An axiom is defined as “A self-evident or universally recognized truth.” The following 10 axioms of personal finance provide a foundation by which individuals, no matter where they are within their own financial life cycle, can measure the soundness and direction of their personal financial planning and lifestyle.
- Knowledge is Power: You do not have to understand every detail but it is important to have a familiarity with the key elements of your financial plan and investment strategy. Never forget that it is your money, resources and lifestyle. Because of that no financial advisor worth her or his salt should ever begrudge you the time in answering questions.
- Protect Yourself Against Major Catastrophes: Everything in life involves risk and it is impossible to protect yourself from all dangers. However, there are things you can do to help protect your health, income, assets and family well-being. Refrain from dangerous activities and spend precious premium dollars on the right type and amount of insurance.
- Stuff Happens (or: the Importance of Liquidity): Despite our best forecasting, the unexpected is always right around the corner. According to whichever old wives tale you wish to subscribe, “Bad things happen in threes,” and “When it rains it pours,” so make sure you can access ready resources for an emergency whether it is in near cash reserves, or a line of credit.
- Do Not Underestimate Future Requirements: When it comes to saving for later versus spending today, it is always simple to rationalize that ‘I will not need as much to support my lifestyle when I retire.’ Increasingly retirees are finding that they have substantially understated the resources that they will require during their retirement years. The reasons for this include higher healthcare costs, taxes, living expenses, travel, long-term care and additional support required by children.
- The Importance of Time: Time is the single most important factor in the success of any investment plan. Time is the greatest cure all for periods of high volatility and low investment performance.
- The Risk / Return Paradigm: Risk and return have an inverse relationship. If we expect a higher return, we need to be prepared to expect a higher risk posture. If we want a lower risk posture, we need to expect a lower investment return. Investors who have tried to flaunt this rule have paid a high price (for example, clients of Bernie Madoff). Remember, if it sounds too good to be true, it is!
- All Risk is Not Equal: All investments carry risk but not all risk is the same. Market or systematic risk cannot be totally avoided by all investors. Unsystematic risk, which is exclusive to a specific holding, can be avoided by limiting your holding in a single investment and diversifying your assets.
- Diversification Reduces Risk: By investing in a broad spectrum of loosely- or non-correlated asset classes, (cash, bonds, equities, real assets, commodities) investors can often reduce their overall risk posture.
- Taxes Affect Decisions: Unlike most institutional investors where pre-tax rates of return are the priority, the after-tax return is critical to the success of an individual investor’s financial plan. Investing strategies that utilize high-turnover trading strategies often generate higher rates of return initially, but when taxes are due the after-tax return is much lower. Asset location in either taxable or tax-deferred accounts can make a huge after-tax difference over time.
- Have a Plan, but Be Flexible: More often than not, the greatest impediment to a successful financial plan is…us! We get busy, we get emotional, we get scared of not being in the pack, we panic, our emotions change our worldview. All of these things can cause us to go off plan and make hasty and ill judged decisions. Sometimes it will be necessary to stray from the plan, but it should be in a thoughtful way as opposed to a knee-jerk way. Financial Plans are not static documents but they are a useful tool in reminding us what our goals and priorities are.