Why You Should Love Investing

April 13, 2017

When a lot of people think of financial planning, they think of investing…with dread. It sounds complicated, time consuming, and risky. But for me, investing is actually my favorite part of financial planning. Let me tell you why…

In most areas of life, we generally get what we put in, whether that’s in terms of the price we pay or the amount of time and hard work we expend. In other words, you get what you pay for. However, investing is the one area of life where you get rewarded for being both cheap and lazy.

Let’s start with the first step, which is diversification. As you’ve probably heard, you don’t want to put all your eggs in one basket, but you still have to decide how many of your “eggs” or money to put in each “basket” or asset class: stocks, bonds, cash, and real assets. What makes this confusing is that there’s a ton of conflicting views on this so investment expert Meb Faber decided to compare 9 of the top recommended asset allocation strategies by various other investment experts and see how they performed since the 1970s. What he found is that the difference between the best and the worst performing strategy was only 1.6% and if you removed the worst performing portfolio (which is an outlier since it only has 25% in stocks), the difference was only 1%. When he compared the models of the major financial institutions, he found that the difference was only about half a percent.

However, just because they ended up in similar places doesn’t mean that they performed similarly from year to year. Each of the models had many years in which they outperformed and many in which they under-performed. If you chose a model based on which was the top performing over the previous decade, you would actually have done much worse. Whether you use a one-stop shop asset allocation fund, a robo-advisor, one of the model portfolios listed in one of Faber’s blog posts above, or a financial advisor’s recommendation, which portfolio you pick is less important than that you pick one (to make sure you’re reasonably diversified) and stick with it through thick and thin. (Everyone, even Warren Buffett, has periods of under-performance.)

There’s one other way you can sabotage your returns: costs. It’s been estimated that the average mutual fund costs .9% a year in expenses and 1.44% a year in transaction costs. (This doesn’t even include any loads or commissions you may pay to purchase the fund.) That 2.34% would be enough to turn the best performing strategy into the worst.

It’s not like you’re getting anything for those costs either. In fact, a recent Morningstar study called low fund fees “the most proven predictor of future fund returns.” Warren Buffett has said the same thing. So as you choose which funds to use in your portfolio, look for ones with low fees (called the expense ratio) and low turnover (which leads to lower transaction costs). If index funds are available, they tend to have the lowest costs and hence tend to outperform more expensive actively managed funds over long periods of time.

The moral of the story is that investment success boils down to three simple rules:

Be diversified. Pick a reasonably diversified portfolio. Don’t be a greedy pig (bet on individual stocks) or a fearful chicken (keep all your money in bonds and cash). After all, both pigs and chickens get slaughtered.
Be cheap. Use low cost funds to implement your asset allocation strategy. In this case, you get what you don’t pay for.
Be lazy. Once you have your portfolio, stick with it. Don’t try to time the market or otherwise, mess with it other than to rebalance it periodically back to the original allocation or to switch to lower cost funds as they become available.

Think about it. Where else are you most rewarded for being both cheap and lazy? Now do you love investing? If so, the first step is to save so you have something to invest, but that’s another story…