The 10 Commandments Of Personal Finance

Photo Credit: 123rf.com

The Shavuos holiday, as Jews around the world celebrate receiving the aseret hadibrot, is also a good time to review the 10 timeless principles of personal finance. With the market crashing, inflation rising and geopolitical turmoil around the world, taking the time to remind ourselves of these core tenets can help investors avoid financial missteps and position them to achieve their financial goals. Let’s go through each of them:

1. Cash is king: The foundation of any prudent financial plan is to have at least three to six months’ worth of expense money sitting in cash. As economists and market prognosticators debate the length of this market crash and inflationary environment, the folks with ample cash might be in the best position. Their cash reserves should allow them to sail through these challenging times of more expensive goods or lost jobs relatively unscathed.
2. Debt is bad: Many advisors note that borrowing money has both positives and negatives. They are right. In some circumstances, leverage may be quite helpful. However, generally speaking, the people who are not indebted to anybody are in the best shape financially. Even the most sophisticated investors and institutions can run into trouble if they don’t carefully monitor their debt loads. As interest rates continue to rise, there will be no shortage of news stories about companies that went belly up, succumbing to their insurmountable level of indebtedness. Being debt-free is one of the most powerful financial positions.
3. A clear understanding of your time horizon is key: One’s time horizon dictates how much risk can prudently be taken within your portfolio. It also keeps rough market conditions in perspective. If you’re a long-term investor, these turbulent markets should not scare you. In fact, it should excite you. It offers you the wonderful opportunity to buy stocks at a meaningful discount compared to what they were trading at just a few months ago. If you are a short-term investor who planned properly, you also should not be scared by the current bear market. Your portfolio should have a large position of cash in preparation for withdrawing the funds. It’s irresponsible to invest without having a clear understanding of when you need to use the money.
4. Dollar-cost averaging keeps emotions in check: Dollar-cost averaging is the process of routinely adding money to investments at regular intervals. Every human is emotionally charged. However, emotional decisions have no place in the world of successful investing. The benefit of setting up automated, routine contributions to your investment accounts is that it helps eliminate emotions from your process. It eliminates the desire to time the market, and it increases your ability to build wealth over time.
5. Rebalancing allows you to make money without much effort: The act of rebalancing is when one adjusts the weightings of a portfolio as investment values go up and down to maintain their original asset allocation based on risk tolerance. Rebalancing allows one to sell the positions that went up in value, while simultaneously adding to the positions that went down. The old adage in investing is to “sell high, buy low.” This is a way to do just that.
6. Diversification is the only free lunch in investing: There is a tendency for investors to find, and pile into, the hot investment du jour. This is great while things are going well, but all companies, sectors, industries, and countries go through cycles. When things go south, having an overly concentrated position in any one area of the market can be devastating. This can be illustrated throughout history, and especially today with the technology-heavy Nasdaq plummeting nearly 28 percent as of this writing. The best way to protect your portfolio from this risk is to have a policy of diversifying across many asset classes.
7. Conservative bonds have a place in everyone’s portfolio: When the market is soaring, many investors won’t even look at high-quality fixed income. Today, investors don’t want bonds because they are dropping as interest rates increase. In reality, bonds serve a crucial purpose in all investors’ portfolios. They provide the psychological benefit of minimizing volatility during turbulent markets. They serve as a cushion that allows investors to withdraw funds from assets that didn’t plummet in value as much during a market correction. Lastly, there are rebalancing opportunities when stocks fall in price and the highest-rated bonds tend to appreciate.
8. High returns mean a high level of risk: Investors tend to search for the silver bullet of high returns with no risk. When times are good, some folks may believe they found this panacea as their investments continue to rise. However, when the economic conditions turn, they soon realize the actual risk taken. The nature of the risk may come in many forms, including leverage, illiquidity, or poor credit. The bottom line is if you want to potentially achieve high returns, you need to be willing to take a high level of risk.
9. Boring over exciting could be the right approach: Investors often confuse an exciting idea with a good investment opportunity. Excitement may be generated from the latest fad, an exclusive deal, or a strategy that promises to trounce the performance of the S&P 500. These “opportunities” are, more often than not, being sold on hype instead of fundamentals. To avoid being lured into one of these situations, pursue an approach of sticking with plain vanilla, boring investments. This may be a combination of blue-chip stocks, index funds, or high-grade bonds. An investor may miss the next hot IPO, but they also won’t get sucked into the next Ponzi scheme. The tradeoff seems worth it.
10. Once you win the game, stop playing: Investing can be addicting. It’s important to understand that the main purpose of investing is for one to be able to achieve one’s financial goals. Once an investor reaches that magic number, there is no reason to continue to put that money at risk. The monies accumulated to fund an investor’s goals should be moved out of risky investments. Investors who have reached that point are in the enviable situation of no longer needing to stress over the next market downturn.

The silver lining of a severe market downturn is that it causes investors to reflect. As they introspect, they’re forced to face the cold hard truth of whether they’ve stuck to these timeless investment principles. If they’ve strayed, it could be devastating and set them back many years financially. However, if they stay true to the principles, it should increase their chances of success in the long run.