In one of his many famous quotes, iconic investor Warren Buffet once said, “Investing is simple, but not easy”. He was referring to his process of hard work and due diligence followed by decades of sitting on his hands and letting his investment grow. You see a large part of investment success is staying invested and letting your money compound over a long, but volatile, period of time. It really is a simple concept to understand, but not an easy one to follow.
Much of personal finance follows the same model. There are a variety of obstacles that can get in your way, but two really stand out as plaguing anyone looking to get their financial house in order. The first is overcoming our behavioral tendencies and the second is choosing the right question or solution for a given problem. We have previously covered many of our behavior roadblocks like overconfidence, sunk cost bias, and regret, so we thought we’d tackle the impact of pairing the right questions and solutions to a problem.
Are you asking the right financial question?
Several years ago the You Are Not So Smart blog posted a fascinating article on Survivorship Bias. One of the highlights was an amazing story from World War II. To crudely summarize, US bombers were being shot down in record numbers with the odds of surviving a run sometimes as low as 50%. In a desperate attempt to help, the military brought in statistician Abraham Wald, who was part of the Applied Mathematics Panel tasked with solving complex military problems. Wald examined records of all the damage from planes that returned from war compiled by the military. They wanted to know where the most damage was being done so they could put extra armor to reinforce and protect the planes. Wald quickly, and correctly, deduced that they were asking the wrong question. Any area that could sustain a lot of damage and still fly home was not critical to operating and didn’t need extra protection. The areas with the least damage actually needed reinforced because the planes that sustained a lot of damage there were not making it back. It was a dramatic case of survivorship bias and a perfect example of asking the wrong question.
One of the hardest jobs for people trying to plan for their financial future, and the advisers assisting them, is asking the right questions. If you were to use Google as a proxy for the type of questions people are asking about personal finance (which is a pretty good assumption these days) you can see the problems. Googling “what is the best way to invest” returns 415 million results, while “should I pay off debt or invest” returns only 93 million. There are about eight times as many results for “mortgage rates” as for “what size mortgage can I afford”. The trend is toward “how can I”, “the best way to”, and “the easiest way to” instead of “should I”. As advisers we love to work with clients to find the best or most efficient way to accomplish a financial goal, but we have to be equally effective at asking the pre-qualifying questions when appropriate before we get ahead of ourselves.
Are you using the right solution?
Sometimes in our quest for perfection we bypass perfectly good, simple solutions to problems in search of complexity. Summed up by a quote attributed to Confucius, “Perfect is the enemy of good”. If you have an affinity for math you may enjoy following along with this example.
You are trying to figure out the weight of a series of animals with a few known variables.
1.) A bunny (A) + a cat (B) = 10 lbs.
2.) A bunny (A) + a dog (C) = 20 lbs.
3.) A cat (B) + a dog (C) = 24 lbs.
How much does a bunny (A) + a cat (B) + a dog (C) weight? At first glance you might decide to work this one out in the following logical way. If the difference between a bunny and a cat and a bunny and a dog is 10 lbs., then the dog must weigh 10 lbs. more than the cat. If we know that fact, then we can look at a dog plus the cat equaling 24 next. Even a little trial and error will find that the dog must way 17 lbs. because the cat weights 10 lbs. less and 17 plus 7 equals 24. Great, now we know the cat weights 7 and the dog weighs 17. We can go back to the first part where a bunny plus a cat equals 10 and find that the bunny weighs 3 lbs. Our final answer is a bunny (A) + a cat (B) + a dog (C) = 3 + 7 + 17 = 27 lbs. Even without knowing algebra you could have worked through this solution.
Now let’s look at it from a new light. What information was originally given? What if you put all that information together? To make it clearer we’ll use the letters for the animals. We were told that A + B = 10, A + C = 20, and B + C = 24. Taken together that is 2A + 2B + 2C = 54. Think about it. If you looked at all the information together you would know what 2 bunnies, 2 cats, and 2 dogs weigh already. The question is what does 1 bunny, 1 cat, and 1 dog weigh. Easy, just divide 54 by 2 and you get 27. That is a much faster calculation, that requires LESS math, and is easier to complete. We took the long way to get there. Where else in your financial life are you using a complicated solution when a much simpler one already exists.
Personal finance is simple, but not easy!
We struggle with financial planning topics for many reasons that have nothing to do with algebra, or statistics, or probability. It isn’t the lack of knowledge in mathematics stopping someone from saving for retirement or establishing a will, but it might be not knowing when the right time to start is. It could be searching for answers to the wrong questions holding people back. We’ve even seen people delay saving for retirement because the convoluted excel calculations they were working on to tell them how much they needed to save was never completed.
Knowledge and experience are important, and we’d be lying if we told you that there wasn’t a lot of math involved in what we do for clients. However, before any of that matters you have to be sure you are asking the right questions and, to paraphrase Einstein, making everything as simple as possible, but no simpler. The solution might be simple, but finding the right question won’t be easy.