@Math_Rocks wrote:
So, my institution was reporting on our financial situation today and laying out projections for the next five years. Since I am heavy into budgeting and coming up with our own DMP, this idea really intrigued me. For them, they have a long history on which to base future income and expenditures. Whereas, our situation has changed multiple times in just the last two years! Is it worthless for me to try to do the same type of thing for our personal finances? If not, anyone have ideas for how to estimate things like increase in cost of living expenses, earnings on retirement accounts, etc.? I'm really interested in this for the encouragement it would offer. Things are tough right now, but I have hope that we will be out of CC debt in 3 - 3.5 years and will have recovered some of the losses in retirement savings. Based on their report today, I think I have a fairly clear picture of what my income will look like over the next five years (my job is very secure) but DH starts a new job next week. We think it is a good fit for him and will be long term but, in the world we live in today, who knows...
Thoughts?
Well, project as best you can based on what you know. Some things you probably can estimate partly from past history. For instance suppose you bought a used car three years ago and plan on keeping it for at least the next year: you can take all repair bills over the last 25 months, divide by 24, then add another 10% or so for aging of the car and that will be pretty close to what you should budget for car repairs (realizing that in many months it will be zero and occasionally there will be a month with a major repair, so in any month when your car does not require fixing you should be putting X dollars away in savings to cover when it does need work).
Other things, as you note, cannot be estimated as accurately. With your math background you can think of it as a statistical problem in maximum likelihood estimation where for each number you have your best prediction and a range of uncertainty. The key thing is, adjust those things you can control such that even if the things you cannot control fall towards the worse end of the plausible range you'll still come out OK overall. So the more uncertain some number is, the more breathing room you need to have in your assumptions about that number!
I have been known to lay out a matrix of scenarios, assigning estimated probabilities to each scenario and then weighting each one in my final result accordingly. I basically handle money the same way I do my scientific research: incorporate all data and all domain knowledge and factor in the uncertainties.
Message Edited by MattH on 08-21-2009 04:43 PM
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