As a successful small business owner and early retiree, my life is a good example of the cause and effect between the daily practice of mindfulness and personal finances. From my perspective, it seems strange that the mental and physical health benefits of mindfulness are routinely celebrated, but the “financial health” benefits of mindfulness are hardly discussed. Perhaps some people feel that bringing up the topic of money cheapens the role of mindfulness in a fulfilling life. Or perhaps discussing money immediately raises the distracting concern that something is being marketed. But in the reality of our society, healthy finances are a bedrock foundation that supports almost all other aspects of a fulfilling life including physical health, mental health, relationships, and even our capacity to love. Let me assure you that I’m not trying to sell you anything, other than an idea. That idea is:
- Mindfulness and healthy finances create a virtuous cycle, where 1) mindfulness improves your finances, and 2) improved finances gives you more freedom to pursue a more mindful, compassionate, and fulfilling life.
The steps in this virtuous cycle are shown in this graphic.
Let’s take a closer look at how this virtuous cycle works.
If you search the internet for the word “diversification”, you will quickly come across a quote like this:
- The only free lunch on Wall Street is diversification.
Everybody loves a free lunch. So, diversification must be the first-stop dining destination for every individual investor, right? Unfortunately, as I’ve written in the Diversification Series at Mindfully Investing, the prospect of a free meal can lead the undiscriminating investor to a stew of overblown expectations and a portfolio that deflates like a bad soufflé.
The purpose of this post is to check on recent market developments and see what, if any, changes may be needed to the mindful stock diversification approach. But first, you will need a little background.
I recently updated Article 5.2 on Evidence Regarding Excess Returns, which I first published in 2016. I added new data from several annually published research reports, which evaluate investor’s ability (or inability) to achieve returns beyond those obtained by investing in index funds. I routinely update articles throughout Mindfully Investing, but I thought it was a good idea to write a post about this particular update, because the results continue to be so important for individual investors.
I’ve read literally hundreds of personal finance blog posts about investing over the last year as part of my development and maintenance of the Guide to Personal Finance Blogs. I’ve found that investing bloggers fall into two main camps. The first camp extols the virtues of index investing and accepts unequivocally that picking individual stocks is doomed to failure. Sometimes these bloggers present evidence to support their position, and sometimes they just seem to accept the merits of index investing without question. The second camp is still convinced that, through diligence and careful assessment of individual stocks, they can achieve better results than index investing. Some of these bloggers pick their own individual stocks and some use actively managed funds that contain stocks picked by “experts”.
As the end of the year approaches, many people start to think about whether to rebalance their investment portfolios or not. But most people don’t consider exactly why they rebalance. It turns out that rebalancing is not the slam dunk decision that the finance industry often claims. I just added Article 8.7 on Rebalancing to the Investing Over Time series. The article explores the good, bad, and ugly of rebalancing, and this post covers the central concepts.
A chief attribute of investing mindfully is to buy a relatively simple set of diversified stock funds (and for the older investor some cash or possibly bonds) and hold them until you absolutely need to spend the money. But like most simple-sounding plans, successful implementation requires following a few important details. One of the most important of these details is rebalancing.
What is rebalancing?
The question of rebalancing arises because the asset allocation in any diversified portfolio will drift over time. The classic example is a portfolio with a combination of stocks and bonds. Because stocks typically have higher returns over time, as your portfolio grows, you will end up with a greater proportion of stocks to bonds. Here’s an example graph from Michael Kitces using average annual returns that shows a 50/50 stock/bond portfolio would be 80 percent stocks after 30 years.
Standard advice is that you should periodically reset (rebalance) your portfolio to its original allocations to correct for this drift over time.
I just added a new Article 8.6 – “The Problem of Inflation” to the Mindfully Investing series on Investing Over Time. The central concepts from the article are covered in this post.
Inflation is a prominent player in any evaluation of investing over time, because inflation is a time-dependent process just like compound returns and market gyrations.
In short, inflation is when the prices of goods and services rises over time, which means the “purchasing power” of your money is falling. A Big Mac may be priced at about $4.00 today. But if the cost of the Big Mac ingredients (beef, flour, lettuce, etc.) and the labor (hourly wages) to make the Big Mac go up by 3% a year (for example), the price of a Big Mac may be $4.15 next year. It’s the exact same Big Mac, but next year you might need an extra $0.15 to buy it. Your $4.00 can’t buy quite as much as it used to; it’s “purchasing power” has gone down.