I just finished reading Jason Zweig’s new book, “Your Money & Your Brain: How the New Science of Neuroeconomics Can Help Make You Rich.” Watch my October 19 Yahoo!Finance column for a full review. Zweig outlines a host of neurological and biological quirks that make us do dumb things with our money.
At the moment, I am struggling with one of these behaviors — procrastination. Last December, I opened a single-K – a 401(k) for corporations that employ just one person, or an individual and their spouse — so I could sock away more for retirement. I did well on the socking away part. Unfortunately, it’s all in cash. The bigger the pile gets, the harder it is to pull the trigger and invest it, because I’m worried about losses if I pick the wrong investment. This is an irrational fear, since I won’t be touching the money for at least two decades.
One problem is that I haven’t created a broad set of financial policies and procedures to follow, as Zweig recommends in his book. I should have made decisions about where the single-K funds would go before I opened the account. Zweig’s book is worth buying for Appendix 3 alone — which offers a sample “Investment Policy Statement” for an imaginary couple, John and Jane Doe. He says your personal statement should include:
1) the purpose of the portfolio
2) your expectations
3) time horizon
4) diversification strategy
5) rebalancing plan (when and how will you rebalance)
6) evaluation of performance (what benchmarks will your compare your portfolio to?)
7) frequency of evaluation (how often will you evaluate performance?)
8) adding and subtracting (under what conditions will you add more to the account, or withdraw money)
9) “we will never…” (a statement of what you won’t do, to keep your brain from making you do dumb things, like trading on tips or hunches)
For more inspiration on establishing your financial guidelines, check out Berkshire Hathaway’s 2006 annual report. Warren Buffet and Charlie Munger lay out clear and straightforward principles for potential acquisitions:
1) Large purchases (at least $75 million of pre-tax earnings unless the business will fit into one of our existing units),
2) Demonstrated consistent earning power (future projections are of no interest to us, nor are “turnaround” situations),
3) Businesses earning good returns on equity while employing little or no debt,
4) Management in place (we can’t supply it),
5) Simple businesses (if there’s lots of technology, we won’t understand it),
6) An offering price (we don’t want to waste our time or that of the seller by talking, even preliminarily, about a transaction when price is unknown). For more detail, see page 25 of the report.
When I rolled my 401(k) from a former employer over to an individual retirement account a few years ago, I worked with a fee-only financial planner to make sure the portfolio reflected my appetite for risk and my long-term retirement goals. Time to stop procrastinating and give him a call.