Occam’s Razor states that “entities should not be multiplied beyond necessity”.
Project management pushes for use of “the minimum viable solution that generates value”.
Similarly, the “Economy of Effort” is a Principle of War in military doctrine guiding the effective employment of resources.
The main resources you apply to investing are your time and cognitive capacity.
Fancy-looking complex solutions look great on the surface. They certainly sell based on “easy” solutions. But they often fail.
These “easy” and over-complicated solutions are often a distraction from the need to rely on your own self-discipline.
We over-complicate things that are simple, but hard to implement. This applies equally to fitness, nutrition, and investing.
Growing wealth can be very simple: Spend less than you earn and invest in a total market index fund aligned with your asset allocation.
If you elect to do that for multiple decades, compound growth will generate serious wealth.
I cover the benefits of simple investing when it comes to growing wealth. But first, I need to define “simple Investing”. Otherwise, this post would be silly.
What Is Simple Investing
I define simple investing as DIY index investing.
There are thousands of index funds, so I need to be more clear. I’m only talking about low-cost total market stock and bond index funds.
A total market index fund invests in all stocks in a stock market, and a total market bond index fund invests in all bonds in a bond market.
These guys can be accessed via mutual funds or exchange-traded funds (ETFs). They both achieve the same effect. In Canada, ETFs are the most common.
There are many theoretical reasons why total market index funds provide the best return for a given level of investment risk. Reasons include:
- Market Efficiency. See the Efficient Market Hypothesis
- Low fees.
With index funds, you get the market return minus the very small fees associated with the fund. These fees are less than 0.2% per year or $20 for every $10k invested.
Asset Allocation ETFs: Super Simple
An asset allocation fund is the pinnacle of simple investing.
Such a fund contains underlying stock and bond total market index funds. It’s a fund of funds.
These funds offer value by maintaining your desired split of stocks and bonds. The funds also stick to a target geographic exposure for both the stock and bond components.
For example, an 80/20 asset allocation ETF will maintain 80% of it’s investments in global total market stock index funds and 20% in global total market bond index funds.
To upkeep these targets, the fund re-balances for you. That means zero re-balancing for you and less complexity.
Asset allocation funds are low-cost portfolios in a box that offer maximum simplicity. You can learn more about them at the Canadian Couch Potato’s Model Portfolios.
Simple Investing Process: An Example
After years of investing and thinking, here is what I believe to be the minimum viable solution to build wealth.
- Ensure a sustainable gap between income and expenses.
- Find out if you are ready to invest.
- Figure out your asset allocation based on your unique risk tolerance. The BMO Questionnaire and Vanguard Investor Questionaire are useful guides. Identifying your risk tolerance is one of the most important aspects of investing.
- Find an Asset Allocation ETF that aligns with your asset allocation.
- Invest in the Asset Allocation ETF consistently for a few decades. Endure a few crashes.
- Self-monitor for changes in risk tolerance. Adjust asset allocation as required.
- Be wealthy.
This is not a recommendation or personalized investment advice. You are 1000% responsible for your own financial decisions.
I’m now excited to dig into the benefits of a simple investing approach.
Table of Contents
1. Simple Investing Enables Rational Decision Making
With index funds, you set it and forget it.
There is no need to buy/sell individual stocks or monitor investments. Asset allocation funds even remove the need to rebalance.
Overall, you will spend less time dabbling in your portfolio, and this limits emotional attachment to your investments.
Low emotional attachment is key to investing. It hurts to see a portfolio drop by 30%. A 100% stock portfolio can even drop up to 60% over an investing career, as you can see from the past 30 years of market swings.
You don’t check the value of your house daily. So why would you check the value of a group of businesses that you own daily?
The value matters when you sell, and that’s in a few decades for investors with a risk tolerance for 100% stocks.
A hands-off portfolio means there is no legit reason to check the value of your investments.
Viewing your portfolio less often has a natural smoothing effect, and that can reduce volatility – the intensity of crashes and the intensity of upswings.
The book Atomic Habits discusses this. Successful people are not more disciplined, they just engineer their environment to limit demands on self-discipline.
In fact, it’s protecting yourself from yourself.
Human biases are normal, and they are the most important thing to acknowledge when investing. You can read more in this post on Human Behavior and Investing: Ways to Control Emotional Biases and Risk.
Simple investing keeps you emotionally detached from market movements, thus keeping you invested. By staying invested, you will receive better returns.
2. Simplicity Preserves Your Most Valuable Resource
As I’ve aged, I’m noticing how fast time is ticking. The value of my time is becoming more apparent.
Investing in individual stocks is very time-consuming.
Before buying you need to research competitive advantages, balance sheets, and income statements.
Then you need to track dynamic changes once you hold the stock. What if the business trajectory changes or a risk materializes?
Plus, an investor in individual stocks will hold at least 20 stocks to diversify. Otherwise, they will be exposed to “uncompensated” risks. They don’t get paid to take on uncompensated risk.
I sure won’t take risks that I’m not being paid to take. Silly.
Researching and monitoring 30 individual stocks is a mission. Plus, you need to buy and sell, incurring capital gains tax and transaction costs.
Therefore, you may ask yourself if the stock selection is worth your time, knowing that most skilled stock pickers fail to beat the market over the long haul. It may be worthwhile if it’s your hobby.
Investment portfolios of individual stocks and bonds consume time and cognitive effort. Index investing frees up this time and energy for the important things in life.
3. Simple Investing Is Tax Efficient
A total market index fund does very little buying and selling of the stocks within the fund. It doesn’t trigger as many taxable events, so it’s more tax efficient.
For example, when a small company explodes in growth like Tesla, it naturally makes up more of the index. Or if a large company like General Electric implodes, it naturally makes up a smaller portion of the index.
The fund will organically self-regulate for changes in the size (market cap) of businesses (stocks) contained in the fund. Therefore, there is little need for a manager to buy/sell stocks.
When a fund manager buys and sells stocks in a fund, you pay tax on the capital gains income when those stocks have gone up in value. It may not seem like a big deal, but it imposes a “tax drag” on compounding.
Total market index funds are very tax efficient because they minimize taxable events. This doesn’t matter much in tax-sheltered accounts. But tax efficiency becomes important when the TFSA (Roth IRA) and RRSP (IRA) are maxed.
Plus, tax tracking in a taxable account is simplified with only one investment. It’s easier to track your Adjusted Cost Base and there is only one T3.
Simple investing in total market index funds can reduce tax losses and improve long-term after-tax wealth.
4. Simplicity Enables Consistency
Do you ever notice how even simple tasks can be hard to implement?
I see this at work all the time. There are always unforeseen complexities. Overcomplicated solutions rarely work.
Due to human behavior, ease of implementation is extra important in personal finance. Ease of implementation enables repetition.
And repetition builds habits that can be left on autopilot for the rest of your life. Habits are a worthwhile investment.
I get it. The simple solution is not sexy. It is boring.
An asset allocation ETF, for example, is very boring, and very easy to implement. You just buy the same asset when money is available from your savings.
By repeating the investment action over and over it is likely that you’ll form a strong habit of consistent investing.
To further improve consistency, I like investing the same amount monthly, rather than having inconsistent investment sums. I invest nearly the same amount every two months.
One way to boost the consistency of savings is with sinking funds. They allow you to distribute lump sum expenses over time.
Simple investing processes help you build habits that persist. Building wealth is a long game, done over many decades. To learn more about habits, I highly recommend the book Atomic Habits by James Clear.
5. Simple Investing Keeps You Away From The News
Did you know the world is wealthier than it’s ever been? Lifespans have never been longer, and more people have been lifted out of poverty in the last 3 decades than ever before. It’s mind-blowing.
But you don’t hear about this on the news. News is biased to the negative, warping your perception of reality.
But I don’t blame news agencies. Negative news sells, thanks to the loss aversion bias.
Negativity plays on your threat detection systems that are biologically designed to keep you alive.
This amplifies emotions that encourage panic selling when times are tough, and speculation when times are good. The result is buying high and selling low.
With total market index funds, there is no need to track news. Geographic diversity erases any care you have for individual companies or specific market sectors.
Plus, all information you get on the news is already priced into your stocks and bonds before you have time to take action. To learn more about this, read about the Efficient Market Hypothesis.
There is no need to watch investment news with simple index investing. Not only does this preserve your time and energy, but it keeps you away from the negativity that amplifies costly behavioral biases.
Another side effect of removing negativity is higher happiness.
6. Simple Investing Saves Cognitive Effort
Complicated investing decisions consume cognitive capacity that cannot be devoted elsewhere.
I know that I have a finite capacity to make decisions.
I prefer to save this cognitive capacity for high-impact activities, like writing this blog and gaining new skills that can increase my earnings power (human capital).
It seems the amount of high-impact focus work that humans can do daily is capped at around 4 hours.
Cal Newport estimates that you train yourself to complete about 4 hours of daily deep work, in his book “Deep Work”. The Neuro Scientist Andrew Huberman estimates you can do three 90-minute sessions of focus work daily. So 4.5 hours.
Simple investing preserves your cognitive capacity. You can use this capacity to increase income and make solid decisions in other areas of your life.
7. Core Concepts Are Infinitely Adaptable
One of the things I loved when I studied physics was the power of core concepts. A few concepts explain a wild amount of phenomena.
Core concepts enable simplicity, and simplicity keeps you focused on what matters. Similar to the principle of war called “maintenance of the aim”. Focus on what is important.
These core concepts work well in personal finance because the ideal inancial approach is unique to each individual. Here are some critical concepts that are central to simple investing:
- Compound Interest
- The Underlying Source Of Stock Returns
- Risk Tolerance
- The Sources of Human Wellbeing
By understanding a few core concepts, you can plan your financial life around your unique desires.
Investing is a unique activity. A simple hands-off approach will optimize risk-adjusted returns while preserving your time and energy.
Asset allocation ETFs maximize simplicity with a set-it-and-forget-it portfolio.
Here are some benefits of a simple investment approach:
- That can reduce emotional attachment to a portfolio by limiting interactions and keeping you away from the news.
- Preserves your time and cognitive capacity for the things that matter.
- Helps you build good investing habits through consistency.
- Helps you improve after-tax wealth due to the tax efficiency of total market index funds.
Simple investing is nice, but it’s not the only aspect of personal finance that benefits from simplicity. Frugal living also enables lifestyle simplicity.
In fact, I find simplicity to be the benefit of frugal living rather than cost savings. Learn more in 13 Frugal Living Tips to Save Time, Money, and Energy.
I hope you’ll look at simplicity from a different perspective.