Simplicity vs Complexity In Finances

What is the trade-off in simple but inaccurate vs complex but cumbersome

Happy Independence day weekend - hope you all had some good time with family, friends, food, and fireworks.

“What is the right level of complexity to apply?” is a question that applies often in life and across many areas.

Simple is nice since it allows for quicker answers, cleaner explanations, and transparency. All very positive and desirable characteristics. However, it often leads to more inaccuracy, more frequent tracking and updating. And worst case, if you oversimplify, you can get to the wrong conclusion.

For example, think about the stock market return assumption many people make. The market grows at 8.5% per year. It is a simple assumption and simple to model and project forward. It is very easy to explain ‘the market has historically grown at 8.5% on average’. And in many instances, it is a fine assumption to use.

Complexity can be hard to explain and can take longer to reflect. If you have too much complexity, you can get counterintuitive results even as the interactions of the various layers jumble everything up. But, adding complexity adds accuracy (if it doesn’t, remove it) and better decisions.

For example, instead of just a flat 8.5% equity growth rate, you use different scenarios and see the results along the different paths. Modeling more scenarios and compiling/analyzing the results will take more time, but it should give more accuracy and a better understanding of the possibilities.

If you are looking at a long-term growth projection of your portfolio, the path the market takes over the projection may matter even more than the average annualized return over the projection. (See some of the sequence of returns posts like this one here)

That said, it probably isn’t feasible or worth your time to build a multi-factor stochastic-on-stochastic model of equity returns.

There is likely no right answer of how much simplicity vs complexity is needed, since personal finance is very individualized.

That said, there are likely a lot of answers that are pretty close to being not-right answers. I won’t say they are wrong, but they are dabbling around the edges of wrongness. It is in the gravitational pull of being wrong.

I am a huge fan of the concept of 80% answers. This is where you try to identify the minimal amount of work to get to 80% of the ‘optimal’ answer. Maybe 20 mins of work gets you 80% of the right answer but to get to 90% it will take 4 hours additional work and to get to 99.9% it takes 4 weeks of additional work.

You try to efficiently get close to the correct answer and that tends to get a nice balance between simplicity and complexity.

This post will cover some areas of personal finance and explain the answers that are too simple and too complex that are often recommended. Then I’ll provide what is that nice middle-ground area. It is often just a couple quick and easy steps that end up drastically improving your results.