1. Why are all bankers crooks?
2. Isn't that really boring?
3. What stocks are hot?
I'll park the answers to questions 1 and 2 for another blog. Suffice to say that I am biased, believing our industry to the the most regulated in the world (including virtually all aspects of conduct relating to question 1), and that I continue to harbor a morbid curiosity for all things financial, since my winning streak in Monopoly at the tender age of 9. This blog is all about question 3. Word of caution, my response is going to be along the lines of "if a stock ticker is the answer, you are asking the wrong question".
In a nutshell
Question 3 really asks the question "how do I make more money". It misses a crucial step, which is "how much money do I actually need". The amount of money that you need depends on your actual and planned expenditures, which themselves are partially fixed and partially discretionary. This blog views the concept of financial planning through a lens of what money outflows are expected (your liabilities) and only then goes to look at the money inflows required (your assets). You will see that this is more like risk management, where all components of superfluous risk is minimized rather than sought. It is always bad to use words that carry emotive or even judgmental connotations, but really pALM is an approach to avoid any aspects of deliberate or inadvertent gambling in order to bring one's financials into as stable a position as possible, to focus on the real objectives of life.
Academic Foundation
There are plenty of academic articles out there describing what personal (or individual) asset liability management means in theory. Some of these academic articles are from rather reputable institutions. However, I personally find these to be too theoretical to find any practical applicability to inform actual decision making. Not to knock my alma mater, but I've never had to use Ito's lemma in Brownian motions to satisfy anything, including decisions relating to personal finance. Not at the grocery store, and not for any more meaningful financial decision either.
That said, for those interested, the article does provide a bridge between the ultra theoretical world of academia to the broad rule of thumbs pervading the advisors inhabiting the wealth management industry. And fundamentally, the concept of having to match your assets to your liabilities is one that I not only subscribe to, it is one that you ignore at your peril. In fact, the concept of pALM is so powerful, that it is often a sufficient not just necessary condition for financial well being.
pALM Concept
Let's dissect this concept word by word.
Personal
Asset
Liability
Management
Personal simply describes the fact that this relates to you. You in this case could be you as an individual, you as a household, you as a family, whatever unit you want to consider. Maybe this should be called yALM but that just sounds like appealing that pALM.
Asset Classes
Assets are all assets of relevance, which tend to be financial assets. From most to least liquid, this is generally:
- Cash (in hand or at the bank)
- Fixed Income (bonds)
- Equities (stocks)
- Real Estate
They are not the wrapper (funds - mutual funds, ETFs)
They are not the
Hedge funds (don't read this article) - separate article
Crypto (volatile cash)
Real Estate -
How to access the asset classes
Finance Philosophy
I said at the very beginning that the question asked was the wrong one. So what is the right question to ask? In my mind, the objective of personal finance is a subordinated one. I don't know what the ultimate objective of life is. Probably something along the lines (or a combination) of happiness, health, and a connection to family, friends, society, the universe in general. Unless you are a sociopath, none of these objectives can be met through the tools of personal finance.
However, personal finance can provide you with the means to support a stable, independent, safe, and fulfilling life, where financial considerations remain subordinated to your genuine life objectives. It is more of a hygiene factor, allowing you to focus on what matters to you. If the financials are in order, you don't have to worry about them. Anyone who has ever faced financial distress, in whatever form, knows that this will drown out most other considerations. That is to be avoided at all costs.
What does this actually mean in practice? It means in practice that for your personal finances, you should act more like an accountant, actuary, or risk manager, than an investor, entrepreneur, or maverick. If you are a professional investor, entrepreneur, or Tom Cruise, that's obviously fine. But if you have a salaried job, you shouldn't moonlight as a personal finance maverick.
Read on
Chapter 8 - We Ken Do It
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