Financial KISS

KISS is an acronym for “Keep It Simple, Stupid” or, for the easily offended, “Keep It Simple, Silly”. It’s more than an acronym, though; it’s a valuable policy in general.

I spent 7 or 8 years finding microprocessor bugs before changing jobs recently. One thing I could always count on when reading a specification was that if I could not completely understand the spec, it was likely that no one else could either. And if the architect who created the spec or the designer who implemented the spec didn’t understand what they were architecting or designing then there were guaranteed to be fundamental bugs present in the implementation.

Even if they thought they could understand what they were doing, if the design lacked simplicity and elegance there were sure to be bugs. Unfortunately recognizing and valuing simplicity often takes a back seat to meeting deadlines. So a design that may have started out as simple and elegant gets complicated and ugly as features are tacked on without refactoring the design.

But what does this have to do with personal finance?

In my opinion the same principles apply. No matter how smart one may think he is, if one’s financial strategy is not simple it is sure to have bugs in it. The bugs may be minor, such as missing bill payments. Or they may be fundamental, such as poorly allocated savings.

When browsing the web for personal finance articles, one will find all sorts of articles on strategies for making the best use of money.

Some of these articles suggest investment strategies that include picking individual stocks. The authors assert that it takes only a few hours per month to pick stocks that will beat the market.

Other articles tout the flavor of the month mutual fund. This month, precious metals! Last month? Small cap stocks! Why don’t you check on that hot dividend income stock fund from a couple years ago — you know, the one that was supposed to benefit from the new tax laws. How’d that fare relative to the market?

Many authors have devised tricks to make small amounts of money out of large amounts of money by performing financial acrobatics with credit cards and internet savings accounts.

Some even provide strategies for engineering your debt and assets to try to optimize your credit rating (so you can take on more debt?).

What do all of these strategies have in common?

They’re complicated.

It is possible to beat the market by picking individual stocks. But you probably won’t be the one who does it. Studies show that most individual investors who try to beat the market get creamed, if not because of capital losses than because of taxes and expenses.

The fund of the month strategy has been debunked ad nauseum. “Hot” funds result from statistical fallacies, such as survivorship bias. This year’s hot fund is rarely next year’s hot fund.

But many folks aren’t yet to the point where they’re saving much. They’re just trying to make it month to month. To these people the credit card arbitrage and interest-rate chasing schemes must seem especially appealing. They have the double-benefit of appearing to provide “free money” while simultaneously “sticking it to the man” (i.e. the financial services companies).

These strategies advocate transferring large sums of money between credit cards or bank accounts to take advantage of incrementally lower (or higher) interest rates. A simple exercise for the reader should easily expose the flaws in these strategies.

If you have $5,000 in a savings account, calculate the annual difference in interest earned from moving your money from an account yielding 4.5% to an account yielding 5.0%. Now calculate what’s left over after you pay taxes on it. For the mathematically challenged, here’s a hint: you might get a few coffees at Starbucks for your effort. And several extra tax forms to worry about at the end of the year.

Credit card arbitrage has the potential to be more rewarding, and simultaneously more dangerous. Unfortunately, those who can best afford the risks have the least to gain from the rewards. And those for whom the reward is meaningful may be sunk if problems arise.

Ultimately the question one needs to ask oneself is:

How much money is my time and peace of mind worth?

If your time isn’t worth much, and you don’t mind spending some sleepless nights worrying about your investments, you may stand to benefit from stock picking and day trading. If you don’t mind monitoring every transfer between different banks, filing extra 1099s, and tracking credit card due dates with scientific precision you may benefit from trying to beat the system by pursuing high yield savings accounts and credit cards with low-interest balance transfers.

For many of the people advocating these strategies, the strategy is an end unto itself; they may investigate interest rates rather than going to a movie, or transfer money instead of reading a book. And that’s fine; it’s a hobby for them, and probably a healthier habit than smoking crack or killing baby seals.

 But you should recognize up front that the financial rewards for such activities are likely to be underwhelming and that the resulting financial noise may distract you from your real goals. If your goal is making and saving money, your efforts would be better served by following a budget.

One more thing about “Financial Noise”

Financial Noise is a term I like to use, because noise is something I think we can all relate to. Financial noise refers to the cacophony of bills and statements resulting from having numerous bank accounts, credit cards, and loans. For me this financial noise hit a peak shortly after college when I was paying back perhaps a dozen student loans, car payments, and several credit cards. The best thing I ever did for my peace of mind was paying off those debts, and keeping my finances simple ever since.

So what should you do? 

This is the best part. Finances are easy. Here’s a short process to get your finances under control

  1. Close your extra credit accounts. Close your store credit cards. Close all your major cards except a couple. Pick a couple that have low interest rates and reasonably high credit limits.
  2. Spend less than you earn. No matter how hard you think you have it, you can almost certainly achieve this.
  3. Pay off your debts. Pay the minimums on all debts but one. Plow all the spare cash you have into that one.
  4. Open an account at Vanguard. Start saving money in the Vanguard Prime Money Market fund. The yield is as high as you’ll find most places, and the service is better. Over time, start moving money into a Target Retirement mutual fund.

There you have it. A 4-step process to achieve financial simplicity. Ignore credit card offers that arrive in the mail. Ignore the temptation to open an account at the internet bank du jour, just because it’s offering a promotional rate and a toaster. Those are gimmicks, and gimmicks complicate your finances.