At least once a day, I find myself saying, “Another truism of financial planning is…” To be honest, I don’t know if they meet the strict definition of truisms, but below are the twelve concepts I’ve found most helpful in navigating the world of personal finance.
- There are always two answers to every question. There’s the mathematical answer and there’s the “how do you feel about it” answer. It’s okay—and in fact, it’s to be expected—that these answers differ. But ideally you want to make choices that satisfy both needs.
- Taxes aren’t always a bad thing. Sometimes they’re far better than the alternative. A short-term gain, for example, is always better than a loss. And it may make sense to incur a gain if you’re trying to take down the risk in your portfolio. To be sure, no one likes taxes. But zero taxes may not be a sensible goal either.
- There are many roads to Rome. That is to say, there are lots of ways to build a successful financial plan. Some people—usually the proverbial brother-in-law—love to talk about how great they’re doing with their investments. That’s fine. Let them talk. But remember that other people don’t need to be wrong in order for you to be right.
- I’m only half joking when I say you don’t truly know someone until you’ve seen their tax return. So be careful of trying to model other people’s financial strategies. They may not be doing exactly what you think they’re doing. The fact is, you can rarely tell what’s going on in someone else’s house from the outside.
- Once your balance sheet is beyond a certain size, risk is optional. To illustrate this, imagine you’re Bill Gates. If you kept all your money under the mattress, it wouldn’t be a problem. It would erode due to inflation, but you’d still have enough for more than one lifetime. Alternatively, you could keep every dollar invested in stocks, and that wouldn’t be a problem either because you could weather market downturns unscathed. Bill Gates is at an extreme, but as your assets grow, this dynamic will become more and more applicable. Risk will become more and more optional.
- Risk tolerance is a moving target. By the time you’ve reached a certain age, you’ve likely experienced multiple market downturns. As a result, you might feel that you understand your tolerance for risk. But that might not be the case. You only know what it’s like to endure downturns in one phase of life. But you don’t yet know what it’s like to handle a downturn at a different stage—when you’re retired and drawing down on your portfolio, for example. In short, risk tolerance changes as you change; it’s not hard-coded in your DNA.
- All data is, by definition, backward-looking while all decisions are, by definition, forward looking. This is a critical concept. You should view historical numbers as a guide, but don’t spend too much time trying to apply higher order math to your financial plan. In financial planning, greater precision only provides the illusion of greater accuracy. This is one of the reasons I don’t put too much stock in Monte Carlo analysis.
- Utility is in the eye of the beholder. Economics 101 teaches that every consumer wants to “maximize utility.” I suppose that’s true, but not in the way that it’s normally presented. Utility shouldn’t be measured strictly in dollars. Don’t let anyone else—or any textbook—tell you that your choices are sub-optimal. Everyone derives happiness differently. And that’s okay.
- None of us is average. There’s the old joke about the six-foot-tall man who drowned in a river that was five feet deep on average. This is another reason why you don’t want to worship too seriously at the alter of historical data. Long-run averages rarely align with any one person’s investing timeframe. That’s one reason why I take “sequence of returns” risk very seriously. Through no fault of our own, some of us will end up above average while others will end up below.
- None of us is (fully) equipped to manage investments. That’s because investing requires a split personality. As I’ve outlined in my “five minds” framework, investing requires that you simultaneously channel the minds of an optimist, a pessimist, an analyst, an economist and a psychologist. That’s why I’m an advocate for intentionally seeking out contrary opinions. If you’re a pessimist, for example, find an optimist to bounce ideas off of.
- There’s little value in kicking yourself. If you made a financial decision that didn’t work out, don’t kick yourself. There’s limited value in looking back—for the reason cited above. To be sure, there’s value in reflecting on decisions. But nothing that happens in the world of investing provides an iron-clad guarantee of what will happen the next time.
- Financial planning becomes easier with each passing year. The future is, of course, full of uncertainty. How much will you earn? How much will you save? What will the market do? What about my health? What about inflation? But as each year goes by, the future moves a step closer, and a little bit of that uncertainty falls away. So don’t worry if your financial plan feels like it’s built on a large number of assumptions. It will get easier.