Sunday, July 23, 2006

Principle #2 - Have a Back Up Plan

I previously wrote that having a plan was a fundamental part of financial planning and investment. Even with the best plan in the world, things can and will go wrong. The blue chip growth stock you purchased ends up in Chapter 11 (Enron) , the market drops 20% in a week (October 1987), the stock market experiences a 14 year decline (Japan) etc. Bad things happen in the world of finance just as they do in other parts of our lives.

Spending some time thinking about things that could go wrong and having a back up plan to deal with contingencies is also a good idea. Having a back up plan serves at least three useful purposes:

1. it preserves self confidence. When your investments head south, it is not only the balance sheet that suffers. If there is one thing that investors and do it yoursef financial planners must have, it is the confidence to back their own judgement. Without that things get a lot harder. Stress levels would probably go up as well;

2. if the back up plan is good, then your ability to react quickly and appropriately will be enhanced. It is easier to make sound decisions when you are not experiencing the stress of an investment turing out badly than when it was all gone horribly wrong;

3. preparing a back up plan forces you to look hard at the risks associated with your financial planning and investments before you put your money on the table.

An example of a back up plan for a long range financial retirement plan is here .

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