Discover How The Inherent Complexity Of Investing Makes Over-Simplified And Free Investment Advice Your Most Expensive Choice.
- Why investing is complex, but personal finance is simple.
- How “buy and hold” is a special case, investment half-truth dangerous to your wealth.
- Reveals why ambiguity and complexity are an investor's best friend… seriously!
We desire simplicity and comprehensibility.
We wish things worked the way they're supposed to.
We long for black to be black and white to be white.
Why do we want these things? Because it gives us confidence in the outcome. It creates a sense of certainty in an uncertain world.
It feels secure.
That's why we want investment advice that's succinct, conclusive, accurate and understandable. We don't want to muck around in financial mud.
The human mind wants security in financial affairs and is uncomfortable with exploring all the subtle shades of gray inherent in a complex, uncertain investment world.
“Illusion is the first of all pleasures.”– Oscar Wilde
Unfortunately, reality doesn't care what you want: it just is.
The future is unknowable, investment decisions are complex, and risk management is subtle shades of gray. That's reality. Sorry.
If you want to invest profitably, then your strategy must be congruent with reality regardless of how you wish things were. Investing based on how you want things to be, rather than how they actually are, can be a very expensive indulgence.
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Why Simple, Free Investment Advice Is The Most Popular
The investment marketers and media give us simplistic, free investment advice because that's what sells best. It's what people want regardless of whether or not it's profitable.
Investment marketers and media are focused on their profits … not yours. This isn't some big conspiracy theory, it's just business common sense.
For example, visit your newsstand and review the cover articles in the financial magazines. Notice the sizzle in the headlines designed to capture you attention:
- “Ten Funds to Own for the Next Decade”
- “The Bull is Back: What You Must Own”
- “Five Stocks That Could Double This Year“
The headlines will vary, but the formula remains constant. Each article promises a powerful benefit delivered in a brief and easy to digest format.
No research or specialized knowledge required. The implication is you can unlock the vault to profits for very little effort. Nonsense.
Their job is to sell magazines, and they know darn well that very few people are going to rush to the checkout counter for factual headlines like the following:
- “Ten Funds with an Unpredictable Future”
- “Bull or Bear? Your Guess is as Good as Mine”
- “Five Stocks with No Better Odds of Doubling than Any Other Stock”
Would you pay for that kind of information? Probably not. Why? Because there's no promised benefit and no allure.
Accurate titles don't motivate people to take action and purchase the product. People need a benefit to drive them to action – whether or not it's true.
That's the way marketing and sales works so the media responds by promising that benefit. Their job is to sell you on consuming their product – whether it's good for you or not.
“The man who reads nothing at all is better educated than the man who reads nothing but newspapers.”– Thomas Jefferson
Numerous studies have analyzed the value of such advice, and the results are universally unimpressive. Sure, there's an occasional accurate forecast, but a broken clock is correct twice a day, and you wouldn't be foolish enough to use it to tell time. Why should sound-bite investment advice be any different?
Maybe I'm naïve, but I want investment advice that maximizes my profits and not the vendor's. I want investment advice consistent with reality even if reality is complex. For that reason, I don't want sound-bite investment advice if it's incongruent with the reality of investing.
What about you? What do you want from your investment advice?
The Thin, Gray Line Dividing Fraudulent Investment Advice From Deceptive Half-Truths
Suppose someone came to you and claimed you could earn 100% guaranteed every six months following their simple, proven, investment advice. Just plunk down the cash and watch your money grow.
Would you take the bait and invest? Probably not.
A smart investor would investigate deeply and perform thorough due diligence before risking a dime because above market returns, guarantees, and “something for nothing” are all red flags signaling potential investment fraud.
They're marketing tools designed to make your greed glands salivate so that caution and common sense are forgotten.
Simplistic, one decision investment advice is just one step removed from the above scenario. It's the same thing, but it's less obvious because it's less extreme.
It's designed to appeal to the same human weaknesses of wanting simplicity when complexity is the rule, wanting certainty when risk is unavoidable, and wanting something for nothing.
Simplistic investment solutions should serve as a red flag triggering greater due diligence on your part because it's out of congruence with the inherent complexity of a competitive investment world.
Examples of such simplistic investment advice include:
- Buy and hold for the long term.
- Buy stocks on splits for immediate gains.
- Stocks outperform bonds.
- Stocks outperform real estate.
All of these statements are partially true and all of them are partially false: they're investment half-truths.
To understand how they can be both true and false you have to dig behind the simplicity and unmask the inherent complexity of the underlying subject matter … investing.
“Buy And Hold” Is An Investment Advice Half-Truth
“The greatest obstacle to discovery is not ignorance – it is the illusion of knowledge.”– Daniel J. Boorstin
For example, “buy and hold for the long term” is simple, actionable investment advice that's so widely believed to be true that it approaches religious dogma within the retail financial community.
What's amazing, however, is that the very people who preach this investment advice don't walk the talk. Mutual fund companies have average annual portfolio turnover rates of 107% for U.S. stock funds according to a study by the Wall Street Journal.
John Bogle, founder of Vanguard and champion for the mutual fund industry, admits the average mutual fund turns over its portfolio roughly every eleven months. This is hardly “buy and hold” for the long term.
Why do the very people who preach buy and hold as a simple, one decision investment model, do exactly the opposite? Because the issue is much deeper and more complex than they lead you to believe.
Here are some facts they aren't telling you when they deliver this sound-bite investment advice…
The Hidden Statistics Behind Buy And Hold Investment Advice That Nobody Ever Told You … Until Now
Buy and Hold Fact 1:
Based on U.S. historical data, a 20 year “average holding period” is required to be confident that you'll eventually profit from buy and hold investment advice. Historical holding periods of 15 years or less have resulted in capital losses for U.S. data and holding periods in excess of 30 years have resulted in losses on international data.
In fact, both Burton Malkiel and Jeremy Siegel (buy and hold proponents) show that after adjusting for taxes and inflation, the 15 year period from 1966 to 1981 would've actually showed negative returns for stocks.
If you wanted to beat bonds for the same time period, it would've taken many more years. If you wanted additional return to compensate for the added risk of stocks, you'd need to wait even longer. If you included international data, you would have waited longer still.
Other periods in history show similar results. The point is: buy and hold for the long term is really long term.
“If a man is offered a fact which goes against his instincts, he will scrutinize it closely, and unless the evidence is overwhelming, he will refuse to believe it. If, on the other hand, he's offered something which affords a reason for acting in accordance to his instincts, he will accept it even on the slightest evidence. The origin of myths is explained in this way.”– Bertrand Russell
Buy and Hold Fact 2:
A 20 year “average holding period” (necessary to be statistically confident of a profit) is so hard to achieve for the average investor, it's statistically meaningless unless you wear diapers and watch Teletubbies on television.
That's because “average holding period” is very different from how long you invest.
Most people think that if they invest for thirty years, then they'll have an average holding period around thirty years, but it's much shorter.
The bulk of most people's savings occurs later in life, and they often begin spending principal upon retirement, causing their average holding period to equal a small fraction of their total investment career.
What this means is most investors are being led into a strategy that has a much higher risk of loss than they expect because their holding periods are much shorter than statistically required to assure a profit.
Buy and Hold Fact 3:
The often quoted expected returns from buy and hold are meaningless averages. The likelihood your return will equal the average is close to zero for two reasons:
- Your actual mathematical expectation for buy and hold is a function of the overall valuation level of securities at the time you begin your holding period. All times are not created equal. To expect average returns, the market would have to be valued at the average when you began your “average holding period”. Higher valuations offer lower mathematical expectation, and lower valuations offer higher mathematical expectation.
- Even if valuations were average when you began your holding period, the reality is average returns are a statistical fiction that rarely occur in practice, and they shouldn't be expected. Nassim Taleb, author of Fooled by Randomness, determined the average return for the Dow Jones Industrial Average from 1900 to 2002 to be 7.2%; however, only 5 of the 103 years had returns between 5% and 10%. The bottom line is, you shouldn't expect anything close to the average return you're quoted over any time period as meaningful to the average investor.
I could continue on and on about all the statistical fictions and half-truths used to support buy and hold as a simple, one decision investment strategy, but that's not my purpose.
(Ed. Note – Make sure you don't miss my super-long comment below responding to Telsaar with much more information about buy and hold problems seldom discussed…)
My point is to show the inherent complexity that hides behind even the simplest investment advice. Probably less than one in a thousand buy and hold investors really understand the risk and variability of returns associated with their investment strategy; yet, they're staking their financial future on it.
“Reality is that which, when you stop believing in it, doesn't go away.”– Philip K. Dick
Why Two Top Experts Can't Even Agree On The Simplest Investment Advice…
Buy and hold is so complex despite its surface level simplicity that two highly educated, very intelligent, well-reasoned experts can study the topic and come to diametrically opposed conclusions despite having access to the same data and statistics.
At the 2004 New Directions for Portfolio Management Conference, Jeremy Siegel, a professor at the University of Pennsylvania and author of “Stocks for the Long Run,” squared off directly opposite Rob Arnott, a hedge fund manager and editor of “The Financial Analysts Journal”.
Related: How Your Financial Advisor is Taking 75% of Your Retirement Income (or More!) Video, PDF download, or Audio.
These two learned and respected authorities had the same data and research at their disposal, and arrived at opposing conclusions about the long run prospects for stocks. Their only significant agreement was to agree to disagree.
If two highly credentialed experts immersed in extensive research on the subject can't agree, then what does that imply about the validity of your broker's opinion?
“As far as the laws of mathematics refer to reality, they are not certain; and as far as they are certain, they don't refer to reality.”– Albert Einstein
I believe buy and hold provides an adequate risk/reward ratio only under certain specific market conditions, and even then is only appropriate for investors with certain risk tolerances and objectives.
It's not an investment strategy appropriate for the masses at all times as it's commonly marketed, and it may be totally inappropriate for you.
Does this answer sound more complex than the sound-bite investment advice fed to you by the media, mutual funds, or your financial adviser? Probably.
But remember, my job is to help you retire early and wealthy by teaching you what works, what doesn't, and why.
Albert Einstein provided sage advice when he recommended keeping analysis as “simple as possible, but no simpler.” Why? Because simplicity can deceive when the subject is inherently complex, and Albert should know a thing or two about simplifying the complex.
Profitable Investment Advice Is Reality – Not Simplicity
In case you think that over-simplified investment advice is limited to buy and hold, I'll lampoon one more sacred cow to make the point that this problem is pervasive.
Studies are occasionally published claiming to prove which investment class offers superior returns: stocks or real estate. The analysis appears conclusive on the surface. Simply compare price changes in each investment class over long periods of time to see which one grew more.
Usually stocks come out on top depending on the time period analyzed.
“I believe in looking reality straight in the eye and denying it.”– Garrison Keillor
Unfortunately, this is pure rubbish. The real question is not percentage price change, but return on investment net of taxes and expenses. By oversimplifying they're asking the wrong question.
Stocks are customarily purchased for cash, so return on investment is a combination of dividends and price change.
But real estate is very different. It's usually purchased with financial leverage, magnifying price changes five or ten times over a cash purchase. In addition, it has significant tax advantages not available to stocks, further adding to total return.
Any analysis comparing stocks to real estate that doesn't account for these differences is oversimplified and meaningless.
In short, there is much more complexity to analyzing return on investment than simple price changes. Once again, real world investing differs markedly from simplistic, sound-bite investment advice.
How Is Personal Financial Advice Different From Investment Advice?
It's important, however, to complete this discussion by contrasting the complexity of investment advice with the straightforward simplicity of personal financial issues like savings, insurance, tax strategy, and personal record keeping.
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Investing is complex; personal finance is simple by comparison.
Personal financial advice can be safely generalized into black and white truths that fit into sound-bites. Below are some examples from my Seven Steps to Seven Figures course:
- Lifestyle should lag income so that you can invest the difference for long term financial security.
- You should only insure what you can't afford to lose.
- Run your personal financial life like a business … because it is.
So why can personal financial advice be safely simplified, while investment advice is inherently complex?
Common sense provides the answer. Investment results are determined by a competitive, free market. You're not in control of the outcome of your portfolio – the market is.
Additionally, the future for the markets is unknowable and determined by an infinite number of forces outside of your control.
“To succeed at anything you need to have passion for it and devote yourself to it – not be constantly looking for ways to cut corners.”– Unknown
You may want investing to be black and white, but the truth is subtle shades of gray. Investing is filled with risks and unknowns that are unpredictable.
The markets are dynamic and constantly evolving. Simplistic investment advice is incongruent with that reality.
Contrast investment markets, where you have no control, with your personal financial affairs where you're solely in control. Nobody but you determines your savings rate, debt, or which mortgage and insurance you buy.
The principles of successful savings, insurance and record keeping have changed little in decades. It's a relatively static and stable environment that's not transacted in competition like investments are.
The competitive, free market, uncontrolled nature of investing is the difference. Investment advice can never be black and white because if it was, then everyone would do the obvious, causing the obvious to no longer work. That's the nature of supply and demand in free markets.
Any competitive advantage that can be exploited by the masses through simplistic investment advice will be exploited into non-existence.
Bummer, but that's the way it works.
How Quality Investment Advice Creates Ambiguity
Sigmund Freud described the neurotic nature of most investors when he stated: “neurosis is the inability to tolerate ambiguity.”
I believe you can't understand an investment until you reach the point of ambiguity.
In fact, in my own investing I've found my confidence and clarity are inversely correlated to my results. Typically, the more confident I am at the point of decision, the more likely I'll be wrong.
Why? Because my confidence is a symptom of my ignorance to reality. It means my depth of knowledge is insufficient to know all the ways I can lose money with that particular investment.
Gaining that missing knowledge offsets blind confidence and creates ambiguity. Yet, ambiguity is what most investors avoid because it makes them feel uncomfortable. They want clarity and simplicity.
I'm not alone in these thoughts. Robert Rubin once observed that some people are more certain of everything than he is of anything. Excessive confidence in investing is dangerous because you don't reassess flawed conclusions.
Nobody can know all the facts, yet some people see the world full of certainties when in reality, it's only probabilistic.
“What is important is to keep learning, to enjoy challenge, and to tolerate ambiguity. In the end there are no certain answers.”– Martina Horner
When you embrace probability, then reality appears as subtle shades of gray rather than black and white, and most people don't like that. It's psychologically difficult. People prefer certainty because it breeds confidence… even if it's wrong.
Uncertainty can be paralyzing because you only know enough to know how little is really knowable. You recognize that everything beyond the limits of your understanding represents risk – risk of loss. Simplicity fades away and is replaced by complexity.
However, the advantage of uncertainty is that it motivates due diligence. You realize you can't ever really know, thus you gain as much knowledge as possible in pursuit of the unattainable goal of eliminating all doubt.
I encourage you to embrace ambiguity as investment truth. Seek it as the antidote to ignorance. The future is unknowable. Life is uncertain.
Only when you reach the point of ambiguity are you fully informed and capable of balancing risks with rewards to make consistently profitable investment decisions.
This may feel uncomfortable at first, and it certainly isn't the simple answer, but it's congruent with reality.
You need to learn how to sort what works in investment markets from what doesn't. Your financial security depends on this skill.
“A lie told often enough becomes the truth.”– Lenin
You'll be confronted with every kind of investment advice you can imagine on your path to retire early and wealthy. The sources of this advice will appear confident, qualified and knowledgeable.
Despite this air of expertise, the quality of the advice will range from great to garbage.
One way to separate good investment advice from bad investment advice is to know whether or not the advice is consistent with the inherent nature of the subject matter.
That's why I created the distinction between personal financial advice and investment advice.
- Investing is a complex subject filled with subtle shades of gray. For every point, there is a counterpoint. For every truth, there is an exception. Every investment strategy has its Achilles Heal. Even the supposed experts frequently fail miserably at investing because of the competitive nature and complexity of the game; therefore, simplicity and sound-bite investment advice should be viewed with caution.
- Personal finance issues, on the other hand, are relatively simple by comparison. Truths can be distilled down to simplistic rules that'll hold up in practice. While few experts will agree on best investment practices, most experts will agree on how to manage debt or save for college.
You must be clear on this distinction because without it, you're prone to fall prey to simplistic sound-bite investment advice when it's inappropriate or inaccurate.
Nobody can give you the how-to's of investing in a single article, book, or worse yet, sound-bite interviews on television. Yet, that's exactly what you see in the financial media every day. Don't let it influence your decisions.
The people who profit from selling you stocks want you to believe equities are superior to real estate because they can't sell you real estate.
They want you to believe you can profit from simplistic models like buy and hold because then you'll invest your money with them.
If the salesman can make it sound simple, then he's far more likely to get the sale. Complexity breeds indecision and is the nemesis of the investment marketer.
This is not some big conspiracy theory. It's just the way business works.
It's reality, and your job as an investor is to learn how to profit from it.
I hope this helps.
Here’s how to make more by losing less…
If you're looking for an investment strategy that goes beyond "buy and hold" while controlling risk and requiring as little as 30 minutes a month to manage, this is the answer. It’s so good I wish I had built it myself. Take back control of your portfolio and start getting results today.
And yet buy and hold is one of the best strategies for long term investing. Caveat, you are investing in a broad based fund like an index fund that eliminates individual security risk and only contains market risk. Balanced your buy and hold strategy with some risk management to include knowing when you will need a specific amount of funds. Temper it with your risk tolerance. You can establish the best opportunity to make money while minimizing the risk that your money won’t be there when you need it. With stock, while made unclear in your article, has a positive expected return from day one. However, there is high volatility and hence there is significant risk of losing money in the short term. And some risk of losing money in the long term. Now referencing the 15 year period you showed as a losing period, I took the highest day of S&P 500 in 1966 = 94.06 and the lowest day in 1981 = 112.77 and showed a worst case gain of 0.198 %or 1.2 %/year compounded annually. I don’t think this included dividends. On the other hand, From Jan 1950 to Jan 2015 the average 15 year return was 218% ( a little better than doubled), the worst case return was 5.67 % and the best was 849%. The standard deviation was 173.6%. Again, I don’t think these numbers included dividends, I leave it to the reader to verify. (source Yahoo, ^GSPC daily prices.)
I find financial and investment so complex that there is no risk free scenario. Rules of thumb are a must because the full analysis is too complicated to program and resolve for every scenario. Just like every business opportunity, there is risk. Just beware of these risk. While buy and hold may in reality be the second best strategy, the best strategy requires a lot of work and understanding to be informed enough to ‘time’ your buys and sells and most folks can’t do it.
telsaar I love how someone always has to defend buy and hold and parade the usual statistics. Thanks for stepping up to the plate, Telsaar.
You state “buy and hold is one of the best strategies for long term investing” but I 100% disagree. I agree that it is a valid long-term strategy because it has provable positive expectancy, but that is not the same thing as saying it’s the best.
You also state “balanced your buy and hold strategy with some risk management” but then completely fail to provide additional risk management. Holding a reserve doesn’t qualify. In addition, your point of risk management is important because it is the largest problem with buy and hold – no mechanism for managing market risk. The primary risk management tool in B&H is diversification, which fails during big bad bear markets because correlations rise toward 1. This is critical.
You also state that stock has a positive expectancy from day 1, but that simply isn’t true. The expectancy from a diversified portfolio of stocks is inversely correlated to the valuation at the beginning of the holding period. Tell someone who owned stocks from the top in 2000 or 1929 or 1973 that they had positive expectancy and they will likely disagree.
You also provide stats supporting holding period returns but don’t specify if they include/exclude dividends or include/exclude adjustment for inflation. You also don’t specify if they are compound or average returns. These distinctions are critical.
The key point is most data supporting buy and hold is from the U.S., and that is because the U.S. was the economic Prom Queen of the last century. If you broaden your analysis to international data you will be far less confident in your position. It is surprisingly common to find 30+ year periods of negative returns from buy and hold.
Finally, toward the end you say to “Just beware of these risk.” when your entire analysis encourages buy and hold which is tantamount to blindly accepting these risks.
My whole point is risk must be managed, not blindly accepted.
You conclude by stating any alternative requires too much work to be viable, but given that you are clearly in the buy and hold camp and advocating that position, it hardly places you in a position of authority or expertise for the work required for alternatives.
The methods I teach require a few months of part-time effort to develop the working knowledge to implement, and the actual implementation requires around 30 minutes per month to implement. I hardly consider that a “lot of work” given the potential benefit and peace of mind.
My main point is not to attack to you, but to encourage all the buy and hold advocates out there who feel the need to “defend the religion” to not repeat the worn platitudes that are so common on this subject, but rather to provide real solutions to the actual problems inherent in the strategy.
Specifically, there are three core problems (1) there is no risk management for big bad bear markets because correlations rise toward 1 (2) there is no flexibility regarding extremes in valuation thus treating all periods in time as if risk is justified by reward, when in fact history proves that is not true (3) the mean variance optimization that results in an efficient frontier for asset allocation is a cute theory that completely fails in practice because it is nothing more than a historical optimization of past data, which is a provably flawed strategy.
Those are the problems. They are significant. They matter. And they must be addressed with practical solutions.
The truth is buy and hold is an acceptable strategy because it has provable, positive expectancy given sufficient time. However, it is nowhere near the “best strategy” as you claim because it provides horrible risk/reward characteristics from periods of high valuation and/or low interest rates.
Coincidentally, that is exactly where we are at today.
I’ll defend buy and hold until you can teach me to time the market. I think there are clues. I’m learning to recognize bubbles in the market but I’m not confident yet. Since I’m something less than a geninus I have failed to see which metrics can reliability guide me. Certainly P/E and PE10 help. I struggle when you say you 100% disagree that BH is one of the best methods. I’m actually sold on picking individual stocks but that requires significant leg work but I discovered that I dislike reading company reports, going through financial statements and making the final decision of which stocks to pick. You have to learn when to buy and when to sell which requires valuation skills. I believe a person suitable for this can manage a portfolio of about 25 stocks at any given time which might start looking like a full time job. Maybe I just never got through the road blocks. However, I do believe you can beat the indexes when these skills come together. I believe someone with the skills can double their money every 5 years on average during bull markets. I also think that someone doing this can earn their fees above the index funds, you know, the 1.5% some fund managers charge. I don’t think I would feel diversified enough if I held less than 15 stocks in my total stock portfolio. Can this be managed in less than 30 minutes a month?
My version of risk management falls into a bucket approach where I calculate my annual needs from my portfolio out to 10+ years. The first three years are in CD’s, The next 4 to 10 years are blended to provide a historical minimum outcome of 100% of the desired spending budget for that year. Excess growth in the near year funds will be reinvested for the new outer years. The blends are combinations of CD’s, Bonds, Preferred stock index fund and Total market index fund. I am confident that market risk is mitigated by long term but to think we can eliminate it is foolish thinking.
Maybe I used expectancy wrong. At least your definition seems different than mine. Let me illustrate what I mean another way. For S&P 500 from 1/3/1950 to 1/23/2015, the average daily return is a positive 0.03% with a standard deviation of 1.0339%. This implies that there is a 51.2% chance of a positive daily result. And even another way of looking at the data, of 16369 daily returns, 7574 (46.27%) were negative, 125 (.76%) were equal and 8671 (52.97%) were positive. This does not include dividends and neither did the data I presented in my earlier post. The numbers representing all the 15 year performances from 218% (average), 5.67% (Minimum) and 849% (Maximum)is total increase in share value not including any dividends. In a 15 year period, based upon historical performance, there is some risk of your investment in the S&P 500 not keeping up with inflation. But per my definition of expected return, is to better than double in value plus dividends. Of course, the future may not necessarily be represented by the past.
The problem with expectancy is probability. Take the lottery. Realistically those who purchase a lottery ticket are full of anticipation but they have no expectancy (mathematical) to win. Yet, someone will win. Due to probability, the true outcome is not always the expected outcome.
telsaar Financialmentor I’m engaging because the myths you are operating under are shared by so many readers that the discussion should prove helpful for others.
Your first paragraph is all about stock picking, but the research is quite conclusive on this subject. The ability to add value in excess of costs through stock picking is extraordinarily rare. That is why low cost passive indexing trumps actively managed mutual funds in research study after research study. The sole exception are an isolated group of hedge fund managers as tracked through 13F filings, but they are the rare exception. Since people who spend their whole careers pursuing this goal generally fail, it is not a wise path for you or I to pursue.
Another myth in your discussion is a generalized view on “market timing.” It is important to draw the distinction between “forecasting” and “statistical risk management.” Because the future is unknowable, any attempt to forecast is downright nutty. So all methodologies premised on any forecast of the future can be eliminated. However, statistical risk management algorithms have proven valid historically and have worked in real-time as well. (Please don’t ask me to specify exactly what those are. Numerous examples exist as typified by valuation indicators and/or simple trend following algorithms.)
The problem with your “bucket” approach to risk management is that it is risk dilution. It is investment product based as opposed to process based. When you limit your work to investment product you are stuck in the reality of risk equating to reward. In other words, as you dilute risk with bonds and cash you dilute your reward (expectancy). This is not good, nor is it necessary.
Regarding a definition of expectancy, it is probability times payoff. It is determined by the relationship of average winning trade to average losing trade and percentage winners to percentage losers. The key point is expectancy is what determines the return on your portfolio. It is the key to the whole puzzle, and it is determined as much by the positive as the negative. Most investors focus on offense but fail to properly emphasize defense; yet, defense is key to the whole equation.
Regarding your example of expectancy, that is why I call the long-term averages myth. Yes, it is true that when you look at enough (U.S.) data the long-term average is positive. That is why buy and hold is valid. It has positive expectancy, and there are specific reasons why.
However, most investors live in a world of 10-15 year holding period returns. The 10-15 years before you retire and the 10-15 years after you retire. That is not the same things as 20-30 years. These 10-15 years holding periods have wildly varying expectancies that must be managed to assure financial security.
It is not acceptable to rely on 65 year or 30 year analysis of expectancy as your basis for strategy because that is not reality for real-world investors seeking to live off their portfolios. It is deceptive.
Hope that helps clarify some of the issues.
Hi Todd and thanks for your latest thoughtful article. I particularly like the distinction you make between financial planning should be simple and investing is complex. It seems that too often the popular press get that backwards. You and I may disagree sometimes, but I appreciate that you always have your audiences’ best interests in mind in whatever you write. Thank you and keep up the good work.
Steve Juetten, CFP
smjuetten Just as you appreciated how I drew the distinction between personal financial planning and investment advice, I appreciate how you drew the distinction between agreeing with me and recognizing I’m always working toward my audiences’ best interests. I think what you are saying here is really important.
There is plenty of watered-down corporate speak on the internet for these topics so it does nobody any good to add to the drivel already shared on the big name sites. Who cares? I always try to be clear in sharing my viewpoint, even if it means someone will likely disagree (see these comments as evidence).
I try to support everything based on proven research and actual experience. I’ve come to a lot of conclusions that aren’t mainstream so by definition that means there will be many points to disagree with. I’m cool with that.
However, I’m always working to serve my audience, and I really appreciate you making that distinction. Thanks for noticing.
rwohlner Financialmentor “To read a newspaper is to refrain from reading something worthwhile.” Business papers handmaidens to abuse.
RecoveredBroker Financialmentor I honestly don’t understand this comment
@rwohlner RecoveredBroker Financialmentor I like the quote (Isince it came from this article)
Right on the money, Todd. Thank you.
I find that the same issue you raise about the world of investing also applies to the world of life insurance. Advisors keep promoting simplistic rules to make the purchase of life insurance simple. The fact of the matter is that this product is very complex and some pretty deep thought is needed to determine exactly what is appropriate. Throw in the emotional sensitivity of facing one’s mortality, and you have a financial decision that lends itself more to philosophy than it does to formulas.
Do you also see the same level of complexity when determining one’s need for life insurance?
SteveKobrin Hate to disappoint you, but I see life insurance very simply. It shouldn’t be used as an investment vehicle, as it is commonly sold. Instead, you should only insure away a loss you can’t afford to take. In other words, if you lack assets and have dependents to care for then it makes sense. In short, only the old, traditional use of life insurance – to transfer the risk of death for the primary breadwinner – makes economic sense. KISS.
Financialmentor SteveKobrin Understood. I agree that life insurance should be bought for the death benefit. Cash value is icing on the cake. But are you saying that those people who are able to self-insure should therefore not buy a policy? Consider this: let’s suppose somebody did have assets. In that case, they would be covering the risk of death dollar for dollar. If they bought life insurance anyway, they would be covering that risk for pennies on the dollar because of the leverage a pooled-risk product gives you. Doesn’t that make economic sense?
SteveKobrin Financialmentor The mistake in your analysis is that someone with sufficient assets has no risk to insure. His/her dependents needs are already covered by the assets. Purchasing life insurance in this situation is just an unnecessary expense.
Financialmentor SteveKobrin Thank you for your quick response. To be clear: my point is that unleveraged assets are not an economical way to remove the risk of death. Let’s suppose the cost of someone dying is $10 million, in terms of final expenses, debts to be paid, and income to be replaced. If he has that amount of money in an investment product then he has eliminated that risk dollar for dollar. He would have to use $10 million of his money to eliminate that $10 million risk.
If he had purchased a life insurance policy and paid even as much as $1 million in total premium, then he has eliminated that risk for $.10 on the dollar. He would have had to use only $1 million of his money to eliminate that $10 million risk. Which method of affording the risk makes the most financial sense?
SteveKobrin Financialmentor I don’t want to use this column as a forum for you to promote life insurance. Let’s just say I disagree. Your viewpoint is only shared by those who sell life insurance and makes no financial sense (except to insurance companies). There are a mountain of angles to discuss that are being ignored by your analysis and extend beyond the scope of what is appropriate for a blog comment. For example, you are portraying this as if the 10 million is compensating for death risk. It’s not. The 10 million is buying financial freedom for the person and his/her dependents whether he is living or dead. Because he has that financial freedom there is zero financial risk left to insure. Buying life insurance when there is no risk to insure is a complete waste of money. It is like buying a car when you don’t drive. It is an unnecessary expense, and no amount of reframing can change that reality. I hate to be so black and white because I understand you are trained to see it differently as an insurance salepserson and I want to be respectful, but the whole point of this article was to keep things simple where they can be kept simple. The life insurance decision when you are financially independent is simple.
Financialmentor SteveKobrin Thanks so much for your clarification, Todd. Much appreciated.
Hi, this is a very long article to destroy the buy an hold. But nothing constructive, nothing actionnable, nothing usefull. Sorry but after reading it all, I feel that I wasted my time. Is all your content like this?
I’m sorry you felt that way. The purpose of the article was to show the distinction between personal finance (that can be accurately simplified into sound-bites) and investing (that’s inherently complex and should not be over-simplified). Unfortunately, your focus was on the buy and hold aspect of the article, which was merely illustrating the point, but not the actual purpose of the article. This response is common for people who are emotionally married to the buy and hold strategy thus finding it difficult (if not impossible) to look at the facts accurately. With that said, at least now you know my educational content doesn’t work well for you. I hope you find writers who better serve your needs.
I’ll admit that I do (mostly) enjoy reading your articles, although I think this is in large part due to the copious amounts of excellent quotations that you reference. Sometimes I find myself scrolling through your articles just to read the quotes!
I think what is frustrating for the average reader is that most of your content is not actionable. It’s primarily about what not to do and deals very little with what actually should be done. I understand your view that each person’s situation is unique and your hesitancy with providing blanket recommendations, but it does get tiresome after a while.
I can’t help but get the feeling that the primary purpose of these articles is to act as a funnel for your paid content (coaching/ebooks). There is certainly nothing wrong with this, but it leads to a feeling of disappointment rather than enlightenment after most of your articles
The following quotes are from your comments above:
“The methods I teach require a few months of part-time effort to develop the working knowledge to implement, and the actual implementation requires around 30 minutes per month to implement.”
“Those are the problems. They are significant. They matter. And they must be addressed with practical solutions.”
Eventually you are going to have to expand on what your “methods” are and actually provide the “practical solutions” that you yourself are calling for, otherwise your readers are probably going to give up.
I hear your frustration. I’m sorry, but it’s the nature of the beast. Single articles can fully explain what not to do. It’s relatively simple to show the flaws and problems and debunk myths in single articles. However, fully explaining what you need to do requires an entire course to properly explain how all the information connects into a single, actionable body of knowledge. The fact that most people try to explain investing in single articles is why so many investors are frustrated with all the apparent contradictions in various people’s instruction. It’s incomplete and over-simplified. I’m current producing the Step 3 Expectancy Wealth Planning course, and when that’s complete I will produce the Step 5 Expectancy Investing course. Availability will be announced to subscribers via the email newsletter. Sorry for your frustration. I will produce it as soon as possible because many other’s want this knowledge as well. Hope that helps explain.