A Simple but Not Simplistic Investment Strategy

I am back from a family vacation in Japan, which renewed my appreciation of the beauty of simple design. Why have a dozen flowers when only one is needed? 

The trip reminded me of a quote attributed to Albert Einstein: “Everything must be made as simple as possible. But not simpler.”

The same is true for our personal finances. Unfortunately, too many investors choose unnecessary complexity or over-simplification. Neither is optimal.

Investing Complexity Increases Risk

In my 35 years in wealth management, I have seen complex account structures which take advantage of every possible tax minimization technique. Seeking the perfect tax strategy often reduces flexibility to adapt to a changing economic environment or a family’s needs. Prospective clients have shared with me monthly statements an inch thick, with every stock and bond listed but providing little insight into what matters. Too much detail may distract from seeing the total risk exposure. (For related reading, see: These Financial Products Are Too Complex for the Average Joe.)

The Value of a Simple Financial Strategy

My view is that each family should agree on their primary financial goals and understand how their investment portfolio is positioned to achieve them.  Simplicity increases the confidence needed to stay the course during difficult financial markets. Here are some suggestions:

Write down your financial goals and investment approach – commonly referred to as an investment policy. If you are working with a professional investment advisor, make sure you understand the investment policy they drafted for your portfolio.

Establish a logical overall structure for your financial assets and liabilities. For example, group them into three buckets:

  1. Safety (liquid, low volatile investments for your near-term needs). This would include both your emergency fund as well as very safe fixed income funds.
  2. Appreciation (higher risk and return investments to meet long-term goals). The investments should be well diversified across stock and bond markets.
  3. Aspirational (a limited number of special opportunities, which may include ownership in your company, art or vacation homes, or access to investment partnerships).  For example, local real estate that you manage as investment properties would fall into this bucket.

Implement simply through high quality, cost-effective diversified mutual funds or exchange traded funds. Avoiding the temptation of trying to beat the market will minimize unnecessary trades and help focus on avoiding the big mistakes.

Don’t Over-Simplify

Einstein noted the importance of not taking simplicity too far. All your wealth invested in only one bond fund or 10 stocks is taking simplicity too far. You need a sufficient number of investments exposed to independent sources of risks and returns to minimize risk and capture the value of diversification. Don’t invest in anything you don’t understand, but don’t limit your portfolio to only what you know best.

Distinguish Between Simple and Simplistic

There are simple strategies that are overly simplistic. Subtracting your age from 100 to determine the equity allocation is one example. Simple can be a sophisticated solution like E = mc2.

(For more from this author, see: Save More for Your Retirement by Managing Risks.)