A new and useful idea is starting to enter the realm of financial planning. It's known by the catch-all phrase, "real options." Planners are applying it to investments, taxes, debt, insurance everything.
For every one of us, life events are unpredictable, including the length of life itself. Yet we're often asked to make decisions as if we know what lies ahead. That leaves us out on a limb, unprepared for change.
When you were young and questing, your parents might have advised you to "keep your options open." This new approach to planning builds on that common-sense advice.
When you keep your options open, you deliberately wait before making a final choice. Waiting is often smart, when the action you're asked to take is expensive or impossible to undo. As a simple example, you might wait to marry, because of the high cost of divorce.
I don't mean procrastinate, by the way. I mean deliberately delay a decision, in case your life changes or better choices turn up.
"Real-options thinking puts a high value on flexibility," says Glenn Daily, a fee-only life insurance planner in New York. If you have to make a decision, lean toward the choice that keeps more of your options open.
All this is pretty abstract. So let me give you some real-life examples of how real-options thinking works:
Case one. You're in your early 20s and earn a modest wage. Everyone says you should save for retirement, in an IRA or 401(k). On the other hand, you might need cash to repay student loans, marry, move or buy a house. If you have to take money out of your retirement plan, you'll pay a 10 percent penalty.
Most 401(k)s let you keep your options open, because you can borrow against them if you must have cash. A Roth IRA is flexible, too, because you can take out your own contribution at any time.
But traditional IRAs usually penalize you for early withdrawals. They're pretty inflexible for the young, so they're less attractive.
Case two. You've always had term life insurance and are now middle-aged. You're thinking of switching to a cash-value policy, which you could keep, at a fixed premium, for the rest of your life.
But why act now? You can preserve your options by buying term insurance that's convertible into cash-value coverage, up to age 65, Daily says.
Between now and then, your life situation might change. Maybe you won't need cash-value coverage after all.
Some people buy cash-value policies to cover future estate taxes. But Congress might reduce or repeal that tax. In that case, the policy would become irrelevant.
Case three. You want to borrow against your house to invest in stocks. You expect to earn more in the stock market than the interest cost of the extra loan.
But if stocks run against you, you'll lose the option of using your home-equity for other things say, college tuition. By waiting, you can still invest a few years from now, when you're earning more and can better afford the risk.
Case four. You're retired and depend on your savings to supplement your Social Security. You're afraid you might outlive your money. For protection, you turn to an "immediate" annuity, sold by an insurance company. It turns your savings into a monthly income, guaranteed for life.
But what if your health goes bad, reducing your probable life span? What if your son builds you an apartment over his garage? You might be able to live on your savings, after all.
There's value in waiting, before locking yourself into fixed monthly annuity payments. For men, the late 70s is an optimal time to buy, says Moshe Arye Milevsky, finance professor at York University in Toronto. Women might wait until their early 80s.
Case five. You're middle-aged and thinking about long-term care insurance. You'd pay less at 40 than at 60. But over those 20 years, many things will change. Today's policies might rise in price; better coverage will appear; the health care system will evolve. Why not wait and see?
A caveat: These new ideas don't guarantee that you'll always make the right decision, says planner Robert Levitt of Boca Raton, Fla. Hindsight is always 20/20. You might wish that you had hurried to lock up a particular financial choice.
But on balance, your chance of success will rise if you hold your financial life open, to see what happens next.
Syndicated columnist Jane Bryant Quinn can be reached in care of the Washington Post Writers Group, 1150 15th St., Washington D.C. 20071-9200.
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