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Page 1 of 3  The financial industry would have you believe that investing is far too complicated to be left in the hands of the small investor. We beg to differ. This is not to say that you shouldn’t use all the help you can find. In the first of a series of commentaries, we look at a subject so mundane many view it with derision. Yet, rules of thumb and checklists can make the difference for many investors between i) throwing up their hands in disgust (investing is so complicated and time consuming!) and deciding to rely on others for their financial well-being, and ii) empowering themselves to chart a do-it-yourself approach to investing. Can rules of thumb and checklists really make such a difference? Read on.
Independent Investor
Let’s go back to basics. Who has the profile for self-investing? (for more on this subject, see The Independent Investor on our site). Beyond the basics (can you read and write etc) other pre-requisites are:
- Time available. There is a perception among many investors that investing requires a major time commitment. Yes, self-investing does suppose being minimally organized, but the actual time commitment can be surprisingly modest.
- Your personality. Some persons like to retain and exercise control while others are born delegators. Some people are more susceptible to reacting
emotionally to risk and to the inevitable up’s and downs of the markets then others; and
- Having the requisite degree of investment knowledge.
There are no black and white, right and wrong, answers to whether an individual has these prerequisites. What is certain is that choosing the right investment style (active vs. passive- see Beat the market? on our site) can make all the difference. A simple passive or index approach will be of great help in meeting these prerequisites; an active, trying to beat the market, approach is so demanding that it condemn most persons to relying on advisers (ironically, the advisers’ fees almost insure you will not meet your objective on an after-cost basis).
Where do rules of thumb and checklists fit in?
They can reinforce and assist a passive or index approach, helping reduce the time you need to devote to your investments by benefiting from the experience of others, making organization easier, helping you keep a business-as-usual approach at all times, and in generally lowering the required threshold of minimal of investment knowledge.
Let’s recap. Rules of thumb and checklists are not recipes to manage a portfolio on auto-pilot.
You need an overall framework within which you invest, or what Etzioni
doc.1589 (p.505) describes as taking into account multiple considerations in the real world.
Our readers know our overall framework is an index, passive approach to investing. Not surprisingly, in this series, we will look at rules of thumb and checklists as a tool used to make a passive, index investing framework so user-friendly that most investors will feel comfortable in self-investing. This said, many rules of thumb and checklists are valid even for investors who go the adviser-assisted route, as you will see in the future installments of this series.
Rules of thumb and checklists are not unique to the financial world. In the balance of this commentary we look at them more generally in order to convince you of their usefulness.
We will look at their use in the world on investing in future commentaries.
What are rules of thumb and checklists
Rules of thumb are known by various terms: rules, routines, maxims, habits, heuristics, computational procedures, educated guesses, intuitive judgment, common sense and theorems. Common to many of these terms is the idea that they seek to simplify, to help find an acceptable, economical solution, not necessarily the best or definitive solution.
Here is how our good friend Wikipedia
expresses it:
A rule of thumb is a principle with broad application that is not intended to be strictly accurate or reliable for every situation. It is an easily learned and easily applied procedure for approximately calculating or recalling some value, or for making some determination.
Heuristics and rules of thumb are considered part of the family:
Heuristics are rules of thumb that direct the solution approach toward the best solution, but do not guarantee that it will be found. More specifically: “A heuristic… is a short cut process of reasoning … that searches for a satisfactory, rather than an optimal solution. The heuristic, which reduces the time spent in the search for the solution of a problem, comprises a rule or a computational procedure which restricts the number of alternative solutions to a problem, based upon the analogous human trial-and-error process of reaching acceptable solutions to problems for which optimising algorithms are not available”, Hinkle and Keuhn (1988:61). Source: Burger-Helmchen
doc.1586, p. 11
Checklists are just that: lists that have been compiled of things to check in specified circumstances to minimize errors. In his book The CheckList Manifesto, 2009, Metropolitan Books, the surgeon Atul Gawande refers to them by the term eptitude: making sure we apply the knowledge we have consistently and correctly. Gawande p.10
The role they play is very similar to the role of rules of thumb.
It is common to misconceive how checklists function in complex lines of work. They are not comprehensive how-to guides, whether for building a skyscraper or getting a plane out of trouble. They are quick and simple tools aimed to buttress the skills of expert professionals. Gawande, p. 128
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