The problem with conventional wisdom is that it represents the masses, but there’s a whole host of things that conventional wisdom gets wrong. By default, that feeds into what investors get wrong.
Listen now and learn:
- What investors get wrong
- A new way to think about risk
- How to define investment success
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Show Notes
In this episode, I’m joined by Ashby Daniels, author of Money Visuals as well as two retirement books (Creating a Retirement Income Plan Simplified and Medicare Simplified)
One of Ashby’s favorite quotes comes from Nick Murray, who’s kind of like the advisor’s advisor.
“If most people were right, most people would be rich.
And since most people aren’t rich…”
…you get the idea.
The problem with conventional wisdom is that it represents the masses. And in most cases, it’s the media’s version of what it takes to earn clicks and additional advertising. So there’s a whole host of things that conventional wisdom gets wrong, which by default, feeds into what investors get wrong.
We dive deeper into that theme in our conversation.
Blaming the Market Instead of Yourself (1:59)
People tend to find reasons other than themselves to blame for their performance, which is very counterintuitive.
In the life of the average 65-year-old, the S&P 500 is up about 100 times in price—that excludes dividends, which is an enormous omission. An investor didn’t have to do anything except own it in perpetuity—you just have to sit there. But that’s not what we as investors do.
Ashby attributes this to the fact that many people take their investment ideas from a news or media source.
The media isn’t in the business of helping you be a successful investor, they’re in the business of selling advertising.
The best way to sell advertising is to get more eyeballs, and the best way to get more eyeballs is to tell you why the world is going to hell in a handbasket.
Earning the market returns is simple in theory—just own the market and don’t sell.
But it runs counter to everything that we hear in the day-to-day news cycle, which makes it hard in practice and explains why so many people historically have failed to capture the market’s returns.
When you look at historical market returns alongside major world events, many of the periods of market losses look like mere blips. But at the moment, it feels like an eternity. A disciplined investor looks beyond the concerns of today to the long-term growth potential of markets.
Earning the market return is relatively simple from a strategic perspective, but incredibly difficult from an emotional and behavioral perspective. If the only thing you need to do to earn the market return is own the market and not sell, then the only obstacle to earning the market return will be your own behavior.
One thing that helps on the behavioral side is having the proper expectations. Historically, the S&P 500 falls at least 10% roughly every 12 months, 20% or more roughly every three and half years, and 30% or more roughly once a decade. Obviously, these losses don’t follow a perfectly predictable schedule, but those averages suggest it shouldn’t be a surprise when markets go through periods of losses.
So rather than trying to predict and avoid market downturns, you should plan on them occurring with a similar magnitude and frequency as they have in the past. That way you don’t have to worry about whatever the media deems to be the crisis of the day.
Defining Risk (8:30)
Most people define risk as volatility. This is straightforward from an academic measurement perspective, but risk is so much more than that.
Ashby defines risk as one of two things:
- The probability of complete and total loss.
- Any decision that moves you further from rather than closer to your goals.
When thinking about Ashby’s first definition, this is far more relevant for investments in individual securities. If you own the entire market—as Ashby and I both agree is prudent—the diversification benefit makes the probability of complete and total loss practically zero. That makes Ashby’s second definition of risk more relevant to investors that share our general investment philosophy.
Over the last 100 years, stocks have earned an average annual compound return of about 10% while bonds have earned about 5%. Using Ashby’s second definition of risk, choosing to own bonds over stocks introduces risk to a portfolio because that choice moves you further from your goals—reducing your return requires you to work longer, save more, or spend less.
This is a big reason why Ashby and I own 100% of stocks in our portfolios (the other being that our human capital reduces our need for bond exposure). While stocks do experience more volatility in the short run, we don’t actually recognize losses unless we sell.
You don’t own bonds to enhance returns. You own bonds to reduce volatility. Sometimes the reduction in volatility is necessary to help investors stay the course.
During the Financial Crisis, the difference between your portfolio losing 30% or 40% of its value from peak to trough (because you owned bonds) rather than losing 60% (because you only owned stocks) might very well be the difference between you staying the course. And as we’ve repeated several times during this conversation, you can’t earn the market return if you sell.
One final point from this part of the conversation: The purpose of investing is to grow your savings faster than the rate of inflation without taking undue risk. Long-term real stock returns (returns net of inflation) are less volatile than the long-term real return in bonds. This supports Ashby’s second definition of risk very well.
That said, it can be extremely difficult to stick with an all-stock portfolio. Bonds help reduce the risk of selling at inopportune times and thus missing out on earning market returns.
How to Define Investment Success (15:16)
Ashby defines investment success as the probability of reaching your financial goals.
Many people think of investment success as beating the market. Still, empirical evidence shows us that beating the market is extremely unlikely for all but a handful of investors out of the millions of market participants.
The better measure of success is something that brings us closer to our life’s purpose. Carl Richards spoke about this a few episodes ago as well (EP.100 – What Real Financial Advice Means)
Similarly, in Episode 87: How to Measure the Success of Your Portfolio, I suggest that people need a goals-based benchmark in addition to the more standard portfolio-based benchmark.
For me, a portfolio-based benchmark simply allows you to better understand your investments, which are the vehicle for helping you achieve your goals. But investors also need a way to measure progress towards their goals because that’s what matters most.
When you get overly focused on a portfolio-based benchmark, you start trying to beat that benchmark. One of the biggest misconceptions that I deal with on a day-to-day basis is the idea that benchmarks were designed to be beaten, but that just really isn’t true.
Again, all you must do to earn the market return is own the market and not sell. Once you deviate from the market portfolio, your performance is going to be different. And a benchmark helps explain why your performance is different.
Ashby and I have talked about the pursuit of the average many times before.
The word “average” doesn’t sound great, but if you get that market return, you’re probably beating 90% of investors.
The latest S&P Indices Versus Active (SPIVA) Scorecard showed that 91.79% of all U.S. Equity Funds trailed their respective benchmarks over the last 3-year period, 87.53% failed over the last 5-years, and more than 90% failed over the last 10-, 15-, and 20-year periods. Global, International, and Emerging Market Funds failed to beat their benchmark 80-95% of the time depending on the time period measured.
See EP.74: The Failure of Active Management
No Need to Be Smart. Just Don’t Be Stupid (20:00)
Ashby and I agree that investment success is mostly about avoiding mistakes. The best way to be smart is to not be stupid.
The idea that any of us are going to replicate the performance of investing greats like Warren Buffett, Munger, Peter Lynch, Bill Miller, etc. is simply unrealistic. Just look at The Intelligent Investor, which is the Bible of many investors. There are five editions of that book and none of the five have the same formulas!
And yet, investors still listen to forecasts and overly focus on selecting the best investments or timing the market—but pretty much anything other than sitting on your hands is probably a mistake.
It’s easy for us to say sit on your hands and do nothing. It’s basically impossible for the media to do that. If all they do is say, “Hey, do nothing”, no one’s going to buy a subscription, and no one’s going to tune into their segment or their show.
People who tune in to financial experts don’t realize beating the market requires one of two things:
- You have better information than everybody else in the world (or)
- You’re better at interpreting information than everybody else
Often in life, better outcomes require being smarter or working harder—you can’t just sit around and have good fortune come your way all the time. That’s why doing nothing and staying the course with your investments seems counterintuitive.
When we say “stay the course,” it doesn’t mean we have our heads in the sand and don’t see all the things that are negative. Nor does staying the course mean that things couldn’t get worse. But the evidence is overwhelming, that doing nothing is usually the best option.
And yet, people are always drawn to forecasts. There’s something about our human nature, we crave certainty despite living in an uncertain world. Unfortunately, people are notoriously horrible at forecasting.
There’s a great book on this topic called Superforecasting by Philip Tetlock. It addresses all kinds of studies from all kinds of forecasters and finds that experts in their field are right less than 50% of the time.
But because that uncertainty is so unbelievably uncomfortable, we would rather be wrong. It’s crazy how often experts are wrong because they offer a ton of compelling evidence, but there are no facts about the future.
“There are absolutely no facts about the future.”
Howard Marks
The idea of not listening to forecasts is about removing stumbling blocks. If a forecast has the potential to cause you to make wrong decisions, then why would we introduce it as a possibility of becoming a stumbling block? Sure, it may be right. But it probably won’t be. At best, it’s unnecessary. At worst, it’s detrimental.
Investing Like an Optimist (29:15)
Faith in the Future is wildly underrated as a piece of what it takes to be a successful investor. This doesn’t mean being a starry-eyed optimist. Instead, it’s simply the belief that human progress will continue.
This is not a complicated idea. Almost everyone you know will rise in the morning with the idea of making their future and their family’s future better than it was today or yesterday. Progress is inevitable because of what human beings are. We all want tomorrow to be brighter than today.
If progress continues, markets will go up because capitalism is nothing more than financial evidence of progress.
Human progress isn’t linear, it is exponential and our brains struggle with that. Similarly, compounding is something that everybody understands and know is important, but they probably don’t because it’s not intuitive.
Going back to our earlier example of equities earning a 10% rate of return and bonds earning a 5% return. If you invested in the two asset classes over 30 years, what will be the difference in your ending asset value? Almost everybody would say the 10% return will be twice as big as the 5% return. But in reality, the difference is not two times, it is four times greater.
This is why Ashby says he pounds the table over and over again on why we invest in equities—because the difference of voluntarily choosing a lower rate of return is an enormously different ending value. To Ashby and me, avoiding temporary volatility isn’t worth that enormous difference.
The Value of a Financial Advisor (34:24)
Ashby believes an advisor adds an unbelievable amount of value in three areas of an investor’s life.
The first is simply trust. You’re paying someone to look after your affairs, to free up the headspace so that you can do what you truly want to do. Most people aren’t wrapped up in learning about the markets and reading hundreds of investment books and so on.
The second is a unique expertise. In other words, you cannot know what you do not know. That we are ignorant of our own shortcomings of knowledge.
There are an immense number of ways an advisor may add significant real dollar value to your life beyond the investment side of things that we spoke about in this conversation.
Taxes, estate planning, retirement planning, etc….having somebody in your corner whom you trust and who also has unique expertise is extremely beneficial.
Third, and most possibly most important, is objectivity. You’re not paying somebody because they’re necessarily smarter than you. You’re paying somebody because they’re not you. That’s the point.
When things look bleak (or outright horrific), it’s insanely difficult to remove emotions from your financial decisions. We don’t know when we will make a mistake and need the services of a trusted advisor that is not only looking out for you today but will be looking out for you decades from now.
We don’t drive around in our car hoping we get into an accident so that we can use our insurance. And yet, people manage their own money because they think they may not need an advisor right now. But by the time you do need one, it’s too late (or you simply don’t realize you’ve made a mistake of some sort).
That’s why you pay somebody to be objective, whom you trust, and who you believe has your complete and utter best interests at heart.
Where To Find Ashby
Money Visuals is a service that creates content for advisors to share as their own with their email lists. I highly recommend checking it out. Ashby authors this content for others to use with the end goal of helping a greater number of investors act more rationally.
Ashby’s weekly newsletters along with monthly charts and links helps advisors communicate the timeless principles to others so that those following them can be more successful in reaching their goals.
Resources:
- Money Visuals
- Creating a Retirement Income Plan Simplified by Ashby Daniels
- Medicare Simplified by Ashby Daniels
- Ashby Daniels on Twitter
- Ashby Daniels on LinkedIn
- Don’t Predict, Plan
- What You Need To Understand About Bonds
- EP. 100 – What Real Financial Advice Means With Carl Richards
- EP. 87: How to Measure the Success of Your Portfolio
- EP.74: The Failure of Active Management
- The best way to be smart is to not be stupid
- The Intelligent Investor by Benjamin Graham, Jason Zweig, Warren E. Buffett
- Why Expert Predictions Are BS
- Superforecasting by Philip Tetlock
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About the Podcast
Long-term investing made simple. Most people enter the markets without understanding how to grow their wealth over the long term or clearly hit their financial goals. The Long Term Investor shows you how to proactively minimize taxes, hedge against rising inflation, and ride the waves of volatility with confidence.
Hosted by the advisor, Chief Investment Officer of Plancorp, and author of “Making Money Simple,” Peter Lazaroff shares practical advice on how to make smart investment decisions your future self with thank you for. A go-to source for top media outlets like CNBC, the Wall Street Journal, and CNN Money, Peter unpacks the clear, strategic, and calculated approach he uses to decisively manage over 5.5 billion in investments for clients at Plancorp.
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