Recently, legendary investor Charlie Ellis was interviewed by Barry Ritholtz on his Bloomberg Masters in Business podcast. The whole interview is worth your time, but here I wanted to focus on just one of the topics they covered: The danger in using rules of thumb.
Here is the exchange:
Ritholtz: As an investor, how do you aim in the right direction?
Ellis: Well, I can’t give you a straight answer except in generalities because each of us is unique. But start with: how much money do you have? Are you saving money or spending money? How many years do you have before you need to cover your retirement or cover you kids going to college, or whatever is your objective? How much wealth do you have? How much income are you creating? Take all those things you can work out an investment strategy that makes good sense.
Let me give you an example; I'm 79. Most people would say, ‘At that age, you must have a lot of bonds.' I have no bonds. …First, I'm still working, and I have enough to cover my operating costs. And second, who am I investing for? I'm investing for my grandkids with an average age of ten.
To sum up his point on investing being all about aiming in the direction of your unique goals and avoiding rules of thumb when they don't match your aim, Ellis uses the following metaphor. Imagine a road trip to Chicago with the rule of thumb being the higher your average speed, the quicker you’ll reach your destination. Ellis instead says:
I don’t care how fast you drive to Chicago, just be sure you aren’t heading to Miami.
Investopedia lists several of these financial rules of thumb to be aware of and suggests taking them with a grain of salt as well:
While rules of thumbs are useful to people as general guidelines, they may be too oversimplified in many situations, leading to underestimating or overestimating an individual’s needs. Rules of thumb do not account for specific circumstances or factors occurring at a particular time or that could change over time, which should be considered for making sound financial decisions.
So, what can you do to account for your specific circumstances when it comes to managing your finances? Well, we have some ideas.