Vaguely Right

ONE OF THE MOST important ideas in personal finance comes not from a financial expert but from a 20th century English philosopher named Carveth Read. “It is better to be vaguely right,” he wrote, “than exactly wrong.”

Why is this idea important? It gets to the heart of why financial planning can be so tricky. For starters, few people—if any—can claim to be perfectly rational when it comes to money decisions. But more to the point, even if we wanted to be perfectly rational, the reality is that it wouldn’t be possible.

Why not? As financial planner Ashby Daniels has written, “All data is, by definition, about the past, but all decisions are, by definition, about the future.” In other words, in the absence of a crystal ball, there’s no such thing as being truly rational when making financial decisions.

That’s why Read’s prescription is so valuable: Instead of trying to be precisely right—an impossible goal—we should instead aim to be roughly right. What does that mean in practice? Here are nine ways to apply Read’s recommendation:

1. How to ensure you have enough. If you’re in your working years, you may be wondering how much to save for retirement. Alternatively, if you’re retired, you might wonder how much you can safely spend each year. To answer these questions, you could build a spreadsheet.

But any spreadsheet will be lacking. There are just too many variables. First, and most obvious, our spending goals might change. Other unknowns are inflation, taxes and market returns. The solution? I suggest starting with a spreadsheet, but not just one. Explore multiple scenarios. You can’t address every eventuality. But if you conduct a handful of stress tests, it’ll allow you to identify a range of reasonable answers—and to be roughly right.

2. How much to save in 529 accounts. These accounts are a special case because the money can typically only be used—without penalty—for education, though the new tax law offers an intriguing exception. Because of that limitation, the key challenge is to avoid saving either too much or too little. How can you be roughly right? Instead of frontloading the account, I recommend making regular annual contributions. That’ll allow you to assess the account’s growth each year.

It’ll also allow you to gain a better sense of your children’s education needs. Do you see them headed to a state university, or do you see them going to a private college and maybe graduate school? There’s a wide gap between those two ends of the spectrum and, when children are young, it’s difficult to know where they’ll end up. Spread your contributions out over time, and it’ll be easier to be roughly right.

3. When to stop contributing to tax-deferred accounts. Conventional wisdom says folks in their working years should take every opportunity to defer income into their 401(k). But there comes a point for some people when they’ve accumulated too much in tax-deferred accounts. How could this be possible? Required minimum distributions from tax-deferred accounts can push up the income of some investors to surprisingly high levels in their later years, resulting in steep tax rates.

Business owners and professionals with access to multiple tax-deferred accounts can find themselves in this situation. I’ve seen folks in their 80s stuck in the top tax bracket. Because of that, it can make sense at a certain juncture to shift future savings away from traditional tax-deferred accounts. When? Again, I’d start with a spreadsheet. But if the numbers could go either way, one solution would be to split your contributions evenly between traditional and Roth retirement accounts. As I’ve noted before, there’s nothing wrong with a split-the-difference solution when there’s no clear answer.

4. How much cash to hold. This is a source of concern for many. On the one hand, no one wants to risk a cash crunch. On the other, no one likes to see assets lying fallow. What to do? Total up all of the possible things that might go wrong—a new roof and a new car at the same time, for example. Since there’s no reason to think multiple bad-luck events would all occur at the same time, this number would represent the absolute maximum you might hold in cash. You can always adjust down from there. But with this number as a guide, you’ll have a better chance of being roughly right.

5. How to design a portfolio. In personal finance, people debate endlessly about how to structure portfolios. Should you include international stocks and, if so, how much? On the bond side, does it make sense to buy corporate or even high-yield bonds? It’s impossible to know in advance which portfolio will be best. Fortunately, there’s good quantitative research on this from Vanguard Group and others, offering asset allocation ranges that can help you to be roughly right.

6. How much to help adult children. Warren Buffett has famously said that his goal was to give his children enough so they could do anything, but not so much that they could do nothing. Even if you don’t have Warren Buffett’s wealth, you might struggle with this question. One sensible approach is to make incremental annual gifts to your children. Smaller gifts are better than one large inheritance for two reasons. First, incremental gifts give you the opportunity to see your children enjoy the gifts. Second, it gives you the opportunity to see how they manage smaller amounts before giving them more.

7. Whether to employ dollar-cost averaging. Historically, the U.S. stock market has risen in roughly three out of four calendar years. That means that, statistically, dollar-cost averaging is illogical. But the alternative—lump-sum investing—has a problem of its own: If the market drops sharply after investing a big lump sum, investors may feel substantial regret. To square this circle, don’t view it as an either-or decision. If you have some money to put in the financial markets, you might invest half right away and then dollar-cost average with the rest. A formula like this could help you to be roughly right.

8. How to reduce a concentrated holding. If you work for a public company, its stock may account for an uncomfortably large portion of your portfolio. But reducing it might entail an outsized tax burden. How can you be roughly right? One way is to set a target for reducing the shares to a specific percentage of your portfolio, such as 10%. Then sell enough shares each month—regardless of where the stock price is—to reach that target over three or five years. Over that period, you’ll capture some good prices and some not-so-good prices, but overall you’ll be roughly right.

9. How to allocate a windfall. Everyone’s heard about professional athletes who’ve earned millions, only to end up in bankruptcy. The fact is, windfalls are tricky even if you aren’t a professional athlete. I suggest developing a framework. You might save 50%, set aside 30% for taxes and give 10% to charity. Of course, that’s only 90%. For the remaining 10%, intentionally do something you wouldn’t ordinarily do. It’s okay to head to the Mercedes dealership or the jewelry store—provided you’re only splurging with a fixed percentage of the money.

Adam M. Grossman is the founder of Mayport, a fixed-fee wealth management firm. Sign up for Adam’s Daily Ideas email, follow him on Twitter @AdamMGrossman and check out his earlier articles.

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