Want to Reach Your Financial Destination? Build In Room for Error

Summer is here, with its warmer days, later sunsets, and the opportunity to step away from it all for a few days here and there. Whether you are heading to the beach for an afternoon or planning an extended vacation, chances are you’ll be making travel plans sometime soon. And when you do, you’ll have a better chance of a successful trip if you follow the number one rule of travel: build in room for the unexpected.

When it comes to vacations, creating that cushion of time can make all the difference between watching your ship sail from the pier because you arrived late, or sipping cocktails from the deck.

It’s why smart travelers arrive at the point of departure the day before sailing, or build extra time into a drive for unexpected traffic. It’s why airplanes need a runway designed with more than enough room to land safely. And it’s why, in the financial world, smart investors use the same strategies to increase their likelihood of reaching their intended goals.

Rules of the Road

As an investor, you are on a journey. Your destination is financial freedom, and you have a better chance of getting there with minimal stress if you follow some of the same principles that savvy travelers do.

That means planning for the occasional delay. When it comes to the stock market, we see that downturns tend to happen in one out of every four years. This trend has been the norm for about 100 years now. Importantly, however, the average positive returns are typically greater than the average negative returns. This means that not only do negative returns happen less frequently than positive returns, but when they do, they tend to occur at a lower magnitude.

What do we learn from this?

First, gains are more frequent and happen at a higher rate than losses, so in order to capture those gains, you have to stay the course even when temporary downturns occur.

Second, temporary downturns will occur, but they won’t derail or devastate us if we plan for them.

Room for Error

The backbone of a rational investment strategy is staying in the game so that you are there to reap the benefit of the majority of the years when there are positive returns. But this requires an acceptance of periodic market downturns happening on a regular basis.

How do we prepare for those downturns? We build in room for error. You can call it a cushion, or a buffer. You can call it a runway or a margin of safety. But at the end of the day, it’s really about contingency planning.

At N1 Advisors, we design your financial plans to withstand those downturns by building in that room for error. We help you create a margin of safety so you have enough to sustain you during those years that show negative returns – and are still there to benefit when positive returns make their inevitable comeback.

How we do that depends on your risk tolerance. We recommend having from five to 10 years of living expenses in assets that historically demonstrate less volatility than stocks – namely, cash and bonds. Once we determine how much of a cushion you feel you need, we design your plan to include a buffer that meets your level of comfort.

Accounting for the Unknown Unknown

Many people view creating a margin of safety as a conservative hedge in their investment portfolio. We view it as a tool that increases your odds of surviving and succeeding. It’s not so much about avoiding risk as it is about making provisions for the one in four years stocks aren’t generating positive returns – all so you can be there to capture the full return when they are.

Building that margin of safety into your investment portfolio is one way we achieve this goal. Another is to consider the “unknown unknowns” in retirement planning. You may, for example, live longer, experience a decrease in income or an unexpected expense, or incur a higher tax burden than anticipated. Using conservative estimates for these parameters increases your margin of safety.

Planning Trumps Forecasting

It’s our goal to help you build the resilience needed to reach that destination of financial independence. Incorporating a margin of safety into your plan will not prevent temporary market downturns, but it will ensure you are still standing for the upswings, and it will give you peace of mind for the duration of the journey.

When you have room for error, forecasting becomes irrelevant – which is good, because consistently accurate forecasting just isn’t feasible or practical as an investment strategy. At N1 Advisors, we’re proud to work with you on a plan that relies not on guesswork but on sound financial principles that take downturns and uncertainties into account, rendering them ultimately less consequential to your overall progress.