Principles to Assist in Financial Decisionmaking

Some smart, common sense advice from a Financial planning site: Principles to Assist in Financial Decisionmaking:

• Plan ahead. Give yourself time to realize your goals. Proact instead of reacting to events

Life is full of tradeoffs.

Working is trading your time for groceries. In deciding how much money to
save, consider the real costs.

Consider Opportunity costs.

The opportunity cost of doing something is highest-valued activity you
might have done instead.

Think on the margin.

Decisions should ignore sunk costs and weigh the marginal costs and
benefits. If I take this action, will I be better or worse off than if
I do not take this action?

Real returns matter.
Your real income, real
wealth, and real rate of return measure your purchasing power, adjusted
for inflation.

The time value of money.
In evaluating cash
flows, we need to convert future dollars into a present value, which
can be compared to the current price of the cash flow.

The power of compound interest.
Earning interest on interest turns seemingly modest saving into
remarkable wealth, an insight that Albert Einstein reportedly described
as “the greatest mathematical discovery of all time.”

Leverage is a two-edged sword.
Debt is one way of creating leverage, in which a relatively small
investment reaps the benefits or losses from a much larger investment.

Efficient markets.

Markets are "reasonably efficient" — but not perfectly so. Prices reflect informed opinions of many observers. If you think the price is
wrong, you should consider whether you know more than the market.

The future is uncertain.
Do not overestimate your ability to predict the future. Place the most
weight on the future that is most probable, but do not ignore other

Be resilient. Don’t despair when the unexpected
happens. Learn from your mistakes, but don’t be obsessed with the past,
which cannot be changed.

Diversification reduces risk. Prudence is a
well-diversified portfolio of eggs in several, very different baskets.

Risk can be rewarding.
In a risk-averse world, safe investments will have relatively high
prices and low anticipated returns; risky investments will have
relatively low prices and high anticipated returns.

Think differently.
If the herd-like instincts of most investors sometimes push asset
prices to unreasonably high or low levels, then consider a contrarian

 Beware of people peddling products. Someone who gets a commission for
selling you something often has a conflict of interest.

If it sounds too good to be true, it probably isn’t true.
Someone selling
get-rich-quick advice evidently believes he can make more money from
selling his advice than from following it.


Smith Financial Place

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  1. wcw commented on May 21

    People sometimes ask my for my best advice investing money. The first thing out my mouth, which usually quiets them right down, is “earn more during your career.” Even if you have five years salary in your retirement and trading accounts put together, you need to be a superstar to outperform by as much as a single, 10% raise gets you in the first year alone.

    It’s funny how few people like hearing that one.

  2. JWC commented on May 21

    Wow. Great list. I was amazed at how much of it matches what comes out of my financially conservative husband’s mouth. Plan ahead, tradeoffs, present value of money, if it sounds to good to be true…. The one thing I didn’t see there that he strongly believes is “live below your means”. We had regular middle class jobs and retired at 55 with a net worth of a million. The company he worked for did have a wonderful profit sharing plan, but we maxed out all of the optional stuff for both him and me. What was invested was very conservative.. but consistent.

    And we are chugging along, doing fine. Still living below our means but living well.

  3. Daryl commented on May 29

    The Principles to Assist in Financial Decisionmaking is a great checklist as a means of employing, paradoxically, small steps (in the realm of awareness) in order to grasp a bigger financial picture. That list has been printed out and posted next to my computer.

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