Short read: The Laws of Financial Health

This month’s correction in the stockmarkets has prodded some of us to believe we need to make some judgement calls about our portfolio – some of us want to sell equities as the first bout of sustained correction is underway coupled with negative newsflow around earnings and economic growth whilst some of us who have been apprehensive about the rally believe it is an opportunity to buy the dip. Either requires us to make a prediction about the inherently unpredictable future – for the former what if this is a minor blip and the market takes in its stride much like it has done with other negative newsflow through this rally or for the latter lot, what if this is the beginning of a sustained economic and earnings slowdown amidst elevated valuations, resulting in sustained market corrections. We don’t know nor do we know anyone who does. This blog whilst talks about the basic laws of securing our financial future, emphasises about why we should be rather systematic in our investment approach i.e, we make a set of rules that govern our portfolio and let the rules make the decisions than trying to apply our inherently biased human judgements.
Before we get to that, Mark’s four rules of financial health:

The first three are simple and intuitive though not easy to execute. But even harder is the fourth piece:

“Whether it’s every week, every time you receive compensation, annually, or anything in between, I don’t care (although my belief is more frequently is better – mathematically, you want as many dollars compounding as early as possible). Use a system and take away the decision of: “Should I save, now?” Instead, save always, and never ask the question. Do the same with the amount, make it fixed and automatic. Invest the funds automatically, as well. Do not force yourself to evaluate your investment strategy every time you make a deposit. Do you need to review your strategy? Yes (although many accounts have done quite well when completely untouched for long periods). Like once a year. You may change it over time as your circumstances and ability to tolerate volatility change.”

Mark adds what’s perhaps the least appreciated benefit of diversification. Most believe that diversifying across asset classes helps at best reduce volatility or risk. That will be true if you leave it untouched. But studies show if diversification is coupled with systematic rebalancing, it not only reduces risk but also improves returns as rebalancing entails the holy grail of investing – selling high and buying low.

“I am also a believer in the value of rebalancing when your allocation drifts, and it will drift. Allocation drift occurs naturally as returns compound at different rates for different investments. And, again, this is something best done by rule, automatically, in my opinion. Introducing our brain into the process is bound to create, for most people, suboptimal results.”