Beginning in the 1870s, a new school of philosophy was being born. It would come to be know as Pragmatism. Philosophers love to ask questions and the main questions being asked in Pragmatism involve use. For example: How useful is an idea to you? What is the “cash-value” of a belief. Charles Sanders Pierce, who is considered to be one of the “founding fathers” of Pragmatism, summed up his philosophy with the following statement: “Consider the practical effects of the objects of your conception. Then, your conception of those effects is the whole of your conception of the object.” A pragmatist would argue that because so many questions in life either don’t have empirical evidence to help answer them or have so many suitable answers, that one should not concern him or herself with whether a belief is true or not, but rather, is it useful?
There are many questions that arise during financial planning that can have many suitable answers. Pragmatism can help us navigate the complex choices we must face in planning our financial future. There are many topics that don’t have easy answers and the conclusions that are reached are often fully dependent on your personal situation. Take risk tolerance for example; determining the appropriate portfolio allocation involves making assumptions about the future of investments like stocks and bonds. We can assume that a portfolio of all stocks will be very volatile at times but will produce the greatest returns over a long period, perhaps 10 years or more. Is this the right portfolio for you? How useful will it be to you? Well, if you are relatively young, let’s say in your 30’s or 40’s, and you are making regular contributions, then because of dollar coast averaging, this portfolio could be very useful to you. In contrast, if you are nearing retirement then it is most likely not useful. If the portfolio is down 40% in the year you would like to retire (a real possibility with a portfolio of all stocks), then this is obviously not a good thing and not very useful.
Another aspect of financial planning that involves personal considerations is Social Security. There are some questions we can ask that will have straightforward answers: Will you retire before your full retirement age? Are you eligible for a spousal benefit? What other sources of income will you have in retirement? But there are other more ambiguous questions we can ask, like how much faith do you have in Social Security? If you should die young, do you mind that all of the money you paid in over the years disappears? Afterall, your Social Security benefit has no estate value, you can’t pass it on to your heirs. With these types of questions, it may be more helpful to approach them through the lens of pragmatism. So instead of asking will the government cut benefits in the future, let us ask: Is your belief that the government will cut benefits in the future useful to you?
Assuming your social security benefits will be cut in the future is a very conservative approach to financial planning. There are additional ways to “hedge” a financial plan: you can assume a greater rate of inflation, or project lower rates of return on your investments. A plan where everything has to go right might not be very useful. When we hope for the best but plan for the worst, we are essentially admitting that we cannot predict the future. So, the next time you examine your financial plan, ask not if the plan is true in the sense that it is a model of how your life will actually pan out, but instead ask, is this model of my financial future useful?