The optimal financial plan does exist.
But what does “optimal” mean?
Let’s debunk the biggest myths around optimization and financial planning.
Before I joined PWL Capital Inc I had the opportunity to study under experts in the field of engineering and optimization.
We co-authored papers in some of the highest ranked journals in the field.
We applied optimization techniques to solve noise and vibration problems in the aerospace industry.
Then I joined PWL Capital Inc and have worked alongside some of the best financial planners in the country for nearly 5 years.
Here’s what I’ve learned.
Financial planners play the role of engineers.
They use software that performs numerical analysis to inform real-world decisions.
They need to understand the underlying theory well enough to ensure that the software generates a meaningful result (no garbage in = garbage out).
They need to understand the real-world implications of their analysis.
Now let’s get to the myths.
Optimal does not imply ‘universally optimal’.
There is no universally optimal financial plan.
Every scenario is different.
Rules of thumb can’t be applied across the board.
But that does not mean we cannot determine what is optimal for a given situation.
To perform an optimization analysis, you need a clear understanding of:
What does this look like in the context of financial planning?
Say you have a primary goal of spending as much as possible, and you want to retire between age 60-65.
Objective:
Variables:
Constraints:
To determine the optimal plan, you solve for the set of variables that maximize spending subject to the constraints.
However, the work does not stop here.
This leads to myth #2.
That is a misunderstanding of optimization.
In optimization, there are two key stages:
The numerical analysis software will spit out the mathematically optimal solution (stage 1).
It’s up to the engineer to ensure that the software is correct.
But that’s only the first half of the process.
The engineer must also ensure:
In the same way, a financial planner must ensure that the optimal financial plan can be adhered to and does not introduce inadvertent costs (i.e. extra trading costs, etc.).
If there is a $1 spending difference between plan A and plan B, plan A is the mathematically optimal plan.
But if plan B is easier to adhere to, or reduces costs in other areas, it is the optimal plan.
It takes the expertise of an engineer/planner to turn a mathematically optimal solution into an optimal design/plan.
This is all a part of the standard optimization process.
The requirement of human expertise does not discredit the optimization process.
The optimal plan is backed by a high-fidelity mathematical model and improved upon by an expert to capture practical considerations.
A simple plan built on rules of thumb and preconceived notions will always be limited by beliefs and rhetoric, even if they are well meaning.
Curious what an optimal plan looks like for you?
Let an expert design a plan tailored to your goals—book a meeting here:
