Fine tune your financial planning with power of Inversion

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This post is ideated from a recent article of safal niveshak, which explains application of principle of Inversion on investing and decision making. The basic premise of that article which also refers to Charlie Munger’s (business partner of Warren Buffet) statement is, if you want to get the best solution to a problem one should think both ways forwards and backwards.

Forward thinking will take you to the process that one should follow and backward thinking will lead you to the things you should avoid. In fact focusing more on what and how to avoid you will automatically put yourself into a process of doing right things.

Giving example of Warren Buffet’s rules of investing – where warren says:

  1. Rule 1 – Don’t lose money
  2. Rule 2 – Don’t forget Rule no.1

The author very beautifully related principle of inversion to this by saying that, one should focus less on things “to do” for investing success and more on things “to avoid” investing failure. As the pain of loss is more than pleasure from gain, so it’s equally important to focus on how to reduce or manage losses than to run only after gains.

In the world where everyone is searching for best, thinking about worst is difficult but to move forward you have to take a step backward. By thinking backward, we create a sanity check on thinking forward.

Principle of inversion normally used in mathematics says that solution to many hard problems can be clarified by re expressing them in inverse form. It’s not enough to think about difficult problems one way you need to think forwards and backwards.

Financial planning is a forward-looking exercise where finances are arranged to achieve long and short term goals comfortably. A Plan is prepared and a process is designed which needs to be followed. Everything would be great if goals get achieved, but what if it’s not.

In the words of Charlie Munger, “A lot of success in life and in business comes from knowing what you really want to avoid – like early death and a bad marriage. Inverting the problem not just helps you in solving the problem, but it will also help you in avoiding trouble.

To find out the flaws in the process and to make the most of it, it’s better to apply this principle of inversion and do some brainstorming with some negative results. Like for e.g. just imagine that your financial plan has failed drastically and you have fallen short of the target money that you need for your child’s education. What lead you to this situation?

There could be many probable reasons:

–          You were into 100% equity as the market was looking bullish, but suddenly it fell and you lost most of the money. ( Read: How prepared are you for market fall)

–          You were into 100% debt, which though made the portfolio secure but could not beat education inflation.

–        2 years back you or some other family member got some health issue and had to be hospitalized so you withdrew from investment portfolio and used major chunk of money.

–          You were not saving enough

–          You were over expecting portfolio performance and thus the rate of return assumed miscalculated the target.

–          You made a real estate investment by selling some portion of your financial investment portfolio, and your real assets could not get sold timely.

–          Property that you sold generated lot of money but to evade capital gains tax you sold it on cash (black), but college fee has to be paid in white and now you are in a fix.

–          Unfortunately few years back your spouse died in a road accident. She/he was the lead or only earning member in the family, but was not adequately insured. So on one side savings stopped and on the other existing savings had to be withdrawn to take care of family expenses

–          The portfolio was doing well so you withdrew some money and bought a new car. But after that the remaining portfolio did not perform as expected.

–          Your adviser’s advised strategy failed. ( Read: Conflict of Interest with adviser)

–          You were completely dependent on fixed savings and did not make any effort to increase the savings amount.

–          You’ve asked for a free review of your portfolio on one blog, but blogger did not reply.

–          You were following a TV channel where experts advised 3 multi- bagger stocks which turned out as beggar companies. You’d lost ample amount in that investment. ( Read: How to make money from equity investments)

–          You were a member of one face book group where some people were of the view that stock market may fall anytime, which created a panic in you and you shifted your portfolio to debt. or vice versa.

–          You did not set a SMART goal, in other words, your goal amount was over ambitious.

–          You lost your job and could not save enough

–          You were not reviewing your financial plan and investment portfolio timely.

Quite possible, these are some more of the “could be” reasons for not achieving your goals. You may think of many other probable reasons. Now to fine tune your financial planning you should seek out answers to these points too. If you are engaged with a financial planner then this is the time to sit along with him and find the answers, else if you are doing it yourself then figure out the probable solutions to the reasons. ( Read : Still searching for best financial planner?)

You have to focus on those things, which matters for your goal achievement and which you can control too. Like for e.g. death or health issues are not in your control but buying adequate insurances and taking care of your health surely are and this is what matters. Investments assets performance is not in your control, but understanding asset classes and following asset allocation is. You cannot time the market, but you surely can rebalance your allocation timely. You should understand that there is no structure being followed while giving free advice on social media or blogs or in newspapers, so paid advice definitely pays….and so on.

Conclusion:

Late Dr Abdul Kalam has said once, “Don’t Read Success stories, you will only get a message. Read Failure stories, you will get some ideas to get success.”

Inversion is no doubt a powerful idea to figure out and plug the loopholes in the process. It lets you stretch your mind and you make decisions after doing a thorough analysis of the situation.

Applying inversion in decision making of any kind will help you improve or assure the expected result.

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