Financial Simplicity

Get What You Pay For

Is Simplicity for You?. Google images

The Ignorance Premium

When people do not know any better, they often pay an "ignorance premium" -- the extra cost associated with not knowing how to fix a problem.

In general, it is not worth the effort to educate yourself enough to avoid paying that premium. It is more efficient to hire an auto mechanic, plumber, lawyer etc. than to learn how to repair our cars and faucets. And we cannot go to law school just to avoid paying a lawyer's fees.

However, when it comes to financial matters, the situation is different. You know that no one you hire will care about your financial well-being as you do. Nevertheless, we do not always have the time or skill to manage our own money (spending, retirement savings, investing etc.), and for some people, ​it pays to get professional advice.

The Simplicity Premium

Carl Richards as coined the phrase 'simplicity premium' to represent the added cost of valuing simplicity. The idea is that people are willing to pay a premium to make their lives easier. We hire people to do tasks we could do ourselves. But to avoid problems, we may elect to pay a professional. Most of the time you get good value and an easier life.  

There is a big difference between the two situations:

  • Paying someone to do something that you are not willing to do (simplicity premium). 

  • Paying someone to do something that you have no idea how to do (ignorance premium).

    Carl's prime example:

    "Investing is simple. But… not easy.

    There really are only a few things that you have to get right, making it simple.  But because there are so many ways to get it wrong, it seems complex.

    It’s simple, but not easy…

    There are so many ways to invest. So many people willing to
    sell you crap. So many entertainers pretending to provide advice."

    It's true.  Naive investors are persuaded by salesmen to buy front-end-load mutual funds instead of no-load or index funds. They take advice from brokers who benefit by selling funds with up-front sales commissions.

    The financial industry is loaded with people who treat their customers badly and who look out for themselves first. That means they want big fees and/or commissions, and if the customer doesn't wind up with something appropriate, too bad. Another example is the mortgage brokers who convinced ignorant  (and all-too-trusting) people to buy homes that they could not afford. Or to refinance quality mortgages with variable-rate mortgages that came with incredible interest rate hikes. True, some people knew they were never going to be able to repay those loans, buy far more were caught up in the frenzy of steadily-rising home prices and believe the broker's lies. When the bubble burst, a large number of home buyers lost their homes to foreclosure. 

    The situation is similar in the options world. There are those who charge large fees to impart knowledge that is available for little or no cost. They sell lessons and materials at very high prices to people for whom those lessons are inappropriate.

    Trading options is suitable for you if you prefer to manage your own finances. And I encourage all investors to at least consider learning what options can do for them. But the self-help plan is not for everyone. If you prefer to pay a qualified financial planner to handle your money, that's acceptable. After all, it is your money and if you prefer the simpler path, then go for it.

    But if you want to learn about options, books and inexpensive/free seminars are available. Search via Google or ask your broker what they have to offer.