Financial Principles by Jason Zweig. Guaranteed to Make You Smart.

Jason Zweig Investing Principles

When it comes to investing or personal finance, there’s a world of difference between a good advice and an advice that sounds good. It might not seem obvious at first, but there is.

And Jason Zweig is one of the best financial writers, who regularly doles out good advice. He prefers to say that he is not smarter than everybody else and that he only knows a lot about what he doesn’t know.

But like million others, I personally think that he is one of the best out there. In 2003, he edited Benjamin Graham’s The Intelligent Investor– a book which Warren Buffett has called ‘by far the best book about investing ever written’.

This speaks volumes about who Mr. Zweig is.

While reading through the archives of his site, I came across his set of principles (link), which I had somehow missed till now.

And this speaks volumes about my ignorance. 🙂

The principles are so accurate, clear, flawless and spot-on, that I couldn’t stop myself from sharing them with you.

The principles focus on using common sense in investing and personal finance, to achieve our financial goals. And that is something, which should be everyone’s concern.

Rest of the post is about those principles. I strongly recommend you read it now, bookmark it, print it and read it again… and again in future. Atleast I will be doing it.

So here it is…

Jason Zweig’s Statement of Principles

 Successful investing is about controlling the controllable. You can’t control what the market does, but you can control what you do in response. In the long run, your returns depend less on whether you pick good investments than on whether you are a good investor.

The first step to reaching your financial goals is to make sure you set goals that are reachable. Your expectations must be realistic. The stock market is not going to provide a high return just because you need it to.

The second step is to recognize what you are up against. Despite what all the daily market reports make it sound like, investing is not a game, a sport, a battle, or a war; it is not an endurance contest in a hostile wilderness. Investing is simply the struggle for self-control – the unrelenting effort to keep yourself from becoming your own worst enemy.

The market is not perfectly efficient, but it is mostly efficient most of the time. Attempting to beat the market may often be entertaining, but it is seldom rewarding.

There’s nothing wrong with gambling on poor odds, as long as you admit honestly that what you’re doing is gambling and as long as you put only a tiny proportion of your wealth at risk.

The brokers on the floor of the Exchange clap and cheer when the closing bell clangs every afternoon because they know that no matter what the market did that day, they will make money – because you tried to. Whenever you buy a stock, someone is selling it; whenever you sell a stock, someone is buying it. Most of the time, the person on the other side of the trade knows more about the stock than you do.

However, you don’t have to lose just because other people win, and you don’t have to win just because somebody else loses. You win when you stick to your own long-term plan, and you lose only when you let greed or fear goad you into changing that plan.

The right time to buy is whenever you have cash to spare. The right time to sell is when you have an urgent and legitimate need for cash. If you buy because the market has gone up, or sell because it has gone down, you are letting 90 million* strangers rule your life with their greed and fear.

* In American context

Once you lose money by taking too much risk, the only way you can earn it back is by taking still more risk.

If you lose 50%, you have to earn 100% just to get back to where you started. And if you lose 95%, you need to earn 1,900% before you break even. You may be able to do that once or twice through sheer luck alone, but the more often you have to try it, the more likely you are to end up broke.

All too many people live their investing lives like hamsters on a wheel, running faster and faster and getting absolutely nowhere.

If you want to have more money, save more money.

Investments that outperform in a bull market are certain to underperform in a bear market. There is no such thing as an investment for all seasons.

That’s what diversification is for: to protect you against the risk of putting too many eggs in the wrong basket. And buying something that has just doubled, in the belief that it will keep on doubling, is an extremely stupid idea.

Your goals are a function of all your life circumstances: your age, marital status, income, current and future career, housing situation, and how long your children (or parents) will be dependent on you. Risk is a function of probabilities and consequences – not just how likely you are to be right but how badly you will suffer if you turn out to be wrong. Investors tend to be overconfident about the accuracy of their own analysis – and to underestimate how keenly they will kick themselves if that analysis is mistaken.

Understanding your own shortcomings as an investor is far more important to your long-term success than analyzing the pros and cons of individual investments.

In the short run, hares have more fun; but in the long run, it’s always the tortoises who win the race.

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How much Life Insurance to Buy & How To Calculate the Right Amount?

How Much Insurance To Buy

A reader had a very specific question in Personal Financial Concerns Survey 1.0. It was about calculations related to life insurance amounts.

This is what he had to say:

In past, I have bought insurance policies for saving taxes and investments. But now I understand that these should not be the main reasons for buying insurance. Hence, I want to buy the right insurance cover to secure my family. How much cover is enough for me? People say buying Rs 50 lacs or Rs 1 Crore coverage works. Is it correct?

Now that’s a question that many people have.

I have seen people earning in 7-figures and having insurance cover of 6-figures! 🙂 They believe that a 6-figure amount will be sufficient to take care of their family in case of their death. And these people don’t even have a lot of money saved up.

Tells of risks that people take with their family’s future.

Insurance is bought simply to ensure that insured person’s family does not have to make sacrifices with their standard of living, are able to achieve their future financial goals and close all outstanding loans. That’s it. Nothing more. Nothing less.

But I am not writing this post just to prove that buying life insurance is a must. I am rather concerned about addressing the reader query, which is:

How much Life Insurance to Buy?

It is not that difficult to calculate.

You life cover should be sufficient enough to take care of the following 3 parts:

  • Provide enough money to foreclose all outstanding loans
  • Provide enough money to help meet regular day-to-day expenses of your family for years to come.
  • Provide enough money for your children’s education and marriage.

Lets take them up, one by one…

Part 1: Provide enough money to foreclose all outstanding loans.

This is pretty simple to understand. Just make sure to add any foreclosure charges that have to be paid in case of loan closure.

Lets call this as Amount-Loan-Closures.

Part 2: Provide enough money to help meet regular day-to-day expenses of your family for XX number of years to come.

(Caution – You need to be really sure about what XX is here – as it is the number of years, you think your family needs to be financially supported).

If you think your working spouse will take care of this part on her own, then that’s debatable. Just remember, that in a dual-income family, life style costs and regular expenses generally increase to use a larger part of the combined incomes.

So if suddenly one income stops, it can become a big problem to maintain the existing lifestyle.

Hence, it’s better and safer to make a provision for this as well.

Now how to calculate this amount?

Step 1: Estimate regular annual family expenses (exclude your individual expenses).

Step 2: Subtract the amount you think your spouse can manage on their own (better keep this as minimum)

Step 3: Understand that multiplying the above amount with the number of years (XX above) you wish to support your family won’t work. Why? Inflation. Inflation will increase these expenses every year. So take a safe inflation assumption (say around 8%).

Step 4: Understand that the amount your family gets from insurance company, will be invested and used to generate income. Don’t expect very high rates of returns from the investment. Lower your expectation are, better it is.

Step 5: Use this information to calculate the required insurance amount. This amount will provide enough money for your family to meet regular day-to-day expenses for the XX number of years.

Lets call this as Amount-Family-Expenses.

Part 3: Provide enough money for your children’s education and marriage.

Now it’s a personal choice here – Do you want to provide for your children’s education or marriage needs or not?

Assuming you want to, lets see how to arrive at this figure.

Step 1: Estimate the amount required for your children’s education and marriage, if it were to happen today.

Step 2: Since you children need funds in future, understand that inflation will increase the amount required. So if a MBA from good college costs Rs 15 lacs today, it might cost Rs 35-40 lacs after say 10-12 years. Calculate the amount in future using inflation numbers.

Step 3: You might have already saved some money for these goals. Calculate the future value of these savings and subtract the figure from amount calculated in above step.

Lets call this as Amount-Child-Goals.

 

Now we have calculated 3 figures for each part.

Add these three figures:

= Amount-Loan-Closures + Amount-Family-Expenses + Amount-Child-Goals

This is you current insurance requirement.

But you don’t stop here.

I am sure that you have been careful in your calculations.

But you see, in all calculations above, we had to make certain assumptions. Assumptions that require us to make predictions regarding rate of inflation, rate of return, etc. Now you know that even experts have trouble predicting the future. So at best, our predictions are mere educated guesses and not future realities.

We can always be wrong in our assumptions.

So in order to provide a buffer for mistakes in our assumptions, increase the amount you calculated above by atleast 10%.

Higher you bump it up, better it is.

I personally take it at 25%. (Even if it means that you family ends up with more money than they actually require, it is a good problem to be in. Isn’t it?)

This is the Gross Insurance Requirement for you.

Once you have calculated the figure, you need to subtract a few things from it. You might already have some other insurance policies,  employer-provided insurance covers, existing savings and investments earmarked for some of these child_goals . Subtract these amounts from above figure.

This will give you the additional insurance cover you need to purchase.

You can use the following grid as a guide:

Life Insurance Calculations

I am sure that once you are done with your calculations, a huge amount will be staring at you from your calculation sheet. Many of you who have endowment plans, moneyback plans, etc. as insurance covers, will even fear asking about the premiums for such large covers.

But don’t worry. Solution is there. And it is to buy plain term insurance cover. Its cheap and can provide coverage of almost Rs 1 crore for around Rs 10,000 – Rs 12,000. But remember one thing – term insurance has no survival benefits. You won’t get any money in case you don’t die within the insured period.

 

Important points:

  • Buying a term insurance does not mean that you don’t need to save for your future goals(retirement, kids education). It is only a backup plan in case you don’t survive that long. Insurance is not investment.
  • You are smart enough to purchase the right insurance cover for your family. But are your family members smart enough to deploy the huge insurance amount correctly (which they get when you die)? Don’t bet on it. Make sure that you sit with them and educate them what insurance is. And more importantly, what to do when they get the big amount. Tell them where to put the money and when to withdraw it. One wrong decision on their part and they will lose the money (a part or whole, who knows). And worst is that this is inspite of you having taken care of everything. So make sure you educate them.

There is a way to reduce your insurance requirements. Suppose you want to provide for your family’s expenses for 25 years (Part 2 of the above discussion). But your child’s education goal is just 10 years away (Part 3). So if you follow the approach discussed in article above, it will mean that you are paying for providing risk cover for the child’s education goal, even after its completion (i.e. 25 – 10 years = 15 years).

Effectively, you might find yourself paying a premium for sum assured that is higher than what is actually required. But that is not completely wrong. As I said, being over-insured is any day better than being under-insured. In any case, your insurance requirements keep changing every year.

The problem (though wrong to call it that), is solvable through an approach known as laddering of insurances. Its an approach where one buys term insurance plans of different durations that correspond to major goals like kids education, marriage, etc. Once the period of shorter-term plan is over, it frees up cash that can be invested elsewhere. Its an interesting topic – Laddering. I will write about it in another post soon.

When to Choose a Not-So-Great Investment Strategy?

Not So Great Investment Strategy


Few years back when I was working in oil sector, I was posted in a very remote location in Rajasthan. Since there was not much to do there, I used to regularly undertake biking trips to explore the state with my adventure-seeking colleagues. (Good Old Days) 🙂

A frequently debated topic for us then was about the best strategy to reach our destinations. Some advocated driving at ‘really’ fast (average) speeds and saving on time. While others were more inclined towards driving at less-than-insane speeds and focus more on ‘reaching the destination’ first. 😉
Eventually, the speed of our biking-gang was set by the slowest biker. That is what worked for us (and is indeed, the basis of Theory of Constraints).
Now lets come to the point that I wanted to make here – a great strategy in our case was to drive fast and save time.
 
But that ‘great’ strategy would not have worked for slow drivers. Driving at very fast speeds is not easy (and not recommended). So pushing ‘comparatively slow’ drivers to drive fast would have increased the chances of accident. Isn’t it?
Same is the case with investments. There are some great money-making strategies in stock markets. Yes. Even in the short term.
But will that strategy be suitable for you or not, is the most important question for you.
A person trading in F&O may have a strategy to make serious money in the short term. But just blindly copying his strategy will not work for you. Why? Because that person might have some buffer (which you are unaware of) that can bail him out in case of financial accidents. You unfortunately, might not have that buffer.
 
So for you, the best words of advise would be as given by Cliff Asness:
A great strategy you can’t stick with is obviously vastly inferior to the very good strategy you can stick with.
This is a very important concept that most investors fail to realize. Something that worked for others might not necessarily work for you. Plain and simple.
And as Ben Carlson of A Wealth of Common Sense says –
 
“People are taught their whole lives that if you just work harder you can achieve all of your goals. Unfortunately, trying harder in the financial markets doesn’t usually yield better results and most of the time it actually hurts performance. This is what happens when investors shoot for perfect instead of accepting good enough.”
Grass will always look greener on the other side. There will always be someone getting better results than you.
But don’t let that push you off your course.
 
Ofcourse as long as what you are achieving is working for you. If your financial goals can be achieved by earning 11% average annual returns in 15 years, then why would you risk going after a trading strategy that has the potential to give 20%+ return, but also high chances of going wrong and giving (-)40%?
 
(Read thisto know the real meaning of investing)
In times of low returns, most people will start questioning perfectly legitimate long-term strategies – as for them, the pain becomes unbearable in the short term. When equities do badly, people start looking at other asset classes and forget that the best time to load up equities is when everything looks bleak.
So I suggest you do one thing – evaluate your financial decisions of the past, especially the mistakes where you lost money. Be honest with yourself. Did you try to go for a ‘Great’ strategy and abandoned a ‘good’ one that worked for you? This exercise will help you clear your thoughts and being clarity in the way you think about your finances.
 
By the way, the speed of our biking-gang was set by me. 😉