The most important thing about personal finance is that it is simple — and far simpler than those who make their living selling it as a service would have us believe. Here are ten key rules that I have learned in decades of studying and writing about personal finance and investments. Most are about how we manage our lives, not about how we invest our money.
Rule #1: Know yourself, and pay attention.
One of the most useful psychology books I’ve ever read was by David D. Burns (no relation), who is known as a prime mover in cognitive therapy. That’s a therapy where attention is paid to our immediate habits of thinking rather than the buried injuries of the past. Burns found that people made regular errors in thinking that led to bad results in their lives.
Here are a few: All-or-None, polarized thinking; Overgeneralization; Mental filters; Magnification (Catastrophizing) or minimization. Today, others have created an entire investment research discipline called behavioral finance.
The easiest and most direct way to avoid all of these thought errors is to become a low-cost index investor, a person who admits that no one can foretell the future.
Here’s a link to the paperback version of his book on Amazon (an Audible version is also available).
Rule #2: Know what you spend.
Here’s a tough reality: the vast majority of people, regardless of education or income, are clueless about how much they spend or where they spend it. Small wonder few people save. One man, Dave Ramsey, has built an advice empire simply by helping people get out of debt by watching, and controlling, what they spend.
But many people, perhaps a majority, believe that saving happens when money is “left-over.” We live in a consumer society. I have never met a “left-over” dollar. We can start to save when we begin to make decisions about where we are going to spend our money.
Rule #3: Marry, and stay married.
Yes, I know: It’s easier said than done. Living with love, care and compassion with another person takes way more effort than suggested in any wedding ceremony. But while two can’t live for the price of one, there are economies of sharing. And, believe it or not, having children — regardless of their expense — can make the task of retirement saving easier, not harder.
Why? Simple. All the money you spend on children is money you never have to spend on yourself. So you don’t have to replace that income when you retire. It’s a big silver lining in the most demanding life project we face. Yet most financial planning doesn’t consider this reality.
Rule #4: Save as long as possible, start early.
Lots of people can save enough over 50 weeks to take a 2-week vacation. But ask how long it would take to save enough to take a year off and most people will say it’s impossible. Well, retirement is a still larger project. You have to save enough, in the 30 to 40 years you have to work, to pay for as much as 30 years of retirement.
Part of the solution is compound growth, earning a return on your money for as long as possible. So the earlier you start, the better. In life, compound growth is on our side. In today’s society it’s about the only thing that is.
Rule #5: Work longer, if possible.
Every additional year of work does triple duty. It adds another year of growth to what you have already saved. It adds another year of saving to what you have already saved. And it subtracts a year from the length of the retirement you need to pay for.
Retire at 62 and you have to finance 28 years of retirement if you live to 90. Retire at 70 and you’ve had 8 more years to save to finance a retirement of 20 years, if you live to 90. Big difference. So find work you love.
Rule #6: Own a house, but avoid most debt.
One of the biggest illusions in our consumer society is that our consumption is really an investment. It isn’t. There is no such thing as “investment clothing,” whatever some retail stores advertise. Ditto cars, treasured rare rugs, antique furniture and silver. “Diamonds are a girl’s best friend” is a song, not an investment truism.
The only consumption that might be “investment” is in our shelter. And the only debt that may be “good debt” is home mortgage debt. The reason is that a well-chosen house may appreciate enough in a year to increase your net worth by the amount you spend on it.
This is not a Universal Truth. It has not worked, in my lifetime, for the homeowners of Detroit and many other rust-belt cities. It has worked in spades for homeowners in the coastal states. So borrow with care and remember that every dollar you spend on loan payments in retirement is a dollar you don’t have for something you probably need.
Rule #7: Don’t believe in magic.
Sometimes it is hard to believe, but we love more than we hate, and we create more than we destroy. That central truth is more important than any investment idea, claim, or management technique. Researchers were finding that professional managers failed to beat a passive index more than half a century ago, a finding that has been repeated ever since.
The most recent large scale study, known as the SPIVA report, completed 15 years and found that over that period 89 percent of all equity mutual funds failed to beat their assigned index. The fail rate for fixed income funds was 82 percent. You don’t hear this figure on TV or even from Morningstar because the SPIVA figures adjust for the multitude of funds that begin a time period but don’t finish. Here’s a link to the entire study, with detailed results.
Rule #8: Be a Couch Potato Investor.
The easiest way to have investment results that are destined to be superior to all but a handful of professional managers — to rank in the top 15 to 20 percent of investors — is to be a Couch Potato investor, a person who shuns expenses, invests in low-cost index funds, and is as slothful as possible once the investment is made.
You can check this for free, any day of the week, by visiting the Morningstar website and looking up the performance record of Vanguard Balanced Index Fund. On the day I write this, this fund provided a higher return than most of its surviving competitors. It was in the top 13 percent over 3 years; the top 17 percent over 5 years; the top 15 percent over 10 years; and the top 29 percent over 15 years.
And remember, about half of all balanced funds failed to survive the longer time periods so the actual performance is better. Here’s the link.
Rule #9: Don’t over-shelter.
We love our homes. That’s why we spend more of our income on “shelter” than on any other single category of spending. And our homes can be a powerful tool in our retirement planning--- if we don’t allow them to become a high-expense albatross by thinking we need the same amount of space as in retirement as when we were raising a family.
If your retirement has come too soon, or if your savings are short of goal, the most potent thing you can do is not to invest more aggressively. The most powerful thing you can do is “right-size” your shelter. The shift, done correctly, can eliminate debt and reduce shelter expenses even as it adds new cash to your retirement savings.
Rule #10: Live healthy.
Somehow, we manage to turn really good things into terrible events. If we are facing a “retirement crisis,” as some claim, the only reason for it is that we are living longer than ever before. So our saving has to catch up with our rising life expectancy. The best way to do that is to live healthy, increasing the number of healthy, functional years in those added years of life. So eat some broccoli.
Finally, remember this. Life uncertainty is greater — much greater — than investment uncertainty. Financial planners like to build plans that assure us of having a 95 percent chance our savings will last through a 30-year retirement. They neglect to mention that a 65-year-old retiree has a 95 percent chance of being dead in 30 years. One consequence is that most people who have prepared for retirement will die with money in the bank. They won’t die broke.
Here are some links you might enjoy or find useful: