Archive | Financial planning

Blog for Financial Literacy: A Simple Plan

Today’s post is part of the Blog for Financial Literacy campaign spearheaded by Glenn Cooke of Life Insurance Glenn encouraged dozens of bloggers to devote their November 15 post to sharing their “single best financial tip,” in recognition of Financial Literacy Month.

Long-time readers of Canadian Couch Potato know I occasionally explore some pretty arcane facets of index investing. I hope this advanced information has helped serious index investors make better decisions, but I recognize it may have left some readers scratching their heads. With that in mind, here’s the single best financial tip I can offer: keep your investing strategy simple.

We need to get rid of the idea that successful investing has to be complicated. If you’re naturally curious like me, you’ll genuinely enjoy spending time and effort to learn the subtleties. Gaining a deep knowledge can be empowering, but it’s not essential. What’s more, it comes with the risk of analysis paralysis and the tendency to second-guess your decisions.

Do you disagree with one of the ETF choices in my model portfolios and want to substitute another?

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Why Plans Should Come Before Products

When I wrote the MoneySense Guide to the Perfect Portfolio last year, I waited until Chapter 5 before I started discussing specific ETFs and index funds. That was a deliberate decision, because I feel strongly that we put far too much emphasis on investment products, and too little on the investing process.

Carl Richards agrees. As he explains in his book, The Behavior Gap, selecting investments should come at the end of the planning process, not the beginning: “You would never spend time researching and debating whether to travel by plane, train, or car until you figured out where you are going.”

During our recent interview, Carl elaborated on this idea. “The reason this is so important is that if we start with the product, we are inevitably going to be disappointed. And that leads to buying things high, and selling things low.” Instead, he says, start by giving your investing a context. “For instance, you may think education is really important for your kids and you want to save enough to send all of them to school. So how much will that cost?

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Ready, Willing and Able to Take Risk

Asset allocation is more art than science. There are no immutable laws to tell you what proportion of stocks and bonds should be in your portfolio. The best you can do is adopt rules of thumb. “Make your bond allocation equal to your age” is a popular one, as is “Don’t invest in equities if you will need the money within five years.” In the end, it comes down to a trade-off between risk and expected returns.

I found a lot of useful insights on asset allocation in Larry Swedroe’s newest book, The Only Guide You’ll Ever Need for the Right Financial Plan (Bloomberg/Wiley, 2010). Swedroe, who writes the Wise Investing blog at CBS MoneyWatch, is one of my favourite financial authors because he always backs up his arguments with hard data and practical advice.

His new book is written for an American audience and most of the financial planning advice isn’t useful for Canadians. However, a large part of the book is devoted to asset allocation decisions, which should be based on “the ability, willingness and need to take risk.” Let’s break down these three factors.

The ability to take risk

Swedroe says your ability to take risk depends on your investment horizon and the stability of your income (or human capital).

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