Social Security has been in dire financial straits for years, with the imminent exhaustion of the Social Security Trust Funds inexorably approaching year after year. Still, new studies from academics at two Ivy League institutions took many by surprise, with their findings pointing to systematic problems in the projections that the Social Security Administration's team of forecasters have made over the past 15 years. Unfortunately, the reaction to the studies has distracted from the true lesson everyone can learn from their findings: relying on estimates with purported pinpoint accuracy always carries unnecessary risk, and a flexible approach is more useful in guiding your own decisions.
What the Harvard-Dartmouth studies said
Researchers took on the monumental task of back-testing the SSA's past projections about the future of Social Security to determine how accurate its findings were. As fellow Fool Sean Williams discussed in more detail last week, the studies suggested that Social Security is in worse shape than its recent projections have indicated, with forecast models having proven biased toward unrealistically optimistic outcomes for the federal program over the past 15 years or so. In addition, the studies called into question the accuracy and predictive value of the SSA's projections regarding the impact of policy changes on the program, characterizing policy debates as being "informed by something that's basically random noise."
It's certainly true that advances in statistical analysis have enabled new techniques that could improve the accuracy of future predictions about Social Security. Using technology to gain a better understanding of the interrelationships among different variables within the SSA's models could remove potential biases and make forecasts more reliable.
The fallacy of a perfect future
Yet the bigger issue involved here is the fallacy of the search for precision in the first place. As helpful as perfect predictions might be, reality tends to throw wrenches into the works, and overly relying on pinpoint forecasts can make your thinking dangerously inflexible.
Already, the SSA acknowledges there is huge uncertainty about Social Security's future. The best-known projections for the Trust Funds to run out of money in 2033 come from the SSA's intermediate set of assumptions, but the agency also uses low-cost and high-cost models. Under the high-cost model, which incorporates lower fertility rates, longer life expectancies, higher unemployment rates, and lower interest rates, the Trust Funds could run out of money five years sooner in 2028. Under the low-cost model, by contrast, the Trust Funds might survive throughout the 75-year period of the SSA's forecast without ever hitting zero.
For policymakers, these uncertainties are hard to handle. When projections turn out to be untrue, they erode confidence in the forecasting process overall, making it difficult to convince people of true threats by the time they become incontrovertible.
Retirement savers face similar uncertainties all the time. Retirement calculators will happily let you input projected rates of return and spit out numbers down to the penny telling you how much your retirement savings will grow decades into the future. Yet as we've all seen on multiple occasions over the past 15 years, reality is never as tidy as a smooth average annual rate of return projections. Even methods such as the Monte Carlo analysis, which aims to incorporate natural volatility into saving and investing decisions, can't guarantee that the future will resemble the past closely enough to make past performance applicable to future results.
The best planning for your finances
At first, the idea that you can't be exact with your financial plan can be frustrating, as it suggests that all your efforts might prove unsuccessful. Yet once you acknowledge that you can't perfectly predict the future, you can see the value of being more flexible in your financial planning, and it can free your thinking about money matters. Unexpectedly bad times can put bigger challenges on your finances than you're comfortable with, but unexpectedly good times can open up new opportunities. Being prepared for both possibilities can give you much more confidence in your financial future.
Social Security will most likely require reform at some point, and you should be ready for the inevitable fallout that results. For your own retirement prospects, though, looking beyond hard-and-fast forecasts of future conditions and adopting a more realistic approach to your money will give you the best chance of enjoying your golden years to the fullest.