204. (Building Finance Intuition) My first order principles for personal finance
“We have always found that, if our principles were right, the area over which they were applied did not matter. Size is only a matter of the multiplication table.” — Henry Ford
With stock markets falling once again, I thought it is time to remind myself of the first principles that I hope to stick to, in my personal financial journey. While I introspect on my first principles, I thought I may as well do it publicly because these principles may be relevant to wider community. In no particular order, here they are:
Neither am I in a hurry nor do I have a destination
“The only urgency I feel is to keep on, at a slow pace, with my journey.” — Alessandro Michele
I have realized perhaps a little late in life that the destination of the journey of life is fixed. We all end up at exactly the same place — nothingness. If destination is not discretionary, then perhaps, journey is to be coveted. In that case, why be in a hurry? To this extent, I do not, any more, treat life as a project with milestones and deadlines — I think of life as more like a going concern. This naturally forced me to think long term (more like infinite time). I think the best way to increasing the odds of favourable long-term outcomes is by doing the “right” things today. Am I doing what I should be doing today, this week and this month? What does today’s (this week’s/this month’s) fall in my stock portfolio mean for my long-term prospects? Nothing. So, do I need to take any action now? No. Is there a need for worry? Quite likely, no.
Only those who survive have any shot at thriving
“Before you can win a game, you have to not lose it.” — Chuck Noll
If I depend on stock market returns for my day-to-day livelihood, stock market falls of 25% will surely affect my standard of life. In fact, a number of other problems will follow. I may not be able to afford our children’s college tuition or a family function. The ensuing worry may affect my health. Forget thriving in the long run, my present standard of life may not survive. So, always ensure that you do not take a risk that you cannot afford. Never be in a position that threatens your minimum standard of life. First requirement for winning any game is to survive the game. Asset allocation is my primary weapon of attack here. Given that I do not have any active income, my principle is to tuck away a minimum of 7–8 years’ worth of my expenses in safe funds. Presently, I’m doing a little better than this — so, my current standard of life is not at stake and hence thriving in the long-term remains a real possibility.
Taking risks
“Take calculated risks. That is quite different from being rash.” — George S. Patton
Thriving in the long term is never guaranteed. But I can surely make myself deserving of good or even excellent long-term prospects. Of course, first I have to ensure that I last the (long) term. But mere surviving will not work — I will have to take risks. I have to take the right kind of risks — the “calculated” kind. I appreciate that risk is an essentially personal concept — it can be best understood only in one’s personal, social and temporal context. Did I allocate “enough” capital to the right “kind” of risk so that when returns ensue, my life becomes consequentially better off. Am I wielding the “asset allocation” weapon well? With well over 60% of my assets allocated to stock ownership, I think I do.
About returns
“Prediction is very difficult, especially if it’s about the future.” — Niels Bohr
I really don’t know how to forecast returns. Of course, there are various models and methods available that can be used to develop future scenarios. But my problem is that I do not think future can be modeled. So, I do not have any specific targets or expectations for returns on my financial portfolio. The essence of my risk-return strategy is to answer the question: will I be able to live with the consequences of my risks materializing unfavourably. I believe I can and that absolves me from having to have any expectations on the returns on my portfolio
On leverage
“We live in an age of infinite leverage, and the economic rewards for genuine intellectual curiosity have never been higher.” — Naval Ravikant
How can one pack a punch above their weight? By using leverage. Leverage can multiply your inputs. I do believe that leverage is critical to long term success. But I’m quite weary of financial leverage. Putting levered capital to risk is an absolute no-no. Thankfully, leverage need not always be financial. In fact, I believe that much better forms of leverage can be found in the form of knowledge and wisdom. By developing critical knowledge, I could materially alter the amount of capital that I put to “risk” and also enhance the nature of “risk” that I took. Wisdom perhaps is the ultimate hack to success but I do not think there are sure-shot ways to acquire wisdom. One can acquire and apply knowledge and then learn critical lessons on the back of that application. And hope that wisdom dawns. If it does, your further actions will automatically become levered. This distills to…. am I learning every day? Yes I am, if not every day, surely every week.
Comfort zone or comfort crisis?
“Always first draw fresh breath after outbursts of vanity and complacency.” — Franz Kafka
Given that I’m more or less sticking to the principles I laid down for myself, is it now just a matter of waiting it out until long-term prospects materialize? It’s a rhetoric question, of course. World is dynamic. Every strategy and tactic will need to be reexamined as the world changes. Perhaps new principles need to picked up and a few old ones jettisoned. All in all, principles have to be held strongly with conviction but dogmatism should be avoided. “Comfort zone” is a dangerous state to be in. But it is inescapable. So, am I taking deliberate actions to upend my comfort zones? Am I on a constant watch out for new niches emerging and old niches disappearing? Am I shaking up my methods periodically so as to get comfortable with being uncomfortable? Am I facing my fears and pushing my perceived boundaries? A reticent “yes” to all these questions, for now.
Bottomline
“Not life, but good life, is to be chiefly valued.” — Socrates
I believe that the path to financial success is built on solid principles. The journey is maneuvered by flexible strategies and tactics and propelled by constant learning and by overcoming comfort zones. It is as simple as that. But like sticking to good eating habits, it is difficult to stick to this path. Reminding oneself of these principles is one way to improve compliance; writing them down is a great way to reinforce clarity and motivation.
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