providing good coverage for relatively low premiums, does not generate cash or investment values, which can generate income for retirement or may be used as security for loans. As such, term policies cannot contribute to the achievement of some important goals.
Beyond that, failing to select beneficiaries carefully can cause serious family conflicts and may even make it necessary for other assets to be used to benefit beneficiaries needing support, possibly interfering with other goals.
No estate plan, or a poor one, can cause serious delays and expenses in the distribution of benefits, thereby making it necessary to care for those in need from other resources or cause them to go without.
Poor retirement planning can lead to inadequate resources to fund retirement, making it necessary for family members to divert funds from other sources to fill the gap, or for the retiree to convert long term assets to provide for day to day living expenses.
Collisions in financial plans are real due to people’s psychological make up, family history, unexpected circumstances, misaligned goals, and poor planning. The sooner corrective action is taken, the better.
Oran A. Hall, author of Understanding Investments and principal author of The Handbook of Personal Financial Planning, offers personal financial planning advice and counsel. finviser.jm@gmail.com
