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Investing Could Be the Easiest Part of Personal Finance

"Just buy an S&P index fund and sit for the next 50 years." Warren Buffett

Personal financial decisions are among the most important choices individuals make, ones that cannot be avoided since doing nothing is in fact a bad plan. Successful personal finance is a multifaceted process requiring both knowledge and discipline. This includes key issues such as spending control, work-leisure choices, and planning for unforeseen events. Investment planning is clearly among the most important of these choices, but surprisingly, it can be one of the simplest.

While important, investing is a secondary step in a financial plan. Investing can only occur if there are savings to invest. This means that self-control is necessary to produce of surplus of income over spending. In this case, sooner is better than later because of the power of compound interest--a dollar saved and invested today will likely increase several-fold over future decades.

Investing is often viewed as a complex process for an individual who must choose among hundreds of institutions and thousands of investment vehicles. Many decades ago this meant choosing among individual stocks and bonds. More recently, mutual funds became the dominant instrument for investing, but this still required choosing among thousands of funds.

The goal of investing should not be to beat the market by choosing investments or investment advisors that can perform better than the market in general. The problem here is that beating the market is highly unlikely because most markets incorporate information about the value of a company so quickly and efficiently that it is very difficult to generate excess returns after adjusting for risk and investment costs. Studies over the last several decades have confirmed this for both individuals and professional investors like mutual fund managers.

Warren Buffett, arguably the most successful active investor, says in effect: Don't try this at home folks. Immodestly, he suggests that active investment is fine for him, but not the rest of us. Buffett recently offered "the most important investment lesson in the world": "Supposedly sophisticated people, generally richer people, hire consultants. And no consultant in the world is going to tell you, 'Just buy an S&P index fund and sit for the next 50 years.' You don't get to be a consultant that way, and you certainly don't get an annual fee that way."

The reasonable goal for most investors is to capture average market returns by participating in the market at a low cost. This can be achieved through various index funds that invest passively in broad asset categories--possibly not just the S&P 500 suggested by Buffett. These funds do not try to pick winners and losers; instead they buy a little of everything usually based on the capitalized value of the businesses. Passive long term investing is not the key to great wealth nor is it exciting, but it allows the investor to share in these gains and avoid the pitfalls of that erode returns.

Given this advice, does an investor need an advisor? The answer depends on the sophistication and discipline of the investor as well the value placed on the time that is involved in self-management. Advisors can provide valuable guidance to the individual investor. For example, even passive investment does not protect investors from their own emotions. Studies show that returns are eroded by market timing where investors enter and exit the market at inopportune times, typically selling in down markets and buying near the peak. An advisor can help provide reassurance and discipline here.

Advisors can also help with asset allocations between various index funds depending on the investor's risk preference and age. There are also important tax questions about when and how to invest in tax-deferred plans such as IRA, 401k and 403b plans as well as when to withdraw from these plans. They can provide also retirement and estate planning help. This leads to the question of how to choose an advisor which can be the focus for another column.