Tuesday, September 27, 2005

Financial Advice-KISS

I was asked recently by FreeMoneyFinance for a brief piece on the best financial advice possible. Unfortuntately I was too busy at the time to do it, but FMF was nice enough to run it anyways. The following is what I wrote.
KISS-Keep It Simple Stupid.

Oftentimes financeprofessors tend to make things too complicated. Such is the often the case when it comes to investing. Sure, we might be able to better with derivatives and complex investment schemes, but these plans probably scare off as many people as they help.

So the best financial advice I could give someone is to let compounding work for them. That is, save as much as you can as often as you can for as long as you can at as of high of rate as you can without taking major risks and start as soon as possible.

To implement this idea, I tell my friends and students to set up automatic investment programs whereby money is automatically invested for both your retirement plans as well as well as savings outside of retirement plans for “life expenses”. It is important to do this because it takes the emotion out of your investment decisions and also you are much more apt to stick to the investment program. Moreover, if you set aside the money prior to actually having the money, you will never miss it.

This savings plan should be examined annually to make sure you are still setting aside as much as you can. For instance, if you earned a pay raise or get a bonus, make sure you save more. Also if you do need (and I stress need) to take money out of the account,as soon as possible increase your payments to make up for the withdrawl.

As for what to invest in, make sure you are diversified and take the view that the basket that counts more than the eggs in the basket. Thus, worry more that you invest in the right class of securities (equity, fixed income, etc.) than what specific securities you hold within each class.

A final important bit of advice: watch transaction costs and taxes. They will destroy your returns. While your mileage may vary, for me this means using tax-advantaged accounts and investing largely in index funds and ETFs that both lower transaction costs and the tax bite of frequent trading.

So nothing earth shattering, but I hope useful.

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