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Politics and Personal Financial Planning

The political votes we cast can influence our –and other people’s — finances.

But the influence should usually not be allowed to flow in the opposite direction. That is, personal financial planning decisions should, in most cases, not be influenced by our political views.

For instance, I’m a vegetarian treehugger atheist liberal snowflake. And if you’re a steak-loving truck-driving devout evangelical conservative, a portfolio of actively managed funds with high expense ratios would be as bad an idea for you as it would be for me.

If for some reason your marginal tax rate is lower this year than you expect it to be in the future, a Roth conversion is probably a good idea. The math is the math, regardless of where you sit on the political spectrum.

We might disagree about what tax rates should be for one particular group or another (or for one particular type of income as opposed to another). But if your finances and my finances are similar, the tax planning decisions that make sense for you make sense for me as well. The likelihood of a particular legislative change occurring and effecting us is the same, regardless of how we feel about that potential change.

The insurance coverage that you need has nothing to do with who you plan to vote for in November. (If anybody is dependent upon you financially, you should have life insurance.  If you are dependent on your income from work, you should have disability insurance. And so on.)

If you do or don’t like the person in the White House, and you begin to let that feeling make you think that you can predict what the stock market is going to do over the next month (or 48 months), you’re in for a rude awakening. No one person has that much control over the stock market.

Of course, there are some exceptions — some cases where your political and other views will (and should) inform your financial decisions. Most obviously: your charitable donations. And some portfolio decisions could reasonably be influenced by political views, though as I’ve written before I sincerely think that the most common version of “ESG” funds are unhelpful and likely detrimental to the very causes they ostensibly serve.

In most cases though, as soon as you let your political views begin to inform your personal financial planning decisions, you start to make worse decisions. And you open yourself up to manipulation.

Many products (financial and otherwise) are sold based on fear. If somebody can tap into your political fears, they’ll have an easier time selling to you. You political fears may be well founded, but as soon as you notice that somebody is trying to sell you something based on those fears, your level of skepticism should be at its maximum.

Using an All-in-One Fund During a Downturn

A reader writes in, asking:

“You’ve written before about using a Vanguard Lifestrategy fund for your retirement savings. Have you been happy with its performance through all of the volatility this year? Do you think it has made it easier to ‘stay the course’ as Bogleheads say?”

To be clear, my level of satisfaction with the fund is not really a function of its performance. It’s just a fund of index funds. And because we use the LifeStrategy Growth fund, it has a mostly-stock allocation (80% stock, 20% bond). So if the fund is doing well at a given time, that’s just because the global stock market is doing well, not because of anything brilliant about the fund.

Similarly, when the fund is performing poorly (e.g., Feb-March of this year), that’s not a failing of the fund. It’s just what happens when you own index funds and the market performs poorly.

Having said that, yes, we are happy with the fund. And yes, it probably has made it somewhat easier to “stay the course” through all the volatility.

It has been nice not to have to think about when to rebalance or anything like that. All we’ve had to do is just keep putting money into the same fund (i.e., precisely the same thing we’ve been doing since we began using the fund ~8.5 years ago). It’s a very low-stress, low-hassle way to save and invest.

Granted, I imagine that if I were using a DIY allocation, I still would have been able to calmly continue with the plan (i.e., continuing to contribute and rebalance). I had no trouble doing so in the bear market of 2008-2009, and that was a worse decline (in terms of percentage).

And, to be clear, the behavioral/psychological benefits that I’ve experienced with the LifeStrategy fund are not particular to LifeStrategy funds. They’d be just as applicable to any “all-in-one” fund, including target-date funds or balanced funds.

And finally, the same caveats as always apply:

Pick Your Own Asset Allocation

A reader writes in (regarding last month’s article about “total market” investing):

“Your article made me feel much more comfortable with my market-cap weighted portfolio!

However, after reading your email, a news story came out about Wealthfront. Burton Malkiel has written extensively about the merits of market-cap weightings. He and Charlie Ellis helped me build my simple portfolio!

However, it just came out that Malkiel is ignoring his own advice, and has decided to add smart beta ETFs to Wealthfront portfolios. This is a crushing blow. It seems more and more of my favorite investing authors are abandoning the plain vanilla portfolios they have written about for decades, and instead are embracing momentum, value, and small stock overweights in hopes of beating the market.

I am trying very hard to keep it simple and stay the course. But it seems we are losing members of the plain vanilla club every day! Losing Malkiel and Ellis was not fun for me to read about this morning.”

Firstly, advisory firms (including robo-advisors) have an incentive to make their portfolios look smart/complicated. If it’s a simple total market portfolio, people might wonder: why not just handle it on their own? Or why not just use a less expensive target-date fund?

The more important point, however, is that there are no clubs or teams here. It doesn’t work to weigh the names on one side of an asset allocation debate against the names on the other side.

Ultimately you have to weigh the evidence and arguments on each side of the debate and then decide for yourself.

If you decide based on the names on each side, it will always be a struggle to stick with the plan, because on any asset allocation debate there will be experts — credible ones — who disagree with you, regardless of which side of the debate you’re on. And they’ll have convincing-sounding arguments and data backing them up.

For instance on the topic of bonds, several parties I respect greatly have made different arguments.

Personally I would find it impossible to weigh the credibility of one of those parties against the credibility of the others.

In addition, if you decide based on names, you always have to revisit your portfolio decisions whenever a) an expert changes opinion or b) you encounter a new expert with an opinion on the matter.

Conversely, once you’ve made the decision for yourself, you can put it out of your mind and move on with your life.

Reading a new expert opinion or reading about an expert changing their opinion should be roughly as impactful as reading a list of “Top 10 Cities for [People of Your Generation]” in a magazine. Even if your town isn’t on the list, you don’t consider moving. You’ve already made an informed decision, so the writer’s opinion has no impact on where you choose to live.

In short, with any asset allocation decision, regardless of what you end up choosing, the goal is to take your time with the decision, so that ultimately it’s your decision, and you can be confident/content regardless of who agrees or disagrees with you.

Is It Time to Overweight Energy Stocks?

A reader writes in, asking:

“What do you think of an Energy Mutual Fund such as Vanguard’s Energy Fund for a 3-5% position within one’s stock portfolio at this time?

Some investors such as Buffet have suggested that the time to invest in markets when there is “blood in the streets”, and there is crying from obvious pain.  Do you think the rapid price decline of oil and related energy stocks is a good investment through an energy fund, or should one be satisfied with the percentage of energy and related stocks through an S&P 500 fund or total market index fund?  Is there enough pain and blood in this sector to warrant at least a look at an energy fund for a longer term hold of at least one to three years?”

As of 12/12/14, the Vanguard Energy Fund is down just over 30% from the peak it reached in June of this year.

For an investor considering a temporary overweighting of this industry (relative, that is, to the portion of the overall market that it makes up), the question that must be answered is whether this 30% decline is an overreaction, an appropriate reaction, or an underreaction to the decline in oil prices. It would only make sense to overweight this industry if you were convinced that the recent price decline is an overreaction to the news (i.e., share prices have gone down more than they really should have, making today an opportunity to buy at bargain prices).

So, how would you determine whether the price change is an overreaction?

In short, you’d have to do some math (and a lot of research).

Specifically, you’d have to calculate your expectation for the industry’s future earnings given the new lower oil price (which would necessitate, among other things, an estimate of how long the price of oil will stay where it now is). And then you’d have to calculate what you consider to be a fair value of the industry, given those new earnings expectations.

As for me personally, such calculations and estimates would be well beyond the sort of thing I could do with any significant degree of confidence.

But if you don’t actually take the time to do the research and math, all you’re really doing is guessing.

You could make the case that, yes, it’s a guess, but if you make many guesses of this nature over the course of your investing career, you’ll be right more often than not given that investors tend to overreact to news. But there are, in my view, at least three compelling points against such a strategy:

  • Monitoring the news and moving in and out of various funds is quite a bit of work, relative to a simple buy-hold-and-rebalance strategy,
  • It involves higher costs, due to transaction costs and/or owning funds with higher costs than broad-market index funds, and
  • There’s evidence of a “momentum effect” in most equity markets, which might suggest that investors actually tend to underreact to news at first.

Waiting to Invest Doesn’t Make Things Any Easier

A reader writes in, asking:

“We have an undesirably large sum in cash at the moment, nearly a third of our total financial assets. Interest rates can go nowhere but up, but who knows when? Is it best to invest this money right away, or given the current situation, should we wait until we know better what’s happening with the market and interest rates?”

To start with, I think it’s a mistake to think that interest rates have nowhere to go but up. Right now, interest rates are significantly higher than they were at the beginning of this year. (For example, as I write this, the yield on 10-year TIPS is a full 1.3% higher than it was on January 1, 2013.) Given that rates were lower just a handful of months ago, I don’t see why they couldn’t go that low again.

Unfortunately, with interest rates, we’ll never know where they’re headed next.* For example, imagine a scenario in which interest rates rise by 2% over the next year. That would put them at a more historically normal level, but there would be no reason they couldn’t rise further. In other words, no matter how long you wait to see what interest rates do, there’s no knowing what they’ll do next.

And, as it turns out, the same goes for the stock market — waiting doesn’t really give us any useful information about what the market will do in the future.

That is, neither stocks nor bonds become any more predictable (i.e., less risky) simply as a result of waiting to buy them. So, in my opinion, the primary question is simply: How much risk are you comfortable taking right now with this money? (And, for reference, I think it’s perfectly reasonable for investors with a low risk tolerance to include cash as a significant part of their long-term allocation.)

Once you have decided on the allocation you want to use for the long-haul, there tends to be little to gain from delaying your move toward that allocation — with, of course, the exception of situations in which the delay results in a predictable advantage, such as allowing you to make the switch at a lower cost due to a short-term capital gain becoming a long-term capital gain.

*Even the market as a whole tends to be unable to successfully predict interest rate movements. (See Figure 7 from this Vanguard research paper for a striking visual representation of just how often the market gets it wrong.)

What to Do About [Recent Economic Event]

One of the most common types of emails I receive is the email asking what to do about a particular economic event in the news (e.g, various actions by the Federal Reserve or, more recently, the Detroit bankruptcy).

My training in economics consists of precisely four undergrad courses, so I have no insights about macroeconomics that your next-door neighbor doesn’t have. And it would be downright silly for me to think that I’d somehow be able to read about a piece of economic news, foresee some consequence that the market cannot foresee, and be able to recommend a portfolio adjustment that will offer market-beating results. And frankly, I think most investors are in a similar situation.

So unless there is an obvious way in which you will be directly impacted (e.g, the news in question is the Detroit bankruptcy and you are a retiree with a Detroit city pension), I don’t see a great deal of benefit* to spending much time thinking about these things, especially not when there are so many other things that you could spend time and energy on that would have a higher probability of improving your finances (without requiring you to predict stock or bond market movements). Things like:

  • Reducing the costs of your investments,
  • Making sure your portfolio is sufficiently diversified,
  • Making sure the level of risk in your portfolio does not exceed your risk tolerance,
  • Protecting yourself against behavioral investing mistakes,
  • Tax planning,
  • Social Security planning, or
  • Making efforts to increase your earnings potential.

At a broader level, that’s the fundamental problem with most efforts to outperform a simple passive investment strategy. To be worthwhile, they not only have to have a greater than 50% likelihood of success, they have to have a greater expected payoff than the payoff you would likely get from spending a comparable amount of time/energy/money on the above list of objectives.

*Personal finance-related benefit, that is. Staying up to date on economic news can of course be worthwhile for other reasons (e.g., to be a well-informed voter). Just don’t expect it to help your portfolio in any meaningful way.

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