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Personal Finance Planning

When you don't know what the future holds, it makes sense to have a few options up your sleeve. 'Scenario planning' can be a useful addition to your personal finance toolbox.

'Past performance is not necessarily a guide to future performance.'

I'm sure you will have seen this disclaimer in advertisements for stock market-based financial products. It's equally true of other financial areas. Your house may have gone up over the past twelve months, but it won't necessarily continue to do so over the next few years. Interest rates are low now but they could well rise steeply in the future.

When it comes to our personal finances, there's no absolute knowing where they might be heading over the next few years. As movie mogul Sam Goldwyn once famously said: 'It's difficult to make predictions, especially about the future.'

Back in 2002, a friend of a friend who was going abroad for a couple of years decided to sell his house. He had seen a growing number of reports in journals like The Economist predicting an impending implosion of the property market, and he decided the canny thing to do would be to sell up and pocket the cash before the crash.

He was wrong. House prices continued to surge and he found on his return that his old house had risen in value by around £150,000 while he had been away. Although his cash had earned a reasonable amount in interest he couldn't afford to buy the house he had owned two years before.

Let's be careful. The moral of this story is not that inaction is the best strategy. The moral is that managing our personal finances effectively requires us to make choices and decisions about what might happen in the future.

This is not just conceptual stuff. Perhaps you know somebody who is planning to sell their house when they retire in two years' time. They have to make a very real, very significant assessment of where the house market is heading in the near future. They need to probe and challenge their assumptions, and to ask the 'what if.?' and 'why not.?' questions.

This is the basis for a technique called scenario planning which describes a process of constructing a series of possible future realities and examining the ramifications of each scenario.

Good scenarios help us to question our assumptions about the future. We can't guarantee always to get it right but, when it comes down to it, the benefit of scenario planning is not a more accurate picture of tomorrow but better thinking about the future.

Our financial futures may be unknowable, but they're not unmanageable. The more options and choices you have available, the better equipped you are to handle whatever the future throws at you. If you only have plan A and maybe plan B at a push, your options are very limited. Which reminds me of my favourite Woody Allen quote: 'More than any other time in history, mankind faces a crossroad: one path leads to despair and hopelessness, and the other to total extinction. Let us pray we have the wisdom to choose correctly.'


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