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The Five Minute Rule

Posted By Jim On 07/21/2010 @ 7:23 am In Personal Finance | 9 Comments

There’s an old adage in investing that doesn’t get enough appreciation or attention – “If you don’t understand the thesis underlying an investment in five minutes or less, take a pass.” I only recently read it in a summary of a talk given by Vanguard CEO Bill McNabb [3] at the Morningstar Investment Conference in June and the quote is attributed to Richard Ennis of the pension consulting firm Ennis, Knupp.

The idea itself takes fewer than five minutes to understand yet it’s so powerful. For year’s I’ve wanted to fully understand the complicated world of options investing. On the face of it, options aren’t difficult to understand. Call options are the right but not the obligation to buy the underlying stock at a specific strike price. Put options are the right but not the obligation to sell the underlying stock at a specific strike price. Easy.

It’s the strategies, the Greeks, and all the ancillary stuff that I can’t keep straight in my head without a quick refresher from a book. Which is why I have yet to buy or sell a single options contract.

If this rule works for investing, it should work for anything. If there is something you can’t understand in five minutes or less, take a pass. If there’s a loan that is so complicated you can’t figure it out in 5 minutes, pass. If you can’t explain why you should get a negative amortizing option ARM, you shouldn’t get it (it’s ideal for people who have irregular income, but good luck getting one now). If you can’t calculate how much interest you’re paying to a credit card, you shouldn’t accumulate a balance.

Savings accounts [4] make sense to me. CDs make sense to me.

If you think that you don’t understand something because you’re just not smart enough or because you’re not a “money” or a “numbers” person, bullshit. Don’t use that as a crutch. Everyone is smart enough, it’s just a matter of time. It’s like solving a maze or a puzzle, you can do it but it’s just a matter of time. If you give up and sign on the dotted line for something you can’t understand, you’re liable and it’s your life that gets trashed if things turn sour.

The five minute rule is golden.

(Photo: mypouss [5])

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[3] summary of a talk given by Vanguard CEO Bill McNabb: http://www.investmentadvisor.com/News/2010/6/Pages/At-Morningstar-Conference-Vanguards-McNabb-on-Restoring-Trust.aspx

[4] Savings accounts: http://www.bargaineering.com/articles/top-5-online-banks-savings-or-checking-accounts.html

[5] mypouss: http://www.flickr.com/photos/mypouss/3615282522/sizes/z/

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