Ian Nar­ine

"Keep it sim­ple, stu­pid."

Of­ten re­ferred to as the KISS prin­ci­ple, it is one of the ba­sic ten­ants that should guide most ac­tiv­i­ties in life. It is best en­cap­su­lat­ed in the the­o­ry known as Oc­cam's Law, a top­ic which I have al­ready writ­ten about in this space.

In a nut­shell, the "law" sug­gests that a sim­pler course of ac­tion is more like­ly to be suc­cess­ful than one that is more com­pli­cat­ed. In­tu­itive­ly, it makes sense as sim­ple is eas­i­er to un­der­stand and to im­ple­ment. Yet, in gen­er­al, we go to ex­treme lev­els to make life more com­pli­cat­ed and, in par­tic­u­lar, turn the process­es for achiev­ing our fi­nan­cial goals in­to a com­pli­cat­ed event that of­ten turns in­to a night­mare.

Rather than re­ward­ing good be­hav­iour we go to great lengths to try to po­lice bad be­hav­iour. In­stead of cre­at­ing sys­tems of "good" gov­er­nance we en­gage in count­less re­views to iden­ti­fy ar­eas of "bad" gov­er­nance. We seem to have a pen­chant for the com­pli­cat­ed, but in the world of in­vest­ing and fi­nance, there is re­al­ly just a sim­ple trade off be­tween two al­ter­na­tives in or­der to achieve your fi­nan­cial goals.

This rule is al­ways ap­plic­a­ble but is es­pe­cial­ly so in the Christ­mas in­to Car­ni­val pe­ri­od. The sim­ple rule is that in or­der to achieve your fi­nan­cial goals you do one of two things. Ei­ther you save more or take greater risk.

Sav­ing vs risk

You save more by man­ag­ing your ex­pens­es or in­creas­ing your in­come. For those on a fixed salary, as would be most of the pop­u­la­tion, the op­tion with­in your con­trol is to bet­ter man­age your ex­pens­es. That means that de­ci­sions on how much you spend and what you spent it on will con­tribute sig­nif­i­cant­ly to your long-term fi­nan­cial suc­cess.

In fact, it may have a big­ger im­pact on your fi­nances than the price of oil, gas, gold, Ap­ple shares, the Eu­ro­pean debt cri­sis or the out­look for the stock mar­ket. Yet we spend all the time fo­cus­ing on all these is­sues, which are out­side of our in­di­vid­ual con­trol, and al­most no time analysing our spend­ing pat­terns, our pur­chas­ing habits and how we pri­ori­tise our ex­pen­di­tures.

Not to be a spoiled sport, but if you ig­nore the con­cept of util­i­ty, then you need to be earn­ing close to $40,000 per month in or­der to break even on a Car­ni­val fete where you spend $1,000 to at­tend. As­sum­ing you spend four hours at a fete, you would have to be work­ing for $250 per hour in or­der to be gen­er­at­ing the same amount of rev­enues for the equiv­a­lent amount of en­ter­tain­ment.

If to­day you en­ter­tain your­self as much as or in this pe­ri­od of fete more than you work, then clear­ly you will have lit­tle if any­thing left over for to­mor­row. It means that you will be work­ing to­mor­row to pay for en­ter­tain­ment in­curred to­day. It is up to each in­di­vid­ual to de­ter­mine whether that is a sen­si­ble val­ue propo­si­tion. In the end, by ex­am­in­ing your ex­pen­di­ture, you can find ways to save more. That is the first step on the road to fi­nan­cial suc­cess.

Ob­jec­tives

The next step is to de­ter­mine what are your fi­nan­cial goals and ob­jec­tives. Most times when I bring up this top­ic with clients, their eyes glaze over. Some quite face­tious­ly sug­gest that their fi­nan­cial goal is to "make more mon­ey". Here is an­oth­er prin­ci­ple: if you don't know where you are go­ing then any road will take you there.

The point is that it is not for your fi­nan­cial ad­vis­er to ex­tend the ef­fort to de­ter­mine your fi­nan­cial goals, but that it is your re­spon­si­bil­i­ty as this is the en­cap­su­la­tion of your dreams, goals, as­pi­ra­tions and ba­sic life prin­ci­ples. Mon­ey is the unit through which much of these are achieved.

Even if you seek life's more ba­sic or al­tru­is­tic plea­sures, it of­ten in­volves tak­ing a con­scious de­ci­sion not to pur­sue wealth as a ma­jor as­pi­ra­tion.

For most peo­ple their fi­nan­cial as­pi­ra­tions re­volve around own­ing a home, hav­ing a car, see­ing their chil­dren through school, be­ing able to re­tire com­fort­ably, cov­er any med­ical ex­pens­es and to trav­el on va­ca­tion. There will in­evitably be a gap be­tween your lev­el of sav­ings, the rate at which you can save and the funds you need to achieve these fi­nan­cial as­pi­ra­tions.

This is why you in­vest. Sav­ing is the job of ac­cu­mu­lat­ing funds. In­vest­ing is the art of putting mon­ey to work for you so that in ef­fect while you are work­ing and sav­ing you have funds set aside that is si­mul­ta­ne­ous­ly work­ing for you. Com­bined, they de­ter­mine your fi­nan­cial fu­ture.

How hard you put your sav­ings to work is es­sen­tial­ly the lev­el of risk that you are pre­pared to un­der­take. A job where you sit be­hind a desk and an­swer in­com­ing calls re­quires a lev­el of skill and the job is com­pen­sat­ed ac­cord­ing­ly. Al­ter­na­tive­ly, an off­shore job on an oil rig where there are sig­nif­i­cant­ly more en­vi­ron­men­tal per­ils has to be com­pen­sat­ed dif­fer­ent­ly for tak­ing on ad­di­tion­al risk.

It is ex­act­ly the same thing with your fi­nances. You may choose to put your sav­ings in­to some­thing that is "guar­an­teed" and is con­sid­ered safe. The com­pen­sa­tion for this lev­el of risk would be dif­fer­ent to one where there is the pos­si­bil­i­ty that your prin­ci­pal can be im­paired.

Com­plex­i­ty

To re­cap, you have es­tab­lished how much you can save by analysing your ex­pens­es, you have de­ter­mined your fi­nan­cial goals and you are now at the stage of eval­u­at­ing the risks that you need to take with those fi­nances in or­der to achieve the re­turns that are re­quired to meet those fi­nan­cial ob­jec­tives.

In the end if you are sav­ing $50,000 per year, but the sum to­tal of your fi­nan­cial ob­jec­tives means that you need to have $1 mil­lion in ten years' time, then there is a gap of $500,000 be­tween your ag­gre­gat­ed sav­ings and the fi­nan­cial goals.

As I said, the choice is sim­ple. Ei­ther you save more mon­ey or you take on greater risk with those sav­ings so that it can earn a re­turn that al­lows you to meet the fi­nan­cial ob­jec­tives. If you are not pre­pared to take greater in­vest­ment risk, then you ei­ther have to save more mon­ey or ad­just your fi­nan­cial goals to suit. You can seek to in­vest in your­self through ed­u­ca­tion that should ul­ti­mate­ly lead to a high­er salary that can al­low you to then save more, but all of these de­ci­sions are a func­tion of time and still come back to the very ba­sic premise that you ei­ther save more or take on greater risk.

At the end it may seem ob­vi­ous, ex­cept that the ob­vi­ous is not al­ways ob­vi­ous, hence the need to be told. Most peo­ple go through very in­tri­cate steps to re­move sim­plic­i­ty from their in­vest­ment equa­tion as they feel they are do­ing more when there is a com­plex so­lu­tion on the ta­ble.

The prob­lem is that we as­so­ciate com­plex with com­pli­cat­ed and fail to un­der­stand the dif­fer­ence. There are some sys­tems that are nat­u­ral­ly com­plex. When some­thing is com­pli­cat­ed, it is be­cause we as peo­ple tend to make it so.

In the con­text of in­vest­ing, we seek out com­pli­cat­ed sce­nar­ios in or­der to pro­vide ei­ther guar­an­teed re­turns, or worse, an il­lu­sion of a guar­an­tee. We com­pli­cate things by fail­ing to ful­fil our roles (such as clear­ly iden­ti­fy­ing our in­vest­ment ob­jec­tives and stick­ing to those ob­jec­tives).

We pur­chase com­pli­cat­ed in­vest­ment prod­ucts that we can­not un­der­stand or do not take the time to un­der­stand. We look at com­pli­cat­ed strate­gies, but fail to fac­tor in the fees as­so­ci­at­ed with such strate­gies. We go for the struc­tured prod­uct with mul­ti­ple sce­nar­ios in­stead of sim­ply pur­chas­ing a port­fo­lio of blue chip stocks at a rea­son­able val­u­a­tion and hold­ing on.

In the end, there is an­oth­er say­ing: if you can't hear, you will feel. It's a com­ment you will hear from many moth­ers and grand­moth­ers di­rect­ed to a dis­obe­di­ent child. It is a re­al­i­ty of life and so is al­so ap­plic­a­ble to the world of in­vest­ments. There are cer­tain ba­sic prin­ci­ples that are al­ways rel­e­vant when un­der­tak­ing an in­vest­ment or try­ing to build a port­fo­lio and, if those ba­sics are not ad­hered to, then you may avoid a neg­a­tive out­come, but it is in­evitable that it will catch up to you, this is when you will "feel" it in your in­vest­ment re­turns.

Keep it sim­ple.

Ian Nar­ine is a bro­ker reg­is­tered with the Se­cu­ri­ties and Ex­change Com­mis­sion.

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