The Solution – ONLY follow financial strategies that are scientific, passive, diversified, savings focused, risk controlled, low cost, and tax efficient
A previous article, “The Problem – Straight answers about personal financial and investment planning are difficult to find,” summarized important reasons why individuals may experience difficulties, even if they are intent upon doing better with their personal financial planning. This article summarizes some general decision rules to address those problems. This article also introduces a series of additional articles, which will discuss these decision rules and related financial practices in more detail.
In general, individuals will benefit greatly and get more enjoyment out of their financial affairs, if they decide ONLY to follow financial and investment strategies that are: a) scientifically grounded, b) completely passive, c) thoroughly diversified, d) savings focused, e) risk adjusted, f) cost effective, and g) tax efficient. While this might seem very challenging to do, in reality all these factors are interrelated. In fact, when you choose financial strategies with these characteristics, your financial life tends to become less complicated. When the complications of personal finance diminish, you can get on with living. You can plan to live and not live to plan.
First, you should always demand that your financial strategies be scientifically valid. Far too many financial and investment strategies have no objective basis and are in fact contrary to what has been established in the financial science literature. Second, the more passive your strategies are, the better they are. Motion without real purpose in finance wastes both your money and your precious time. Motion in finance is futile, because asset price setting is generally very efficient, and the costs of making changes push you backward.
Third, thoroughly diversified strategies eliminate unnecessary risk. In addition, fully diversified strategies usually are completely passive, and they tend to have lower investment risk. Fourth, by earning more and spending less, most people will have much more impact on their future financial well-being than they ever could by trying to be more clever investors. Investment cleverness tends to be counter-productive for individual investors. In contrast, another dollar saved is another dollar to invest. (See: What is the cost to individual investors of sub-optimal portfolio diversification?)
Fifth, investing is about risk-adjusted asset returns. Securities markets tend to pay a premium for risk taking, but only for market-oriented risk taking. Securities markets tend not to compensate for the risks [...]