Last week, I talked about Carveth Read, the English philosopher who’s famous for saying, “It is better to be vaguely right than exactly wrong.” This, in my view, is one of the most important ideas in personal finance. Last week, the focus was on the “vaguely right” side of the equation. But what about the other side: the importance of not being “exactly wrong?” That, I believe, is equally important, so it’s worth exploring what this means in practice. Below are seven situations in which seeking to be exactly right might, counterintuitively, carry more risk than aiming to be just roughly right.
1. How to structure a portfolio. Consult market data, and you’ll find that the best-performing stocks over the long term have been value stocks. In the words of finance professor Bruce Greenwald, these are the stocks of companies that are “ugly, disappointing, boring or obscure.” They’re the opposite of the market’s most popular and well known stocks—Apple, Amazon and so forth. But counterintuitively, value stocks, as a group, have easily outpaced their more well known peers. According to data from Dimensional Fund Advisors, value outperformed growth by more than 4 percentage points per year, on average, between 1927 and 2021. Strictly by the numbers, then, you would allocate your entire portfolio to value stocks. Despite the data, though, that’s not what I recommend, for two reasons: First, as the standard investment disclaimer goes, past performance does not guarantee future results. The future doesn’t necessarily have to look like the past. Also, when looking at historical data, there’s the possibility that the patterns we observe are just artifacts in the data. If that’s the case, and thus they have no fundamental basis, then there would be no reason to expect them to repeat. For both of these reasons, even though the data supports it, I wouldn’t go too far out on a limb with value stocks—or with any other specific investment category—to avoid being exactly wrong.
2. Whether to pick stocks. Years ago, I worked as an equity analyst—a stock picker. My colleagues and I would collect a mountain of data, then sit and analyze companies for days or weeks before deciding whether to purchase a stock. The problem, though, was that there was always information that simply couldn’t be known. An unexpected product recall, for example, or a government inquiry could easily put a dent in a company’s stock. The lesson I learned: When picking stocks, you can get the math exactly right and still be wrong. That’s why index funds which are diversified across hundreds or even thousands of stocks seem to me like the better bet for most investors.
3. Whether to invest in private funds. Investment giants like the late David Swensen earned outsized returns investing across the universe of private funds—venture capital, hedge funds and private equity. Because of that, private funds have developed a certain reputation: They’re seen as the exclusive vehicles that high net worth families use to grow their wealth. But here’s the problem: Because they aren’t regulated as tightly as publicly-available funds, there’s much more room for malfeasance. And because they are much more opaque and tend to pursue more unusual strategies, there is more room for incompetence and organizational failures. In the past, I’ve highlighted some high-profile cases in which private funds turned sour. But those are just the cases that made the news. I have also seen investors lose seven-figure sums in private funds on more than one occasion. The bottom line: Even if a private fund has an impressive track record, I’d steer clear. It’s much easier to be roughly right with a simple investment like the S&P 500.
4. When to invest in the market. Robert Shiller, a professor at Yale University, is the father of the CAPE Ratio, a well regarded metric for valuing the stock market. He has also, over the years, made more than one accurate market prediction. So it was notable when, a few years back, in the middle of the post-2020 market frenzy, Shiller wrote in The New York Times: “The stock market is already quite expensive. But it is also true that stock prices are fairly reasonable right now.” In explaining the apparent contradiction, Shiller pointed out that there are many ways to assess the stock market. Through one quantitative lens, it might appear overvalued, but through another, it might not. The lesson: If even the creator of the CAPE Ratio acknowledges that market valuation is subjective, it’s a reminder to all investors to take a long-term view. Even at times when the market looks unusually expensive or unusually cheap, there’s still no way to know what’s coming next. That makes short-term trading treacherous. But if you set your sights on the long-term, you’ll have a higher likelihood of being roughly right and avoid the penalty of being exactly wrong.
5. How to structure a retirement plan. Suppose you’re age 65 and trying to build a retirement plan. Consult a life expectancy table, and it’ll indicate a life expectancy of about 83. But here’s the curious thing: According to this same data set, the life expectancy of a 70-year-old is 85. And at 80, the average life expectancy extends to 88. It seems counterintuitive, but this is a reminder that, when building a retirement plan, we need to be careful of statistics. Life expectancies also differ across other demographic variables, including Zip code and education level. Because of that, in building retirement plans, I like to stretch the numbers out to age 100. Most people don’t live that long. But here again, it’s better to be roughly right than risk being exactly wrong.
6. What to think of the 4% rule. A frequent debate centers around safe withdrawal rates: How much can a retiree safely withdraw from a portfolio each year to ensure it will last throughout retirement? Some adhere to the so-called 4% rule, while others argue 4% is irresponsibly high. Meanwhile, the creator of the 4% rule, among others, believes that retirees can withdraw more than 4%. Everyone has an opinion. The reality, though, is that all of these models rest on a large number of assumptions. Just a year ago, for example, many argued that 4% was much too high because bonds offered yields that were so meager. I certainly couldn’t have predicted what’s happened with interest rates over the past year, but this should serve as a reminder that, in building a retirement plan, we shouldn’t blindly assume that today’s conditions will prevail indefinitely. Instead, to avoid being exactly wrong, consider a range of assumptions in building a plan.
7. Whether to annuitize. If you have a retirement plan that offers you a choice between a lump-sum payment or an annuity—that is, equal monthly payments for life—you may be tempted to take the lump sum. The majority of workers do, and there are reasons to go that route. Indeed, if you do the math, you might calculate that you’d do better investing the lump sum on your own than relying on your employer’s pension fund manager. But as noted above, life expectancy is a key unknown, and annuity payments guaranteed for life—no matter how long you live—can be an underappreciated benefit. This is maybe the most critical area in which it’s important to avoid being exactly wrong.
