Planning

Is Financial Planning an Art or a Science?

Art is the triumph over chaos. 

~John Cheever

For many people, finance = math. It’s all about numbers and science and proven identities and historical performance. For others, it’s about psychology, emotion, and the endless possibilities that life has to offer. Who’s right?

Before we come to the inevitable conclusion that both are right – and wrong – let’s take a closer look at the case for each.

Finance As a Science

There’s no denying that the financial world is replete with incontrovertible mathematical realities. If you consistently spend more than you earn, you’ll end up in debt. Unless you can find a way to increase your earnings, that’s probably not going to end well. Simple right?

Well, sometimes. There’s an argument to be made that much of our current financial turmoil emanates from an excessive and grossly misdirected use of mathematics for the purpose of generating profits for financial institutions. We’ve mentioned the alchemy of derivatives here on many occasions, so we’ll just leave it there for now.

How about investing? A balanced portfolio of stocks and bonds held for at least 20 years and periodically rebalanced has historically (and statistically) been the best way to save for retirement. You’ve heard that one too, I’m sure. But what is a balanced portfolio? How often should you contribute, and what percentage of stocks, bonds and cash should you hold? When should you rebalance? There’s little to no agreement anywhere on these issues, although there’s no shortage of opinions – and conflicting studies to support them.

Certainly, calculations like interest charged (or better, earned!), amortization schedules, regular dividend distributions and average market index returns are quite scientific. There’s no debating the numbers based on these calculations. There are reams of data showing how difficult it can be for even the most experienced market watcher to consistently time the market correctly, but there are also plenty of studies showing that this or that asset allocation or approach has worked pretty well over time.

Some folks avoid financial planning like the plague because for them, finance = math. And math makes them break into a cold sweat, complete with post traumatic flashbacks of high school examinations. Others love the structure that a scientific approach to finance affords. They can recite historical rates of return and ETF tracking errors like a baseball fanatic throws out ERAs and batting averages.

The Art of Finance

Like it or not, life is unpredictable. So is the geopolitical landscape, the weather, your income, and stock market performance – not to mention your life expectancy. We can calculate statistics until the cows come home, but there are still too many variables in life and finance to have complete certainty.

How we account for all of these variables to cobble together a financial plan that works for us is indeed an art. Statistics can help with probabilities, but there are no certainties. Depending on your personality, you may be more or less comfortable with this reality – and that’s OK.

If you happen to be one of those folks who truly enjoys charts, spreadsheets, statistics, and all of the security that go with them, then they should play a larger role in your financial plan. You may just need to remind yourself every so often that even the most rigourous analysis can’t protect you from the vagaries of life or from capricious market moves. If, on the other hand, those same tools cause your eyes to glaze over, you’ll need to find another medium for your art. Perhaps you’ll use a simple paper and pencil budget or employ a more (or less?) active approach to investing.

The key is to create a financial plan that works for you. If you find a book or approach that promises to be the ultimate guide to the perfect financial plan, chances are it’s just one person’s idea of a plan that works for them. Better to read a selection of such books, taking a little from each and using those tools to compose a plan that works for you.

If you think of your financial plan as a painting, a piece of music or a literary work, you may begin to relax, embracing the uncertainty while creating a reasonably workable product. Your painting or song or book won’t look like mine. You may not like mine. I may not like yours. That’s the beauty of art.

Is your financial plan more a work of art or science?

Comments

  1. Jim Yih

    Another great post Kim! to share the words of Preet Banerjee, finance is 90% psychology and 8% math. I always tell people every decision is influenced by both emotion and logic. In my mind, the key to success is to rationalize with the logic, the math and the science. It is usually the art, the emotion and the psychology that causes people to do the wrong things.
    Jim

    • Kim Petch

      Thank you Jim. I would have to agree with Preet. Although putting too much emotion into your decisions (especially those involving investing) can steer you the wrong way, I think it’s also important to remember that most markets are indeed driven by emotion and should not be expected to behave rationally. Still, that shouldn’t stop us from injecting a little common sense into our choices. 😉

  2. Bret @ Hope to Prosper

    One of the things I have learned from talking to a lot of people about investing is they are intimidated by the perceived complexity. Something as simple as choosing a good mutual fund or ETF becomes overwhelming. This dicourages a lot of people from getting started investing, which is unfortunate. It’s really not that difficult.

    • Kim Petch

      Yeah. I think you’re right Bret. Finance can be as simple or complex as we want to make it.

      Thanks for your comment. 🙂

  3. Tom Napiontek

    Great post, Kim. I never really thought about finance as being anything other than science; but it definitely feels like the creative approach one must have to navigate certain situations is just like artwork. It makes it more fun to think about it that way, too.

    • Kim Petch

      Thanks Tom. Things change constantly in life and finance, but that doesn’t mean we can’t create a stable, yet flexible plan to deal with it.

  4. Tim Richmond

    This is insightful, and it shows that both business oriented people and more free-spirited art oriented people can make a financial plan that works. They just need to take the time to think about it in a way they can understand and appreciate.

    • Kim Petch

      Thanks Tim. That sums it all up perfectly!

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