Financial plans are useful for helping us focus on life goals – goals like paying for education, buying a home, having children, financing your retirement. There are three main tools used in that kind of planning: budgeting, saving and investing.
Expenditures you’ll have to analyze are: what kinds of investments to make, what kind and how much insurance to buy, housing decisions and investments in education --and your children’s education as well. All of these decisions should be informed by reflections on the rewards expected to be won by the decision and the risk of not achieving that reward.
In particular when making investments, it is crucial to understand the relationship between risk and reward. Many financial planners will tell you that the higher the risk you’re willing to assume, the higher the reward. That’s nonsense. Most people who take on high risk investments simply lose their money. There win no reward at all.
What you want to do is determine the amount of reasonable risk you’re willing or obligated to take on and then work out how you can maximize your reward at that risk level. When thinking about this, you have to consider very carefully how much you’re willing to pay in transaction costs. High transaction costs don’t increase the ability for you to earn higher rewards – but they do reduce substantially the rewards you will be able to earn. In fact, the Toronto Stock Exchange estimates that the return on mutual funds investments is reduced by nearly half as a result of transaction costs and management fees. Reduce those fees and you will increase your rate of return with no increase in risk.
And that’s the goal – obtaining a higher rate of return without increasing risk.