Does your financial wiring need an update? Probably so. The wiring in your house provides the framework needed for all the mechanical systems within the house to operate. Likewise, financial wiring supplies energy for all your aspirations and long-term goals.
Rewiring requires that you broadly reconsider what you are trying to accomplish financially over time. Many individuals simply seek the “best” investments they can find with little regard for anything else. That’s a reflexive and short-sighted approach that rarely works.
WHY RISK AND WIRING ARE RELATED
Rewiring starts with understanding what risk actually means to you. Risk isn’t day-to-day volatility in the stock market – that’s baked into the cake. Instead, think of risk as the level of uncertainty you have about how much money you need to sustain your lifestyle for the long-term.
Most of you have heard me say “you should take enough risk, but not more than enough.” That’s sometimes tough to accomplish since investors are often risk-averse and desire high returns for the risk they accept.
HOW TO REWIRE YOUR FINANCIAL LIFE
Here are five steps needed to rewire your financial life:
Step One – You should construct an investment portfolio that's reasonable for your circumstances based on all available information. However, you have to understand that the portfolio choices you make today may not actually deliver what you desire in the future – that’s where Step Two comes into play.
Step Two – It’s crucial to realize that unexpected returns (surprises) might actually comprise the bulk of your long-term outcomes. Market history provides a guide, not a guarantee. This means that you should avoid making portfolio changes in reaction to short-term events – long-term investment returns can’t be precisely engineered.
Step Three – You need to understand the proper role of probabilities within your financial life. You want to use probabilities to arrange your money in a way that favors success. Stacking the odds in your favor, however, doesn’t result in certainty. Things that aren’t likely to happen in fact happen; likewise, things that you believe are likely might not actually occur.
Step Four – You should avoid complexity where simplicity suffices. Many investors are attracted to complexity because they believe this provides an impression of control. Within the investing realm, complexity is often a feature intended to signal extra thoughtfulness. For the main, financial complexity usually hides flaws and you should avoid this feature when possible.
Step Five – Understand that your view of how things will unfold in the future is likely…very likely, wrong. Most investors are overconfident that their view of the world and markets is the right one. When you are overconfident you believe you can see into the future. In reality, that’s not possible.
Just like the wiring in your house, your financial wiring needs to be updated based on your current needs. Your particular goals and circumstances change over time and your financial wiring should reflect these conditions. Start there.