WHEN FACED with an array of possible solutions, we should lean toward the simplest—an insight dubbed Ockham’s (or Occam’s) Razor after its originator, the English 14th century Franciscan friar William of Ockham.
But this principle is regularly ignored by investors, who are drawn to complicated investments and investment strategies, with their veneer of sophistication. Think about the popularity of hedge funds, day trading, equity-indexed annuities and market timing.
Unfortunately, such strategies and products mostly serve to transfer wealth from investors’ pockets to Wall Street’s coffers. The reason: high investment costs. How can we avoid participating in this great wealth transfer? We should listen to William of Ockham—and keep our finances simple.
That means avoiding the complexity and cost that comes with trying to pick individual stocks and bonds or trying to figure out which way financial markets are headed next. Taken to its logical conclusion, this leads us to the simplest of all strategies: buying and holding the entire market, through market-tracking index funds. We can do that either by purchasing perhaps three total market index funds—one each for U.S. stocks, U.S. bonds and foreign stocks—or by buying a target-date fund that holds these total market funds. This simplicity brings with it an important added benefit: rock-bottom investment costs.
A preference for the simplest solution should extend beyond our portfolio. We should favor term insurance over the complexity of cash-value life insurance. We should prefer to own cars rather than deal with the fine print of a lease. We should favor straightforward fixed-rate or adjustable-rate mortgages over more complicated varieties. We should think twice before owning more real estate than just our principal residence. We should only use complicated trust arrangements if they’re absolutely necessary.