New Here? Get the Free Newsletter

Oblivious Investor offers a free newsletter providing tips on low-maintenance investing, tax planning, and retirement planning. Join over 21,000 email subscribers:

Articles are published Monday and Friday. You can unsubscribe at any time.

Don’t let your ego get in the way.

American culture has a deep belief that being average is akin to being a failure. Everybody wants to be above average.

Unfortunately, this desire to be above average rarely works out to our advantage in the field of investing. It leads us to such endeavors as stock picking and timing the market, both of which tend to be counterproductive for most investors.

Index Funds and “Being Average”

As far as I can tell, the primary reason that people are reluctant to invest in index funds is that their egos get in the way.

Ironically enough, with index investing, accepting “average” returns virtually ensures that you’ll come out ahead of the majority of investors.

Another example of ego-related-trouble

What would your thoughts be if I recommended the following investment plan for an investor aged 25?

  • 72% in a Wilshire 5000 index fund (tracking the entire U.S. stock market)
  • 10% in a European stock index fund
  • 5% in a Pacific stock index fund
  • 3% in an emerging markets index fund
  • 10% in a bond index fund
  • Rebalance regularly to maintain this asset allocation

A handful of people might say that it’s a bit on the aggressive side. But I bet most people would say that it looks like a fairly reasonable, well-thought-out strategy for a young investor.

Now what if I had made the following recommendation instead?

  • Put 100% of the portfolio into Vanguard’s Target Retirement 2050 fund.

I bet many people would have some qualms about such a strategy. They’d say things like, “It’s too simple.” or “Putting all of my money into a single fund just doesn’t seem wise.”

The odd thing is that these two recommendations are the same thing!

Again, our egos get in the way. We seem to have a perverse desire to make investing more complicated than is necessary. We want to feel sophisticated, and putting 100% of an IRA into a target retirement fund just doesn’t fulfill that need.

My suggestion:

Do your best to set your ego aside when making investment decisions. Don’t do something just to feel smart. With investing, the simplest strategy is often the best one.

Why Investing Can Be Difficult

I just finished reading Nudge by Cass Sunstein and Richard Thaler. The book argues that, often, people would make better decisions if they were provided with a better context in which to make those decisions. For example, studies show that in high school cafeterias, students will make healthier eating decisions if the healthy foods are placed at eye level and earlier in the lunch line than the french fries/desserts/etc.

Makes sense to me.

Thaler and Sunstein go on to explain that there are certain areas of our lives in which we tend to need more help making decisions, and other areas in which we need less help. They argue that in order for people to be able to make good decisions, they need:

  • Experience with the subject matter,
  • Good information about each of the options, and
  • Prompt feedback.

Uh oh. For many people, investing is 0/3 here.

Lack of experience

The typical investor doesn’t have a great deal of experience selecting investments. They’ve only had to do it a few times–when they open an IRA, or when they switch jobs.

Poor information

Generally, the most important pieces of information about a particular investment (portfolio turnover and expense ratios, for example) are hidden in one of the least appealing pieces of reading imaginable–the fund’s prospectus. With a few noteworthy exceptions, this information is not included prominently in the glossy marketing materials.

Similarly, account fees aren’t exactly made obvious. I’d wager that most investors are unaware that their 401k probably charges them another 0.75% – 1% per year on top of what the underlying funds charge. It is, of course, difficult to make an optimal decision without being informed as to the costs involved.

Lack of prompt feedback

Further compounding the difficulty of making investment decisions is the fact that we don’t find out how well we did until decades later, when we’re actually starting to near retirement.

And in fact, there’s an abundance of meaningless feedback that does occur promptly: Oops, the day after you invested, the market went down 5%! Maybe you did something wrong. Maybe you chose the wrong fund. Maybe you invested at the wrong time. Maybe you shouldn’t be invested in the stock market at all!

Or…maybe this feedback is entirely meaningless, and you actually made an excellent investment decision that will pan out well in the future.

No wonder people have a difficult time with these decisions. It’s as if the situation is tailor-made to be difficult.

How to make investing easier for yourself

Of course, there are things you can do to make investment decisions easier for yourself.

To deal with the “lack of experience,” I’d suggest reading.  It’s hard to build up your own investment experience in a short period of time, so why not learn from the collective historical experience of other investors? Read everything you can get your hands on to see what has and hasn’t worked for people in the past.

Dealing with poor information is easy. If you know what to look for (again, expense ratios and portfolio turnover are great places to start) and you know where to look (fund prospectuses), then you’re all set as long as you take a few minutes to actually do the research.

“Lack of prompt feedback,” however, is a tough one to get around. There’s no magical way to get your money to grow faster. All I can suggest here is to make sure you’re not paying undue attention to the prompt (and meaningless) feedback that is available.

Guesstimating Probability

For whatever reason, there’s been a great deal of talk recently about some research done in the 1970s by Amos Tversky and Daniel Kahneman. It’s been discussed in Predictably Irrational and Nudge as well as in numerous articles/blog posts.

In short, what Kahneman and Tversky showed is that humans aren’t the best at making rational choices. For instance, Kahneman and Tversky were able to show several real-life instances in which people make blatantly irrational choices. (Such as cases in which people prefer A to B, prefer B to C, and prefer C to A–entirely irrational, but apparently common.)

How does this apply to investing?

One thing that they showed in their research is that people aren’t very good at estimating the probability of various outcomes. Unless we have actual statistical data in front of us, our brains use the following method for estimating the probability of an event: We ask ourselves “How easy it is to come up with real-world examples of such an event occurring?” The easier it is to come up with examples, the more probable we assume the event to be.

Unfortunately, this leads to 2 very strong biases:

  • Recent events are much more fresh in our minds. As a result, we tend to assume that a reoccurance is far more likely than it really is.
  • Dramatic events are impressed quite vividly upon our memories. As a result, it’s very easy to access those memories, making us therefore assume that such events are more probable than they really are.

What does this tell us about how we might respond to Recent Worldwide Financial Crises? Do you think it’s possible that people are ever-so-slightly overestimating the probability of such an event being repeated? 😉

How’s Your Financial Fitness?

William Bernstein recently wrote an article for Money magazine where he proposes the idea that your emotional fitness is a huge factor in determining your investment results. Here’s how he explains it:

[Investors] are handing over their stocks, at cheaper prices, to the disciplined investors who began the race in good financial condition. By financial condition, I don’t mean the state of the buyers’ bank account or even their market expertise but rather their emotional fitness to handle market volatility. And most of us aren’t born with that. You have to train.

This is exactly what I said a while back when I wrote that people could increase their tolerance for volatility. Bernstein suggests that it can be done by implementing a system of annual portfolio rebalancing, thereby training yourself to sell high and buy low. I think that’s a great idea.

I would add, however, that I think it can be also be done simply by learning more about market history and its cyclical nature. (Note: I’m not saying to do this instead of portfolio rebalancing, I’m saying to do it in addition to portfolio rebalancing.)

The good news is that unlike an elite athlete, an emotionally fit investor doesn’t have to wake up at 6 a.m. every morning to work out (or tune in to CNBC). In fact, it’s better not to think about investing most of the time. I know no greater investment pro than Vanguard founder John Bogle; he tells me that he peeks at his holdings only once a year. In this race, the edge goes to the disciplined couch potato.

Whether you call it Oblivious Investing, or being a “discliplined couch potato,” it’s a neat concept: Stop worrying about your investments, and they’ll start performing better (because you won’t be ruining their returns).

Side-Effects of a Recession

My sister recently sent me a NYT article discussing the cultural effects of a recession. Toward the end of the article, the author cites research showing that “a generation that grows up in a period of low stock returns is likely to take an unusually cautious approach to investing, even decades later.”

That scares me. I’m afraid that investors will “learn” from this recession that the stock market is a dangerous place for their money. As you know if you’ve been reading here for a while, I don’t see an “unusually cautious approach to investing” as a good/safe thing.

Today’s investors are faced with unique challenges:

  • Longer retirements than any previous generation.
    • More years of retirement quite simply means that we’re going to need more money to spend.
    • Decades of inflation will eat away at our investment returns and demolish the value of assets kept in “safe” investments.
    • We’ll likely incur huge amounts of medical costs during our last couple decades of life.
  • No traditional pensions (for most of us anyway).
  • Legitimate concern as to whether the Social Security system will be able to provide the benefits that it has promised (and that we have paid for!).

In short, we need a lot of money in order to be able to retire. (For example, for anybody my age, less than $2 million is unlikely to be enough unless you have passive income–via a pension or a business–or you plan to rely at least in part on Social Security.)

There’s simply no way to accumulate such a sum of money without a stock-heavy asset allocation during our working years.

Boy oh boy do I hope that my generation doesn’t swear off investing in equities.

Interview: John Bogle and Steve Forbes

Last night I watched this interview between Steve Forbes and John Bogle. As always with Bogle, I found myself writing down several quotes and observations.

A handful of my favorites:

John Bogle on predicting the market: “The mistake we make as investors is when the market’s going up, we think it’s going to go up forever. And when the market’s going down, we think it’s going to go down forever. And neither of those two things happens.”

John Bogle on speculation as opposed to investing: “An investor is a person who owns a business and holds it forever and enjoys the returns…Speculation is betting on price: ‘I think i can buy this for 10 and sell it for twelve.’ …Speculation has no place in the portfolio of the typical investor.”

John Bogle on investment costs: “With investing, you get precisely what you don’t pay for. If you pay nothing, you get everything.”

Steve Forbes on investment costs: “People are very careful with their money when they buy a car. They go online, look at prices. They have coupons when they go to the supermarket. And yet, when it comes to money management, by golly, a thousand here, two thousand there, a percentage here, two percent there…”

Steve Forbes on the marketing of investments: “The problem with new financial products or systems is that it always works in the past. We don’t know if it will work in the future.”

So keep your costs low and forget about timing the market? Sounds good to me. 🙂

Disclaimer: By using this site, you explicitly agree to its Terms of Use and agree not to hold Simple Subjects, LLC or any of its members liable in any way for damages arising from decisions you make based on the information made available on this site. I am not a financial or investment advisor, and the information on this site is for informational and entertainment purposes only and does not constitute financial advice.

Copyright 2020 Simple Subjects, LLC - All rights reserved. To be clear: This means that, aside from small quotations, the material on this site may not be republished elsewhere without my express permission. Terms of Use and Privacy Policy

My new Social Security calculator (beta): Open Social Security