Before he died last year at the age of 99, a friend asked Charlie Munger if he planned to leave his considerable wealth to his children. Wouldn’t it impact their work ethic, his friend asked.
“Of course it will,” Munger replied. “But you still have to do it.”
“Why?” his friend asked.
“Because if you don’t give them the money, they’ll hate you.”
Few of us are billionaires, but I find this comment to be instructive. It illustrates, I think, a reality about personal finance: that the notion of a perfectly optimal answer to any financial question is just that—a notion. And relying solely on a calculator to make financial decisions rarely results in the best answer.
That’s the case, I believe, for three reasons. The first is the one that Munger cited: that emotions can’t be overlooked. No matter how mathematically optimal a decision might be, if we can’t live with that decision—or if our family can’t—then, by definition, it isn’t really optimal.
In addition, even when a question does look like it has an entirely quantitative answer, it’s rarely that simple. That’s because one or more of the variables—and sometimes all of the variables—will change over time. Among other things, markets evolve and tax rules change. So the inputs to a financial decision at any given time will always involve some number of estimates, guesses or predictions. In many cases, in other words, it’s difficult to even define “optimal.”
A final reason it’s so difficult to make optimal decisions: Over time, our goals can—and often do—change. So to one degree or another, financial planning means that we are always contending with a moving target.
For all these reasons, financial decision-making requires a balance. On the one hand, we can’t ignore the numbers. But on the other, we shouldn’t feel too tightly bound by what the calculator says. Below are several other situations in which you might opt for a solution that—strictly according to the numbers—might seem suboptimal.
Holding cash. In 2011, an Illinois man named Wayne Sabaj was in his yard, picking broccoli, when he found an old nylon bag buried in the dirt. Inside was $150,000 in cash. Banks today are protected by FDIC insurance, so this isn’t how most people store their savings. But it’s a reminder that it isn’t unreasonable to hold some amount of cash in your home. It won’t earn interest, and through that lens it might seem suboptimal. But I still recommend it. Why? In recent years, we’ve seen an uptick in cyber attacks, and many of these are aimed at banks and brokers. If your funds were temporarily inaccessible, it could provide helpful peace of mind to have a few dollars on hand—though preferably in a safe rather than in the yard.
Building a portfolio. One of my favorite books carries the title In Pursuit of the Perfect Portfolio. It profiles ten prominent figures in finance and describes how each of their philosophies would translate into an investment portfolio. The irony of the book’s title is that, in the end, there is no single perfect portfolio. A “perfect” portfolio is in the eye of the beholder and depends almost entirely on each individual’s mindset and personal circumstances.
Managing taxes. You may be familiar with the tax strategy known as a Roth conversion. Whether or not to do a conversion often hinges on a straightforward calculation: How would the tax rate on a conversion compare to the investor’s tax rate in future years? That’s the way to make the most seemingly optimal decision. But there are reasons you might make a decision that defies this math. If you have substantial assets, then your accounts might grow faster than expected, causing your future required minimum distributions, and thus your future tax rate, to be higher than expected. Another possibility: Because of the federal government’s debt burden, Congress might raise tax rates down the road.
Maintaining simplicity. If you have significant assets, you might consider steps to limit future estate tax exposure since the federal rate quickly climbs to 40%, and many states levy estate or inheritance taxes on top of that. But despite those figures, some families forgo any estate tax planning. Why? A key reason is that these strategies require financial acrobatics which can be cumbersome and costly. These families know they’ll end up paying more in tax, but for them, the optimal path is the one that makes their lives simpler, even if it doesn’t look optimal on paper.
Loosening the reins. In the 1999 film The Bachelor, the lead character, Jimmie Shannon, learns that he stands to receive a hefty inheritance, but there’s a condition: He must be married by his 30th birthday. The problem for Shannon is that his birthday is the next day. This sets off a scramble, with Shannon scouring the city for a suitable match. This, of course, is comedy, but it gets at one of the key challenges in estate planning: that it’s awfully hard to conceive of every future scenario. Some wealthy parents try to write contingencies into their estate plans for everything from divorce to overspending to substance abuse. These are all serious concerns, but they can be complicated to capture in a set of documents because every circumstance is different. For that reason, many people opt to keep their estate plans relatively simple, even if that means they won’t cover every possible scenario. Similar to Charlie Munger’s view, a plan which is good enough may be the one, ultimately, that is optimal.
Taking the long view. If you’re fortunate enough to have a traditional pension and are approaching retirement, your employer will typically offer a choice: You can accept the benefit as a single lump sum or opt for monthly payments, which would be guaranteed for life. The math in these cases typically points in the direction of the lump sum. But in considering a choice like this, it’s also important to take a step back from the numbers. Consider, for example, the case of Irene Triplett. When she died in 2020, she was still receiving a pension benefit based on her father’s military service in the Civil War. It’s doubtful that her father would have predicted this back in 1865.
Grigori Perelman is arguably the most talented mathematician living today. In 2006, he was offered the Fields Medal but rejected it. Similarly, in 2010, he was offered the Clay Millennium prize but turned it down. In Perelman’s words, “I’m not interested in money or fame and don’t want to be on display like an animal in a zoo.” That’s why he also refused the $1 million award that came with the Clay prize. Decisions like this, in my view, may be a bit too emotional. But in nearly every other situation, it’s important to avoid feeling too tightly bound by the numbers in making decisions.