You Won't Believe These 6 Totally Reasonable Ideas About Money
Ok, I got you with the buzzfeed title. But here’s why I wrote the post. You might be trying to find an advisor. You’d want to know, how do they think about the world? What are their core financial beliefs? So, I wrote mine down for you – here they are:
1) Simplicity beats complexity. The financial plan is worthless if you don’t understand it.
We could make your finances super complex if we wanted to. We could do direct indexing to enable more tax-loss harvesting and/or portfolio customization. Once we run out of losses to harvest, we could do a long/short strategy to generate more losses to further reduce your taxes.
Those strategies might make sense for certain situations. But often, they cause more headaches than they are worth. You might save on taxes, but you will likely pay more in fees. Eventually, you might run out of losses to harvest and need to look at an even more complicated strategy to come up with more losses. And when markets take a downturn, it’s much easier to stay the course with a simple strategy that you understand completely.
2) The future is uncertain, so flexibility and liquidity matter.
No one has their whole life planned out. That would make the financial planning side of things pretty easy. Just tell me how many kids you’re going to have, where you’ll live for the rest of your life, how your career will play out, and I will come back to you with an amazing financial plan. If only!
Your financial plan should give you the ability to change your mind on big decisions:
Your savings probably shouldn’t all be in retirement accounts. What if you want to buy a house sooner than you thought?
Your fixed expenses shouldn’t lock you into a life you don’t want. What if you want to change careers, or take some time off work?
You may not be able to plan perfectly for what you can’t predict, but by keeping flexibility and liquidity top of mind, you can be ready for it anyway.
3) Markets are not perfectly efficient, but in the long run they don’t need to be.
There’s a very neat and clean theory (the Efficient Market Hypothesis) that markets always take into account all available information and asset prices perfectly reflect that information. Of course this is not true. Markets are made up of people, and people can get overconfident, or panic, or just be lazy. So sometimes, asset prices get divorced from reality.
Here are the important questions: Should you try to take advantage of market inefficiency? And can you benefit from the market despite the inefficiency?
There’s a whole set of actively managed funds trying to take advantage of market inefficiency. And the vast majority of them underperform their benchmark after fees are accounted for. Why is that? It’s hard! Spotting an inefficiency is one thing. You also have to correctly predict if and when that inefficiency will be corrected. (Plus, their costs come off the top, and they’re all competing against each other.) So it’s no easy task, and I wouldn’t recommend it.
Can you benefit from the market despite the inefficiency? Yes! While the market is not perfectly efficient, it is efficient enough. Remember those active managers who struggle to outperform their benchmark? Well, in the process of trying to do so, they do usually manage to keep prices reasonable enough for the rest of us to simply buy the market. So in the long run, if you invest over decades, the market is likely to reward you, even if there were inefficiencies, bubbles, and busts along the way.
4) A diversified, low-cost, tax-efficient portfolio will take you far.
It’s not your gross returns that matter in investing – it’s your net after-fee, after-tax returns. What has an outsize impact on those net returns? Diversification, fees, and taxes.
Diversification. We live in amazing times, where you can own a slice of every major public company on earth with little effort. Take advantage of that!
Fees. Pay attention to the fees you are paying. Quantify them in both percentage and dollar terms. Ask yourself if the value you are getting is worth the fees.
Taxes. Consider the tax impact of any financial strategy you are pursuing. Don’t let the tax tail wag the dog, but let’s at least check regularly to make sure we’re not paying more than necessary.
5) We need to pick the right financial tool for your specific goals, time horizon, and risk tolerance.
A doctor has a lot of medical procedures they can recommend. The whole job is to recommend the right procedure for the specific patient. It’s the exact same thing in financial planning. Before we jump on the latest hot trend, we need to ask, what is the problem we are trying to solve, and does this give us the best shot at solving it?
6) Your “why” is the most important thing. What are we trying to accomplish with your money?
Optimizing risk-adjusted returns can be very exciting, especially if you are a big nerd like me. But that’s not the end goal. The end goal is spending time with the people you love, making an impact on the world, or living the life you want to live. Not only are those things more important than the financial side of things, they also dictate how we should manage your finances to help you achieve those goals!
Put together, it looks like this. Keep things simple and flexible so you can handle what you can't predict. Stay diversified, low-cost, and tax-aware so you capture what markets give you. And let your 'why' decide what all of it is for.
The information provided is for educational and informational purposes only and does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor's particular investment objectives, strategies, tax status or investment horizon. You should consult your attorney or tax advisor.
The views expressed in this commentary are subject to change based on market and other conditions. These documents may contain certain statements that may be deemed forward looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur.
