Tag: investing

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Weekly Automatic Deductions – The Key To Getting Wealthy

tax_deadlineHey you, it’s April 12th. If you think the way I think (Let’s just make pretend together for a moment) you’re wondering how you’ll be able to fund your tax-advantaged individual IRA contribution for 2015 by Tax Day, Monday April 18th. Less than a week from now!

Ideally, you’re like, “Ha, ha, no problem. I have that $5,500 maximum contribution right here in my savings account that my favorite blogger Michael wants me to put in. ($6,500 if you’re over 50!)”

But I can’t target this post for the both of you readers who actually scrimped and saved the $5,500 this year. I’m writing for the real, not the ideal.

Which means you should still make your contribution this week, and let’s vow together to do better next year.

But how do we do better next year? That’s the big problem.

Regular automatic transfers

The only technique I’ve ever believed in – when it comes to actually saving money for the purposes of investing – is regular automatic transfers.

Regular automatic transfers are why 401K investing works so well, because your money gets taken out of your paycheck and then invested without you getting your greedy little hands on it.

Regular automatic transfers are often why paying off a mortgage over 30 years can reliably build up middle-class wealth. You simply get in the habit of making your house payments automatically every month, and presto! Thirty years later you have an actual positive net worth via your house.

Regular automatic transfers are why new fintech solutions like Digit, Qapital, Dyme, Acorns, and Betterment all offer to slip little tiny bits of your forgettable change out of your bank account and into a savings or investment account, to at least kick-start your investing habit, or to help you pay down debt. I don’t use any of these services, but their regular automatic transfers game is on point.

$15 a day

On short notice – between now and the end of this week for example – could I come up with $5,500 to put into my IRA? Well if you put it that way, not really.

What about maybe monthly? Do I have an extra $458 per month, after paying for the kids’ needs, and eating out, and losing money at my weekly poker game with the neighborhood dads? (That’s the $5,500 maximum allowable IRA contribution divided by 12, but you knew that.) Who’s got that kind of money? So again, not really.

To get there, how about breaking $5,500 down into the smallest possible increment? Could I save up $15 per day?

I’ve written about the fact that my caffeine addiction already leads me to waste most of that amount of money on most days. Have you ever tracked your “indefensible” expenditures? How hard would it be to save $15 per day? Maybe pretty hard, but my guess is it’s only doable via regular automated transfers.

My bank

Inspired by that thought, I logged into my bank where I have both a checking account and a savings account.

I checked my bank’s transfer set-up online, and I saw I could program it to shift money from my checking account into my savings account once a week. I didn’t see an option for daily transfers, although ideally I’d do that instead.

automatic_transfers
Money transfers from one place to the other

Would I be able to handle an automated $105 per week transfer? (That’s $15 per day, but you knew that)

Something tells me I could. Something tells me that even though transferring $5,500 in early April each year might drive me crazy, the thought of transferring $15 a day (in weekly $105 increments) might be doable. So I set it up to do just that, for the next two years. Would you like to join me in this experiment?

Irrational behavior

I’ll be the first to admit it, regular automatic transfers aren’t “rational,” in the sense that traditional economists assume we are rational people when it comes to money. Why should it matter if I’m moving money from one account to the other on a weekly basis, without affecting my overall net worth? It should not matter in the least. So this isn’t rational, but neither are we when it comes to money. We are all a little bit crazy when it comes to money.

Not for everyone

Another caveat. Regular automatic transfers out of a checking account into a savings account – or better yet, into an investment account outside the reach of your greedy little hands – won’t work for everyone. Some of us will raid that “sacred account” as soon as it accumulates a little bit of money. My only advice – if you think this will be a risk for you – is to make the destination account as difficult-to-access as possible.

Maybe try this: Write down your investment account password on a piece of paper, then rip that paper into tiny pieces. Now eat the bits of paper.

What? You don’t think that will work either? Forget it, sorry, it was just a thought. I guess we’re all irrational in different ways.

 

Please see related posts:

Ask an Ex-Banker: The Magical Roth IRA

Book Review: The Automatic Millionaire by David Bach

How Big is My Latte Effect?

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Five Good Questions for A Finance Columnist

jason_zweigJake Taylor interviewed Wall Street Journal columnist Jason Zweig, who recently published The Devil’s Financial Dictionary and asked him “Five Good Questions”

Q1: What inspired him to write this book?

Zweig says he needed something to update on his website that didn’t give readers an ‘action-item’ in response to market conditions, since that doesn’t tend to be terribly useful.

So instead of a ‘buy this’ or ‘sell this’ Zweig just started posting a humorous definition or two to have fresh blog material. After a while of doing that, he had material for a book.

Frankly I’m jealous of that Zweig came up with that plan. Blog freshness ain’t easy.

Q2: Taylor asked Zweig to explore the linkages between ‘Market Panic’ and The Greek God ‘Pan’

Zweig mentions the obvious link, with Pan as the ‘trickster.’

More interesting, he recalls that Pan is a fertility god, and suggests that the market destruction of a Panic also creates opportunity for growth, at lower prices. That’s a theme with which I concur.

pan
Pan, Master of Panic

Q3. Where does Zweig see his preferred investment style on the intersecting continuum of: “Diversification” vs. “High Concentration,” as well as maybe the alternate intersecting axis of “Be fully Invested Always” vs. “Stay in cash and opportunistic”

Zweig splits the Solomanaic baby, describing himself as preferring a mostly (70%?) diversified Total Stock Index, plus 10% cash, plus 20% concentrated positions, while also saying he’s highly restricted in what he can do in practice, because of his role at the Wall Street Journal.

Personally, I advocate the “100% diversified, 100% be fully invested” corner of the XY Axis.

 

Q4: Are the markets legalized gambling? Or do they serve a purpose of allocating capital?

Zweig answers that investors who figure out their own game are not subject to somebody else’s casino’s rules.

I have my own take on this question, which I wrote about here.

 

Q5: What quality should people cultivate be a good investor?

Zwieg’s answer is that investing success could plausibly derive from three sources

  1. Outwork everyone
  2. Be smarter
  3. Have emotional intelligence, self-knowledge and self-control

Of these, Zwieg says, the third is probably the most useful. Especially if this leads to cultivating patience.

I have answered this one in my own way, by saying that controlling your own investing behavior matters more than anything.

Near the end of the interview, Zweig quotes from his The Devil’s Financial Dictionary with two paired definitions:

Long Term – (adj) “On Wall Street a phrase used to describe a period that begins approximately 30 seconds from now and ends, at most, a few weeks from now.”

Short Term – (adj) “On Wall Street, 30 seconds or less. As opposed to Long Term, which is 30 seconds or more.”

Anyway, it all made me want to order The Devil’s Financial Dictionary, so I did.

Please see related posts:

Volatility in Stocks is a Good Thing

How To Invest

Are Stocks Like A Casino?

Behavior Matters More Than Anything

 

 

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Book Review: Behavioral Investment Counseling by Nick Murray

Murray is the author of one of my favorite investing books of all time, Simple Wealth Inevitable Wealth, and I’m reviewing this later book partly as an excuse to call attention to his earlier book, SWIW.

But Behavioral Investment Counseling by Nick Murray stands on its own quite well.

The book’s bedrock idea – captured right there in the title – is that investor behavior determines an individual’s wealth prospects, rather than “markets.”

Now this strikes me as 100%, Capital T, True, although an uncomfortable truth for many.

Ask me “how are the markets doing?“ and the right answer – as I’m certain Murray would agree – is “Doesn’t matter, how’s your behavior doing?”

Since Murray’s audience for this book is not individual investors but rather investment advisors, the logical lesson is that advisors need to focus on the beliefs and behaviors of their clients, rather than spend much time on asset or manager selection.

I’ve never wanted to be an investment advisor, but the way Murray describes the “behavior investment counselor” makes the profession seem especially noble.

I dig his voice. He’s a wise and slightly weary zen master who has seen all of the investment behavior mistakes possible, and can describe them to you before you even make them.

behavioral_investment_counselingOn many an important point he acknowledges the unknowability or unprovability of his point. Nevertheless, not doing what he says – not intuiting the essential wisdom – leads to grievous error. You’re welcome to persist in your own stubborn views, he seems to say, and best of luck to you.

I’m not as old as Murray but I find myself adopting that same attitude at times. I mean, people enjoy their investment fantasies. Who am I to disillusion them?

In my own words, the message of the book is

  1. The entire value of an investment advisor is captured in the making of a plan taking into account the client’s specific situation – and then the occasional behavioral counseling at key moments (mostly when the market crashes, but also possibly when it is on a tear upwards and there’s a need to rebalance back to the original plan.)
  2. Readers of SWIW will not be surprised to learn that the best plans will rely heavily on diversified equities (rather than fixed income) as this is the only way to grow one’s money, and avoid the most important risks – loss of purchasing power and outliving one’s money.

For actual investment advisors, Murray’s book offers what seems to me a tremendous amount of self-evident wisdom about what an advisor does, how an advisor should go about building a practice, and how an advisor should first ‘pitch’ prospective clients.

If you haven’t read any Nick Murray yet, do yourself a favor…

Please see related reviews:

Simple Wealth Inevitable Wealth by Nick Murray

The Game of Numbers by Nick Murray

 

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Now How Much Would You Pay? Comparing Fund Costs

A wise man wrote about investing: “performance may come and go, but costs are forever.”[1]

Let’s explore a bit how big these cost difference really become for your investment portfolio.

As a starting point, do you already have a sense for whether the cost differences between funds you may own are in the hundreds of dollars? Or maybe the thousands? Could they possibly be in the tens of thousands? Surely not more than that?[2]

(Here’s a sneak preview hint of the answer: Wall Street is very profitable.)

dont_call_me_shirley

Differences over time

To illustrate cost differences, let’s pretend you are a 40 year-old with a $100,000 mutual fund investment that will earn 7 percent annual return in the market, over the next 30 years. I know, lots of assumptions that may or may not be true for you, but we have to start somewhere.

The first key thing to know is that the average actively managed mutual fund charges 0.8 percent as an annual management fee, while the average passively managed – or ‘indexed’ – mutual fund charges 0.14 percent per year, for a difference of 0.66 percent in fees, (this according to mutual fund giant Vanguard.)

Hundreds!

For a $100,000 investment, the cost difference in fees averages $660 per year.[3] So, I guess active management costs us hundreds of dollars per year, then.

Tens of thousands?

how_much_would_you_pay

But wait. Annual management fee costs rise as your funds grows, so the annual fee differences grow as well. Using averages, you should expect to pay your mutual fund company $65,518 total in fees for an actively managed fund that returns 7 percent over a 30-year period, compared to $12,896 for a passively managed fund also growing at 7 percent.

Um, so you’re telling me the average cost difference between an active and a passive fund is $52,622 over 30 years? In the tens of thousands of dollars?

Yes, yes I am telling you that.

Hundreds of thousands!?

But just wait. Even that comparison underplays the differences in costs. Since you are attempting through your investments to grow your money on your money, the lost growth on the money you pay in fees each year actually drags down performance even more than it at first appears.

The difference in final performance, considering the compounding effects of fees paid out of your investments, leads to a $124,141 wealth difference at the end of 30 years.

Wait, what!? Yes, you noticed that. The all-in cost of your mutual fund may end up larger than your original investment.
Pick any assumptions

You could test a wide variety of assumptions and the differences will be dramatic, even if the final numbers vary.

Crank up the annual return assumptions, and the differences become even bigger. Crank up the number of years invested, and the differences become even bigger. Crank up the amount of money invested, and the differences become even bigger. Crank up the management fee of the actively managed fund to a very typical rate, rather than the average 0.8 percent, and the differences become even bigger.

Millions?!?

How about a $1 million stock portfolio, returning 10% over 40 years, paying 1 percent for active management instead of 0.14 percent for indexing? (By the way, these are not crazy assumptions for many people) The wealth difference at the end of forty years, making the simple choice about active versus passive investing, is $11,602,001.

In a related question, have you ever wondered how Wall Street got so big?

Active versus Passive

Now, clever readers will notice something I’ve not yet addressed in my comparison of low-cost versus high-cost mutual funds.

hedge_fund_myth

What if I adopt the assumption of the mutual fund industry itself – which is built on the idea that a good reason to pay more in fees is to get better performance? Meaning, if an actively managed fund can earn 8 percent per year instead of the 7 percent per year from an index fund, then my cost comparisons become irrelevant in the face of superior performance. Right?

Ok, that’s possible.

All you have to do, therefore, is be confident about two things:

  1. Active managers typically outperform passive managers.
  2. You, specifically, (or your investment advisor) have the skill to know, ahead of time, which active managers will outperform passive (aka index) funds over the next thirty years.

Unfortunately for the mutual fund industry’s underpinning assumption – these turn out to be absurd ideas most of the time, for most funds, and for most people.

coin_toss
Picking managers: a bit like this

I’ll start with assumption number one, about the consistency of outperformance of active managers over time. The quick answer is that about 3 percent of mutual funds that achieve top performance over any five year period also go on to achieve top performance in the following five year period. Sadly, the vast majority of actively managed funds underperform their benchmark over the long run. And the longer the run, the fewer the outperformers.

On assumption number two, whether you or your advisor can select the rare winner among active managers, I don’t know. I mean, who am I to say?

Ok fine, I’ll say it: You can’t, and you won’t.

 

[1] Reminds me of the politically incorrect joke from the 1980s about the difference between love and herpes.

[2] Please don’t call me Shirley.

[3] That’s $100,000 times 0.66 percent, but you already knew that.

 

Please see related posts:

How to Invest

The Simplest Investment Approach, ever, by Lars Kroijer

Lars Kroijer on having an ‘edge’

 

 

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Five Bad Reasons To Invest The Way You Do

CoolerThis past month I taught an adult education course on investing. I began the first session with a discussion of the following question: “What are we really trying to do when we invest?”

I’ll conclude this column with what I think we should try to do when we invest, but I can think of at least six common goals that can get in the way of that should.

Seem Smart/Competent

Many of us approach investing as another area for standing out as smart, or for proving our special competence.

Doctors for example – highly competent and smart in their own specialized field – might figure they know which health-care or pharmaceutical stocks to buy.

A marketing executive might see broad societal trends in the fashion world, or a chemistry professor could apply his knowledge to pick small bio-technology  stocks.[1]

When you listen to a group of guys (for some reason it’s usually guys) discussing their individual stock picks, that ‘proving competence’ thing is what’s going on.

Conform

Just as common as the need to ‘stand out’ from the crowd – in fact, probably more common – is the instinct to do exactly what others are doing, to conform. This isn’t necessarily a bad thing under ordinary scenarios.

For an endowment that I help manage, an instinct for conformity can be a very positive thing, because it forces our investment committee to figure out what similarly situated endowments are doing. If we decide to deviate from the crowd, at least we’ll have the chance to think about why we’re doing so.

On the negative side, however, conformity is how we may end up participating in – and suffering from – financial bubbles or financial fads without particularly meaning to. The ‘wisdom’ of the crowd sometimes goes terribly wrong.

Gambling Rush

Let’s face it: Gambling is fun. Winning a financial bet, especially a bet on a stock that moves in a short-term way as predicted, is right up there as one of life’s great adrenaline rushes. I just bought that stock and boom! it jumped 15% in a week! I am a Golden God!

Even losing, as gambling addicts eventually acknowledge, offers a perverse, dark, thrill. Lady Luck, she hates me! Secretly, I know I deserve this shameful loss. (full disclosure: I ate that third Krispy Kreme at 1am when everyone else was asleep). I am a loser, but I rolled the dice and took my chances. I suffered and lost but it feels good to be alive!

Sands Casino Chip

Anyway, I digress, but none of this adrenaline rush from gambling is helpful.

Get Rich Quick

There is no way to get rich quickly from investing.

Wait, let me correct that. There is no reliable way to get rich quickly from investing. There are quite a few unreliable ways.

Anyone can, conceivably, flip a coin and receive heads five times in a row. Heck, that will happen 3.125 percent of the time you flip a coin five times in a row. So, some small amount of people will get rich quickly from an unreliable approach. I wouldn’t recommend any of those ways.

The more you are in a hurry to get rich quickly through investing, the more you will end up flipping tails over heads, right into a financial ditch on the side of the road. (And that, my friends, is the way to mix metaphors. Like a boss.)

Maintain a relationship

This is probably the most hidden yet pervasive reason people make sub-optimal choices with their investments.

“My Dad used to invest with this guy,” or “Everybody at my church follows this person’s advice,” or “I’d feel bad taking my investment account away from my neighbor.”

That’s all fine, as long as you don’t mind paying tens of thousands of dollars – probably more if you have a sizeable portfolio or a long time horizon – to avoid a stressful 5-minute conversation. Hey, that’s cool, it’s your money.

We’ve all done this

Even while criticizing these reasons many people invest, I should point out what I hope is obvious:  I have done all of these things. They are common and natural and I understand. But also, these are all errors. If you’re investing to look smart, to fit in, to satisfy a gambling urge, to get rich quickly, or to avoid straining a personal relationship, over time you’ll probably pay quite a bit for these choices.

So…what is a good reason to invest?

The best I’ve come up with so far is this:

We should invest so that over time (5 years at least), we can grow our money to generate enough passive income to cover our lifestyle costs when we stop working.

That seems simple enough. But in fact there’s a lot of stuff packed into that sentence, having to do with the meaning of words like ‘grow’ and ‘passive income’ and ‘lifestyle costs.’ I’ll unpack those later.

For the moment, however, it’s worth examining which of the above five bad reasons dominate your investing approach, and whether you can afford the many thousands of dollars this will cost you over your lifetime.

 

[1] Forgive me, family members and good friends (you know who you are), for sounding a skeptical note on your stock-picking abilities.

 

A version of this ran in the San Antonio Express News

 

See related post:

How to Invest – I finally give the answers

 

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How To Invest

Keep_it_simple_smartyRather than say, “this is how you should invest,” I prefer to say (and write about) “this is how you should NOT invest.”

I can think of at least three reasons for my preference.

First, I know many more terrible ways to invest than I know good ways.

Second, exotic bad ideas make for more interesting conversation (and reading) than boring good ideas.

Third, by focusing on the negative exhortation, I safely hide behind the critic’s shaming attack of “You didn’t do THAT did you?” rather than the advisor’s defensive apology, “I’m sorry I suggested you do THAT and it didn’t work out. But hey! The theory was solid!”

This is all a lead-in before I poke my head out of my turtle shell to give positive advice about how you should invest, before I quickly return to my more comfortable space of how not to invest.

How to Invest

Are you ready for the most important, boring, good idea on how to invest?

You should invest via dollar-cost averaging in no-load, low-cost, diversified, 100 percent equity index mutual funds, and never sell. Ninety-five percent of you should do that, 95 percent of the time, with 95 percent of your investible assets.

Phew, I said it. That paragraph right there is a trillion dollar financial advisory industry sliced, diced, chopped, shredded, sautéed, and reduced to two sentences, and served on a beautiful platter for you. If you don’t understand all the words, don’t worry, just print them out, bring them to your financial advisor and demand only that. Every time he tries to deviate from that plan, just point back to those two sentences and say, “I want only this.”

You’re welcome.

How Not To Invest

Ok, now let me retreat to my more comfortable critic’s shell and tell you how – given that central piece of advice – you should NOT invest.

  1. You should not invest your money for less than 5 years. When I say ‘invest,’ I don’t mean buy some investment product with a view to selling it the next day, the next month, or even next year. I think five years is kind of the minimum investment horizon I’d endorse. Also, when investing, the best time horizon for selling is ‘never.’
  2. You should not invest in ‘safe’ products, like money markets and bank CDs, annuities and bonds. Since this contradicts most of what the banking and financial industry advocates, perhaps I should clarify this point. Money markets and banks CDs work wonderfully for saving money – to buy a fancy new pantsuit or a personal robot, for example, or some other essential purchase. Unfortunately, saving money offers almost no return on your money, and often a negative real return after taking into account taxes and inflation. Saving money is not the same as investing money. Annuities and bonds offer a wonderful psychological feeling of comfort. But that comfortable feeling is also not the same thing as investing. Parking money – when you can’t afford to lose any principal – is different from investing money. Investing money always involves the possibility of loss. Incidentally, I know your investment account is currently allocated to 60 percent stocks and 40 percent bonds (because everybody’s is.) I’m not your investment advisor, you’re not paying me one way or the other, so I don’t really care, but I’ll just point out that 40 percent of your investment account is poorly allocated.
  1. You should not invest in funds without checking the cost of the fund. Most of us would not dream of buying an ice cream sandwich at the Dollar Store without verifying its price first. I mean, I’ll take it out of the freezer and bring it to the cashier without knowing the price (maybe!) but I’m not too ashamed to ask ‘Hey, by the way, how much is this thing?’ (Although admittedly there are some things I wouldn’t do for a Klondike bar.) Can we have a show of hands from mutual fund investors who know the cost of the funds they bought? In my anecdotal experience, not even one in three investors knows the management fees of their funds. People who have worked in the finance industry usually know enough to ask, but even there I don’t think even one in two bothers to check ahead of time. FYI, it’s costing you a lot more than the price of an ice cream sandwich.
  1. Speaking of upfront payments, there is absolutely no reason to pay upfront fees for a fund, known as the fund’s ‘sales load.’ No reason at all. Do not do this. Oh, you didn’t know how much you’re paying in ‘sales load?’ See rule number 3.
  2. Don’t time the market. If you have investible assets ready to go right now into the market, just put them in the market, and forget what I wrote above about dollar-cost averaging. If, instead, you invest based on your monthly surplus, just set up autopilot investing from your paycheck or bank account and never alter that based on ‘timing’ concerns. There’s never a good time or bad time to be in the market. I mean, obviously there is, but there’s absolutely no reliable way you’ll know it ahead of time.1 Every academic study ever done concludes the same way: Timing is a mug’s game. You can’t win that way.
  3. If you’re not a financial professional, try not to spend too much time, energy, or brain space on this investing task. Simplicity and modesty can actually put you way ahead of the pros trying to do fancy things with their investment portfolios. Most of the exotic products don’t work better than the simple products, but they do tend to cost more, and they tend to go wrong in unexpected ways, at the most inopportune times. Keep it simple, smarty.

 

So that’s about it. If that all doesn’t work out for you, I’m sorry. But hey! The theory was solid.

A version of this appeared in the San Antonio Express News

 

 

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  1. Well, the best time to be in the market is always thirty years ago. But you can’t get there from here unless you start today. ↩

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