Once we’ve established an understanding of rules-based money management – from its definition, significance, principles, rules, and strategies – it’s time to put all these factors together and explore how you can apply this to your financial journey.
Successful investment results are not just about choosing the right stocks or bonds; they are also very much about managing your risks and responding systematically to market changes. Rules-based money management is instrumental in incorporating these aspects.
To illustrate how rules-based money management has been glued together into a comprehensive strategy, let’s examine three key steps:
1. Define your Risk Tolerance:
The starting point of your rules-based money management journey is defining your risk tolerance. Your risk tolerance is the amount of financial risk you can stomach before feeling uncomfortable. Assess your current savings, income, expenses, and your overall financial goals. This will dictate the degree of risk you are willing to take and ultimately shape your investment strategy. A person with an aggressive risk tolerance may have a rules-based system that’s different from that of a conservative investor.
2. Set Rules for Portfolio Diversification and Balancing:
One of the main tenets of rules-based money management is diversification, which helps spread the investment risk across different sectors, markets, and investment instruments. Set criteria for how you’ll diversify your investment portfolio. You may decide to allocate a specific percentage of your portfolio to bonds, equities, cash, or real estate based on your risk profile. Balancing should also be an established rule to follow, with defined percentages and re-balancing periods.
3. Establish sell rules and Periodic Reviews:
A core element of rules-based money management is determining in advance what will trigger a sell decision. These sell rules might be based on a specific percentage drop in value, failure of a company to meet certain financial metrics, or changes in market conditions. Equally important in rules-based money management is the periodic review of your portfolio to adjust according to any changes in personal circumstances or in the market.
Another point of emphasis in applying these strategies is automation. Leveraging technology can make these rules easier to implement and creates a discipline that avoids emotionally driven decisions. There are various software and applications available to automatically balance and diversify your portfolio, and some can even incorporate your sell rules.
Remember, rules-based money management is not about prophecy. No one can predict the future of financial markets with complete certainty. Instead, these strategies provide a systematic framework within which you can operate and thereby reduce emotion, provide clear decision-making parameters, and hopefully improve financial outcomes.
Lastly, while the rules-based approach is advantageous for many, it should not be thought of as a one-size-fits-all solution. Just like with anything in personal finance, your rules should be flexible and adjusted according to market conditions and personal goals.
In summary, you put together a sound rules-based money management system by defining your risk tolerance, determining your investment strategy through set rules for diversification and re-balancing, establishing sell rules, conducting periodic reviews, and automating your financial processes. Having a systematic approach in handling your finances increases your chances of achieving your financial objectives and builds a stronger financial future.
