Today marks the 200th installment of this blog. In looking back, one recurring theme stands out: Managing one’s finances is, in a lot of ways, like managing one’s health.
Ask any doctor, and they’ll tell you the recipe for good health: Exercise, eat right, don’t smoke. It’s not complicated. And yet, it’s not so simple. Environmental factors, genetics and bad luck conspire against us. As a result, even the most disciplined person isn’t guaranteed perfect health.
It’s the same with personal finance. We all know the basic formula: Start early, save consistently, keep costs low. Again, it seems simple. And yet, somehow the path to financial success is far from simple. Why is that?
In 1940, a young Wall Street broker named Fred Schwed wrote a book titled Where Are the Customers’ Yachts? It was satire, but it rang true. The premise: The brokerage industry’s lavish fees allow stock brokers to buy yachts. But also because of those fees, clients aren’t able to afford yachts for themselves.
Schwed’s observation is less true today. The cost of investing has come down significantly. And yet, personal finance still isn’t easy. Why is that?
Fees, it turns out, weren’t the only problem. They definitely were—and continue to be—part of the problem. But I’ve noticed at least nine other obstacles that regularly get in the way of success for investors:
1. Behavioral finance is at least as important as quantitative finance, but it’s harder to teach. In recent years, behavioral finance has gotten more attention and is better understood. But understanding the problem only gets us partway toward solving it. The challenge is that the literature in behavioral finance, excellent as it is, offers very little in the way of solutions. What can you do? Read as much as possible about market history—Charles Kindleberger’s Manias, Panics, and Crashes, for example. I also recommend the work of University of California professor Terrance Odean, an expert on investor behavior—especially his recent paper on Robinhood.
2. The financial world is almost infinitely complex. To make sense of the world, though, our minds are programmed to simplify—and often to oversimplify. When it comes to the complex world of investments, that’s a problem. What can you do? In the past, I’ve talked about Robert Shiller’s book Narrative Economics. I’ve also mentioned Chimamanda Ngozi Adichie’s concept of the “single story.” They’re similar ideas. I recommend reading about both to gain a better understanding of this pitfall.
3. Financial salespeople take advantage of complexity. If anyone has ever tried to sell you a whole life insurance policy, you know what I mean. The industry continues to cook up increasingly complex instruments. These products can be tricky for two reasons: It’s hard to know how a complex investment will behave under different market conditions. And complexity can obscure high fees. What can you do? Keep it simple. If someone tries to sell you a newfangled investment, challenge them to explain how it would be superior to simple investments like stocks, bonds and real estate.
4. The government hasn’t made it any easier. Our tax laws are a thicket. And that thicket is constantly shifting. What can you do? There’s no way to know what Congress will do next. But there’s still value in proactive planning. I recommend sitting down with your CPA during the summer, when they have more time. Go over last year’s tax return and ask for their observations and recommendations.
5. No one can see around corners—but some pretend they can. Turn on the TV, and you’re bound to hear an investment “strategist” talking about the market. What can you do? This one may be the easiest to address. Whenever you’re tempted to listen to an investment prognosticator, just think back to last year, when the coronavirus came out of nowhere, knocking the economy into recession. No one saw that coming. And no one can predict what will come out of left field next. Instead, build a plan that is independent of predictions.
6. Stock-picking is even more difficult than it appears. The most surprising finance paper ever to cross my desk was titled “Do Stocks Outperform Treasury Bills?” Authored by Hendrik Bessembinder, a professor at Arizona State University, the paper concluded that just 4 percent of all stocks have accounted for all of the gains in the U.S. stock market over and above Treasury bills. The other 96%, as a group, have delivered returns no better than humble Treasury bills. What can you do? In today’s market, where some have scored big wins on Tesla and other highfliers, you might feel like you’re missing out. If you’re ever tempted to jump into the fray, though, keep this research in mind. The odds of beating the market are exceedingly small.
7. Investment markets are the master of the head fake. If markets were either fully rational or fully irrational 100% of the time, life would be easier for investors. The problem is that the market is rational just often enough to fool us into thinking it’s logical. We saw that, for example, when tax rates were cut in 2017. But just when it seems like the market makes sense, it goes completely haywire. We saw that last spring, when stock prices dropped to irrationally low levels. What to do? I always stress the importance of asset allocation. This is the only way, in my opinion, to protect yourself from a market that is sure to deliver its fair share of curveballs.
8. Risk is a critical concept, but investors don’t even agree on how to define it. Some investors believe standard deviation is the best measure of risk. To support their view, they point to Nobel Prize-winning research. But others, including Warren Buffett, believe standard deviation is worthless. As an individual investor, this can be confusing. What to do? I’m with Buffett—I think standard deviation is a flawed concept. But in fairness, risk does take many forms, making it elusive. My recommendation: Focus on the most important risk: that you would have a shortfall in meeting your goals. Then structure your portfolio accordingly. If you want to learn more, I recommend William Bernstein’s Deep Risk and Howard Marks’s The Most Important Thing.
9. College tuition has become a wrecking ball. Back in 2017, I related the story of a young college graduate whose life had been hijacked by crushing student loans. In my work with clients, I see this over and over. The cost of college in the United States has been rising at double the rate of inflation, or more, for decades. What can you do? There is still a positive return on investment for some colleges. But as a consumer, you need to be more careful than ever. If you have school-age children, I recommend Ron Lieber’s new book, The Price You Pay for College, to help think more critically about the college question.