This is the Single Most Important Money Lesson I Can Teach (and it's easy)
In a nutshell: Keep it simple.
After more than two decades working with investments and finances, I am convinced that in investing, the simpler, the better.
Investing should be as exciting as watching paint dry. Yes, that boring. To be a successful investor, you don’t need complicated high risk strategies, crazy gambles, or exotic option strategies like “Butterfly” or “Iron Condor” (those are honestly names of trading strategies, not “moves” you’d read in Cosmopolitan magazine).
If financial excitement is what you crave, keep that urge separate from your life savings. Carve out a little mad money and take a trip to Vegas. Have fun. Get a little crazy. Eat sushi. Here’s a financial advisor telling you that is OK. It’ll satisfy that urge to do something exciting with your money–a little risky even, but you aren’t staking your life savings on the outcome. When you return home with a slight headache to your boring as hell investment portfolio that is safe and sound, invested in a strategy that is backed by science, you’ll be happy. I promise.
The world of finance often seems complicated, so we think we need to play into the complexity and make our personal finances just as perplexing as the markets. But the truth is, complex often means that no one understands it, especially when markets go sideways.
Simplicity is Not Ignorance
I think that one of the reasons people fall into a mindset of complication is because they believe that if it’s simple, something must be missing. They think “Finance and the stock market are complicated. So, I need to do heaps of research and create a strategy that is equally complex.” The problem is it’s easy to get overwhelmed with the amount of information available, throw your hands up, and let someone else make all the decisions regarding your finances.
In a study analyzing market complexity, one of the conclusions stated was that many firms gain an advantage by keeping things complicated, not educating clients, and using “complexity as a way to protect market power…[and] by adding more complexity, each firm increases the fraction of consumers who are uninformed.”¹
But it doesn’t have to be this way. Life is complicated; your investments shouldn’t be.
Complexity is the Devil
Why should we keep things simple? Because if we understand how it all works, it helps us stay actively engaged.
One way to keep your investment plan simple–an area ripe for over-complication–is to put your investment strategy on a small, 3 x 5 Index Card. The constraint of the small space forces you to be simple, concise, and focused. You can’t explain an Iron Condor option trading strategy on an index card. Moreover, keeping your investment strategy on an index card means you can explain it to others–like your spouse–which is the true test of understanding.
I want all my clients to understand their financial plan the the investment strategy we employ to reach their life goals. That’s why I spend a tremendous amount of time educating my clients about the details of their overall plan, and why we use Vanguard and DFA mutual funds.
Our finances, dreams, and goals are so intricately tied together. We need to stay focused and truly understand the path that goes from where we are today to where we want to be. If we keep things simple, it’s easy to understand how our financial plan and investments will help us reach our life goals. Otherwise, we just get lost in a sea of complexity and confusion, and ultimately distracted.
Just because something is important to us does not mean it should be complicated. The more information and unnecessary decisions we pile onto our lives often mean that the quality of time and effort that we invest into decisions diminishes.
It may seem too good to be true, but really, it comes down to this principle: “Keep it simple and you will keep moving forward.”
In fact, here is an easy-to-remember acronym to keep in mind when you feel the urge to over-complicate your investments or personal finances: K.I.S.S. Keep It Simple Stupid.
Less is More
How do we implement this mindset of simplicity and apply it to our finances? Here are some ideas to rid yourself of energy-draining, time-consuming over complication in your financial life:
1. Fewer Moving Parts
Consolidate accounts. Do you really need three separate checking accounts, a savings account for each and every goal or credit cards for every type of reward imaginable? How many IRAs have you accumulated or 401(k) accounts from old employers do you have? The more accounts you have to keep track of, the easier it is for things to slip through the cracks or become overwhelming. Narrow it down and start living your life.
2. Simple Investing
Dan Solin, author of The Smartest Investment Book You’ll Ever Read, offers a mind-blowing formula for how to invest simply, build your wealth, and actually know what you are doing with your portfolio. Here it is in all of its simple glory: Determine your asset allocation, buy three low-cost index funds, and rebalance your portfolio once or twice a year.³ Think you can manage that?
3. Focus On the Right Things
Avoid trying to wrap your mind around how and why the market does what it does, especially the short-term moves of the market (just don’t, you’ll drive yourself crazy). Instead, focus on proven, evidence-based investment strategies to build wealth, backed by decades of academic research to improve performance. Own your financial future. Make decisions you understand and are proud of.
Have I convinced you that simplicity is the way to go? We tend to over complicate our lives. I’m speaking from the vantage point of hard-won experience. Before I was a financial advisor, I used to be an engineer. So over-complicating things and over-analyzing ideas are in my nature. I’ve been down that road. It’s exhausting and doesn’t work, especially with investing.
We have way more choices than we will ever need and more information than we can digest. Changing your mindset to focus on simplicity is a discipline, but it is one that will take you and your finances far.
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¹Carlin, Bruce Ian. “Strategic Price Complexity in Retail Financial Markets.” Accessed May 30, 2016. www.gsb.stanford.edu/sites/default/files/documents/2007_02-12_Carlin.pdf
²Solin, Dan. “It’s So Easy, Your Broker Could Do It!” The Huffington Post. May 25, 2011. Accessed May 30, 2016. http://www.huffingtonpost.com/dan-solin/its-so-easy-your-broker-c_b_56296.html