You may know it as Occam’s Razor, the Law of Economy, or Law of Parsimony, or even as the principle of succinctness.  It’s the concept that the simplest solution is the best solution.  This principle is based in observation that the less assumptions required or made tend to result in the most accurate outcome, and it’s pointless to add more of anything when the exact same result can be achieved with less.

I apply this to financial planning and investing because it works. I only use and recommend three asset classes: US stock, international stock, and Treasury bonds. These investment markets are built upon solid economic principles that result in their long-term growth and can easily be owned at a very low-cost using broad market index investments. I’m not trying to beat these markets, just participate in their growth at the lowest possible cost.

When we try to do better by adding “non-traditional” asset classes or making bets by over or underweighting specific companies, industries, or sectors, our costs will increase.  People try it, hoping they will improve their results as well; however, improved results cannot be counted on or even expected because they have now introduced competition to the equation.  In other words, you are no longer just relying on the growth of markets; you are relying on profiting from the mistakes of others trying to do the exact same thing as you: counting on you to make mistakes.  That doesn’t seem simple anymore, does it?

This is easily observed in the fact that few people actually beat markets over their investing lifetimes, yet many more try and end up falling short of market returns, having been better of if they never tried in the first place.  Therefore, those who are content with a simple, low-cost approach have realized better overall investing returns than then those who are not.

If you are still not convinced that simplicity works, it may become more apparent when we consider investing in the context of financial planning.  Part of planning is figuring out how much we should save and how much we can spend in order to achieve desired future goals like a sustained and comfortable retirement. We do this without knowing:

• How long we’ll live
• What inflation will be
• What markets will return

So we are already forced to make some assumptions in order to reach financial goals, but if we try to beat markets we add a two new variables, whether and by how much we will fail or be successful.  It’s not like we can count on earning above average returns and decide to save less or spend more.  But, for what amounts to achieving the same planning result or financial goal, it becomes harder to plan and react with additional variables.  More work, more uncertainty, more stress, same end result.  Keep it simple and sleep well at night.