73% of salaried consumers feel that they have no Financial Planning and are in no control of the way they are managing their money. But if you look at the balance 27%, you would see that they don’t have some magical portions but instead have followed basic laws. The fun part of the law has no relation to finance, which means that all of us can universally use them.
Without further ado, let’s check them out one by one
Law 1: The Preserving Optionality law
The law tells that to get maximum gains, you need to keep as many options open as possible. However, the choice must have a limited downside and an open-ended upside.
Betting in a casino is not an option, as the upside is not open-ended. How about putting money in stocks? That’s an option—the upside is theoretically unlimited; the losses are limited to the amount you invest.
What are the situations when you can fail this law? The main reason for failure to abide is when we take limiting choices or have dependencies. Too Much debt, inadequate insurances, etc. are some of the reasons for this.
Options present themselves all the time, but life-altering ones often come up during times of significant change. If you don’t have the option available, you miss the benefits of considerable changes.
Enabling options should be the law which your financial planning process should follow
Law 2: Follow the Pareto’s Principle or also the 80:20 Rule
Pareto’s principle states that the majority of outcomes are driven by a minority of events. Corollary to that is the law that your decision making regarding money should follow this rule.
This means that you need to be ready for the minority events which are game-changing and ignore the majority event which is noise
For example, checking your portfolio value on each day or event is an 80% action. Buying stocks when the market has crashed by 40% or preparing for job loss or medical emergency are examples of actions to benefit from minority events
Law 3: The Law of Conservation and Efficiency
The law states that things in your control ( conservation and efficiency) have the highest likelihood of making the most significant difference over time.
In the world of money, Personal savings and frugality – finance’s conservation and efficiency – are primarily in your control and have a 100% chance at being as effective in the future as they are today.
You can spend time thing how to reduce your borrowing costs but not spend enough time in delaying the purchase, so that fall in the price is more than the borrowing costs.
Often you would spend hours chasing that right stock or mutual fund to get that extra 1% return. However, in doing that you often ignore that investing in an Index fund automatically would give you that additional 1% returns as the fund management fees are lower than an equity MF
Why we do this? The finance industry is constantly conditioning us by portraying a new thing or higher returns in a much brighter light than saving costs or increasing efficiency.
Following this law is the hardest as it is forcing us to goes against a lot of what we are being conditioned to or taught about. Unfortunately, this law is also the foundation for financial planning
You can look at this Warren Buffet documentary on how he has systematically built conservation and efficiency in his life and investing world.
Law 4: Parkinson’s law of triviality
The law states that the bigger the decision, the smaller the time we want to spend on it.
Financial decisions are often complex and usually have a significant impact and that too not immediately but with a lag. When faced with such a situation are thinking is that since this is a complicated situation but actually has a low impact, so let’s take a quick decision and get over with it. It’s too painful to dwell over such decisions as their impact are not known for a long time
That is why the whole world of tips and calculators exist. You punch in data get an output, you spend 2 min to read a tip and then act on them. You think that these tools have made the decision simple, but in reality, you have taken a shortcut to a complicated decision. Multiple such decision destroy the financial planning process
Law 5: Vierordt’s law of Time Periods
The law states that We underestimate long periods and overestimate short periods.
That is why even though are plenty of goal planning tools, they seldom work as its hard for us to visualize what can happen over long periods. Even if we start the process of goal, the short period goals will overtake precedence.
Therefore, the simple thing to do is make the goal which you can visualize always. The most straightforward goal to do that is to create wealth. That is something you can see, track, and achieve consistently.
Bill Gates gives an interesting corollary to this rule.
That’s it. These are the 5 universal laws to follow if you want to manage money or our taking a decision related to money. No fancy math, no investing knowledge just some basic fundamental laws.