Investing

Keeping It Simple

We live in a world of complexity. Whether it be applying the U.S. tax code or understanding health insurance options or applying for college or developing an appropriate social security draw strategy or developing a credible financial plan or any number of other situations, we’re often required to make decisions on our own without complete knowledge or to trust someone else we’ve hired knows what they’re talking about and isn’t leading us astray. With so many factors to consider in so many critical facets of our lives, how can we effectively navigate such complexity in a way that doesn’t blow us up?

First, know what you don’t know. In economics, the law of comparative advantage holds that an agent (usually a country) will produce more of and consume less of a good for which they have a comparative advantage relative to other agents. Such an advantage may include lower input and overall production costs, technological superiority and/or a more skilled labor force. Whatever the advantage, an agent seeks to exploit it in such a way that is most beneficial for the agent and its constituents. We can loosely apply this law to our individual lives. Generally, we’re all skilled in one thing or another and don’t need a third-party’s assistance in certain situations. For example, a plumber doesn’t need to call another plumber to fix a toilet or sink. An electrician doesn’t need to call another electrician to fix a faulty outlet or circuit breaker. However, the plumber or the accountant likely need a third-party’s help when dealing with tax or legal matters. In other words, we take care of problems and address situations for which we have the expertise (comparative advantage). Otherwise, we outsource to third-parties the tasks for which we don’t have the knowledge and/or ability to complete on our own. Regardless of our area of expertise, it’s still important we develop a reasonable understanding of our situation and what we need from a third-party so we can hold the third-party accountable while promoting our best interests.

The second step builds on the first. Occam’s Razor is a philosophical principle which suggests when provided with two potential solutions to a problem, the simpler solution is most likely the best. In particular, the solution that requires the least amount of assumptions (less complex) is usually correct. If you’re working with a third-party, you have to be alert to the fact that he/she might unnecessarily (and unintentionally) be over-complicating a situation which could result in a higher fee and/or an unintended/undesirable outcome. Again, having a basic understanding of what you need out of a particular situation and third-party can help you hold the third-party accountable. Remember, experts often times gravitate towards complexity to justify their existence/services. Simplicity should be your goal in all situations, where possible. (Note: Sometimes a simple solution isn’t possible. For example, healthcare).

In the world of financial planning and investment advisory services, transparency and simplicity are essential. You don’t need to over complicate your situation. That doesn’t mean you shouldn’t hire a financial advisor. It does mean that your financial advisor should be able to educate you and inform you of what she/he is doing to the point where you understand it. Unless you have a background in tax, investment management, retirement planning and estate planning, it would be to your advantage to hire an advisor or advisor(s) to help you navigate the complexities associated with these situations (Remember, know what you don’t know). As we’ve mentioned, develop a basic understanding of your situation and what you need so you can hold your advisor(s) accountable and promote your best interests. Don’t be afraid to ask questions and insist your advisor educate you. Any advisor worth having will naturally be transparent and will willingly educate you.

In summary, know what you don’t know. Hire an advisor to help you navigate complex situations. However, strive for simplicity in all you do. The simplest solutions are often the best. In the case of your financial future (a very complex and uncertain situation), have a sound financial plan in place, be well diversified and remain disciplined. A good financial advisor can help you with all three of these elements and increase the likelihood of your desired outcome.