When asked about his firm’s investing acumen, Charlie Munger, Warren Buffet’s right hand man had this to say: “We continue to try more to profit from always remembering the obvious than from grasping the esoteric….it is remarkable how much a long-term advantage people like us have gotten by trying to be consistently not stupid, instead of trying to be very intelligent.” In other words, avoiding stupidity is a lot easier than seeking brilliance in the investment world. Playing “not to lose” is a more resilient and reasonable strategy for most people than trying to shoot the lights out with dangerous speculation. Much like the game of tennis, the investing game is conquered by those who tend to make less unforced errors. Here is a list of ways to avoid wearing a dunce cap while building wealth for the long term:
1. Know your time frame. Investing for a 3o-year retirement goal is much different than saving to buy a car in a couple of years. It is impossible to invest or save money without knowing your end game. Many mistakes are made by not making this distinction. Failing to plan with your time frame in mind can have drastic effects on the attainment of financial goals. A recent example of this occurred during 2008-2009. Many parents saw the disappearance of their children’s college funds that were needed to pay tuition within a few years. A simple understanding of time frame would have completely avoided this unfortunate event. The funds should have been allocated to match the time frame that they were needed within (1-3 years). Investing in conservative short-term bond funds or CDs, would have sidestepped the massive collapse in stock prices that took place when the global markets crashed.
2. Control your emotions. Investing is much more psychological than anything else. The collective mood swings of millions of individuals determine the short-term movements of the markets. While no one expects you to have the emotional stability of a Buddhist Monk, at least be aware of your fragile mental state when it comes to market gyrations. A simple way to avoid drama would be to only look at your portfolio once a year. It would give you a much better idea of how markets work and let you avoid by the various manipulators in the media and financial services field who are trained to prey on these cognitive deficiencies.
3. Diversify with cheap index funds and avoid purchasing individual stocks. Investing is not supposed to be entertaining. As the great investor George Soros once said, “Good investing is boring.” Most index funds will clobber stock picking funds over time because of the lower costs involved. While picking stocks might be “fun”, your chances of winning this game are abysmally low. Besides being out gunned by the firepower of large financial institutions, there is another potent enemy that is awaiting you. Research done by Michael Blatnick has proven that roughly 40% of all stocks have suffered a permanent 70% decline in value from their peak (based on a universe of companies from the Russell 3000 Index). To put it simply: There is an almost 50% chance that, if you pick a high-flying stock, you will lose most of your money. Don’t be stupid. Avoid this by sticking with a portfolio of index funds that cover thousands of companies located throughout the world. Play not to lose.
4. Don’t put all of your money into your home. Many investors feel their residence is their prime source of wealth and a way to save for the future. The numbers do not back this up. The average home appreciates about 3% a year while long-term market returns range between 8-10%. This does not include the carrying costs of home ownership. While an individual could pay $20,000-30,000 a year or more to live in a $500,000 a year home, the same amount invested in a low-cost index fund would cost about $250!!! While you cannot live in an index fund, don’t be silly and think that your home will build more wealth than a diversified stock portfolio over a 30-40 year time frame.
5. Devote energy to things you can control. Stressing over market returns, inflation, President Obama, or various global conflicts will not build wealth and will most likely lead to unwise decisions. Things like watching over investment costs; picking an investment advisor who is a fiduciary and receives no commissions for services; lowering your taxes by eliminating short-term trading and market timing; getting a will and health care proxy in place; and, purchasing disability and life insurance will all provide much more predictable and profitable pay offs than watching CNBC all day and charting the market’s every move. A person with a very average IQ can perform all of these tasks with little complications. Avoid making big mistakes by concentrating your energy on productive tasks.
6. Educate yourself. While there is nothing wrong with hiring a financial advisor, it is important that you know the basics and the workings of the investment industry. There are a tremendous amount of free resources today that are not only worth their weight in gold for the average investor, but are entertaining and easy to read. These include, but are not limited to, the following blogs, Abnormal Returns, The Big Picture, The Reformed Broker, A Wealth of Common Sense, The Irrelevant Investor, and Pragmatic Capitalism. A great way to be consistently not stupid is to read stuff from really smart people. You could do a lot worse than spending an hour or so a week perusing these sites and picking through these valuable nuggets of investor information.
Being a “Try Hard” will often lead to bad results. Investing is really about not doing stupid stuff. Knowing this one simple fact will create a guideline for your investment process. As Morgan Housel said: “I have learned that finance is very simple but it’s made to look complicated to justify fees.” Be consistently not stupid and follow these steps and you will most likely end up with much more by doing much less.