I am a huge fan of wonderful musical artists performing live, and I have been blessed to have seen many great ones. My first big concert was Jethro Tull in 1973 and I have tickets for Casting Crowns Sunday evening. The best was probably the Simon & Garfunkel reunion concert in New York City’s Central Park, exactly 38 years ago, on September 19, 1981.
I’ve seen Paul McCartney do a setlist of 36 Beatles songs. The Eagles. Linda Ronstadt. Frank Sinatra. Bonnie Raitt. Stephen Stills. Queen. The Doobie Brothers. Pentatonix. Jackson Browne. Sheryl Crowe. The Four Tops. John Fogarty. Frankie Valli. Rhiannon Giddens. Billy Joel. The Guess Who. Mary Chapin Carpenter. The Spinners. Sugarland. Maynard Ferguson. Manhattan Transfer. Needtobreathe. Journey. The Temptations. Alison Kraus. Chuck Mangione. Stan Kenton. Take Six. The Righteous Brothers. Barry Manilow. Switchfoot. Judy Collins. Chicago. Elton John. Ray Charles. Fleetwood Mac.*
The one constant among all these great events is that the artists played their hits. I’ve seen James Taylor a bunch of times – the first time was Nashville in August 1982, the most recent Las Vegas in May 2019. No matter what album he was promoting at the time, he always played Carolina in My Mind, Sweet Baby James, You’ve Got a Friend, and Fire and Rain.
The exception that proves the rule is the ever-enigmatic Bob Dylan. One of times I saw him he played three Sinatra covers and an Yves Montand (!) cover but no Like a Rolling Stone, A Hard Rain’s A-Gonna Fall, All Along the Watchtower, or Mr. Tambourine Man. Go figure. Some fans get really (and understandably) angry if their favorites aren’t played in concert.
In the worlds of investing and personal finance, it’s easy to focus on the controversial, the difficult, and the arcane. But we should take great care to keep showing fealty to our greatest hits – the tried and true principles that we can and should all agree on and return to routinely. Today, I’m going to circle back to the greatest hits of personal finance — a crisp thirteen-song set — and play them (at least) one more time.
Have a plan. As the great artist, Pablo Picasso, explained, “Our goals can only be reached through a vehicle of a plan, in which we must fervently believe, and upon which we must vigorously act. There is no other route to success.” Yet only 28 percent of Americans have a written financial plan, according to Schwab’s 2019 Modern Wealth Survey even though, according to careful research by David Blanchett published in the Journal of Financial Planning, “Households working with a financial planner were found to be making the best overall financial decisions.” Everyone should have a good financial plan.
Invest in yourself. Education is society’s great leveler. Apple CEO Tim Cook is correct that you don’t need a college degree to be successful, but it helps. A lot. The more you learn the more you earn. Median earnings for those with the highest levels of educational attainment are more than triple those with the lowest level. The employment rate is 86 percent for young adults with a bachelor’s or higher degree and only 59 percent for those who had not completed high school. Indeed, college graduates earn more than non-college graduates in every state in the U.S. In California, where I live, the difference in median earnings between college graduates and non-graduates is an enormous 133 percent. On average, by choosing not to go to college, Americans are essentially forfeiting $17,500 per year and millions of dollars over a lifetime.
Source: The College Payoff (Georgetown University)
Pay yourself first and invest in yourself.
Save (more). Saving enough can overcome a multitude of investment mistakes. It’s another way to pay yourself first. As my friend Wade Pfau succinctly points out in his seminal paper on this subject “[t]he focus of retirement planning should be on the savings rate rather than the withdrawal rate.” Put another way, “someone saving at her ‘safe savings rate’ will likely be able to finance her intended [retirement] expenditures regardless of her actual wealth accumulation and withdrawal rate.” In fact, the single biggest indicator of retirement outcomes is the savings rate.
Invest. Very generally and historically speaking, stocks have returned about 9.5 percent per year, bonds about 5 percent per year, and cash about 3.5 percent per year. That sounds like a big difference, and it is, but the actual difference is even bigger than it seems due to the power of compounding. If, in 1928, you have invested $100 each is cash (three-month U.S. Treasury bills), bonds (ten-year U.S. Treasury notes), and stocks (S&P 500), through 2018, your cash account would have returned $2,063.40, your bond account $7,308.65, and your stock account a whopping $382,850.00. If you are not invested in stocks, or are underinvested in stocks, you should expect to earn a lot less money.
Looked at another way, suppose Tom invests $3,000 per year in an IRA for 11 years beginning at age 24 (in other words, he quits at age 35 and makes no further deposits), assuming 10 percent annual returns, his $33,000 investment will provide him with $1,173,789 for retirement at age 65. On the other hand, if his twin brother Jerry starts investing $3,000 per year in an IRA when Tom quit at age 35, and continues for 31 years, assuming the same 10 percent annual returns, his $93,000 investment will provide him with $600,413 for retirement at age 65. That’s still a handsome sum, but far, far less (despite far more invested) than his twin who started earlier.
Unless you are already independently wealthy, if you want to reach your financial goals, you need to invest, and you need to invest in stocks. And if you haven’t (yet), remember: The best time to plant a tree was 30 years ago. The second-best time is now.
Debt is dangerous. Compound interest is your best friend when you’re investing or saving for a long-term goal, but it’s your worst enemy if you have debt. That’s why debt is so dangerous and can so readily escalate out of control. Moreover, every dollar you use to service debt is a dollar you can’t invest to get compounding working in your favor. Debt is very dangerous business.
Manage your risks. Every investor worries about risk. We generally want to avoid it (in the sense of losing money) but we’re also ticked off when a risk-averse strategy underperforms. What we’re really talking about is risk capacity, which (as I have noted before) is largely a joining of risk appetite and risk tolerance. Unfortunately, the theoretical and the practical are often disconnected at precisely this point.
Risk appetite is about the pursuit of risk (in the probabilistic sense rather than in the sense of losing money). If I am at or near retirement and have saved what I need for it, my risk appetite should be small. If I am 25 and likely have a long investment life ahead of me, it should be far, far larger. Every investor should regularly and routinely ask what success will look like and then go about figuring out how best to get there. That process will necessarily include a careful analysis of risk appetite (or need). It begins with the neglected art/science of estimating expected returns for prospective portfolios.
Risk Tolerance relates to the degree of uncertainty that an investor can handle with respect to a negative change in the value of his or her portfolio. Sadly, it seems as though our risk tolerance is highest when things are going best and lowest when things are at their worst. “I don’t need liquidity (until I do).” Ascertaining risk capacity requires an analysis and a merger of appetite and tolerance. It is a function of capability (how much – as objectively as possible – you can carry) and maturity (your ability to cope with it). This maturity relates to emotions (will you panic and sell at the wrong time?) but also to control (how do you deal with uncertain outcomes?). Your must carefully manage your risks.
You can’t predict the future. The list of horrible market calls by alleged experts is an exceedingly long one. Such failures are absolutely normal. The median “expert” forecast of annual S&P 500 returns is only rarely remotely close to the actual result, and that is almost surely accidental. More than half the time since 2000 the miss has been either too high or too low by an amount bigger than the S&P’s average annual gain. Similarly, U.S. Treasury yields have been expected to rise every year for the past decade, according to forecasts collected by Consensus Economics, yet they have gone down more often than not. Even when yields went up, the moves were close to the predicted levels only once, back in 2009. These are really smart, experienced people who analyze the markets pretty much all day, every day. And they missed by a mile. In fact, the best of them missed by a mile.
If you think you can predict the future in the markets, think again. Your crystal ball does not work any better than anyone else’s. Even when we recognize the fallacy of thinking in terms of single, linear causes (Fed policy, market valuations, etc.), the markets are still too complex and too adaptive to be readily predicted. There are simply too many variables to predict market behavior with any degree of detail, consistency, or competence. Pretty much the only forecast that is almost certain to be correct is that market forecasts will be wrong (and if they are right, it’s probably because of luck rather than skill). Accordingly, you should create a financial plan that is not dependent upon any specific forecast being accurate. You can’t predict the future.
As simple as possible. It is axiomatic that simple theories and statements can be beautiful. They are also easier to understand, remember, test, and follow. As Sir Isaac Newton said, “truth is ever to be found in simplicity, and not in the multiplicity and confusion of things.” In statistics, the Akaike Information Criterion postulates that a model’s ability to predict new data can be estimated by seeing how well it fits old data and by seeing how simple it is. Keep your investment approach and plan as simple as possible (if no simpler).
Financial success is a long-term project. In philosophy, presentism is the idea only the present exists. More loosely, it refers to a narrow focus on the conditions of the moment. Philosophy aside, anyone with even a bit of experience in the financial world will recognize presentism as an apt description of an affliction with which most humans suffer. We do not learn adequately from our past mistakes. We do not plan sufficiently for the future. Instead, we remain excessively fixated on the present and its incessant demands and distractions. Our focus, dangerous though it is, is understandable because, as Nobel laureate Daniel Kahneman has explained, “the long-term is not where life is lived.”
Because of a vicious circle involving tribalism, herding, excessive certainty, overconfidence, self-serving bias, our ideological nature, our propensity for confirming what we already believe as well as our general inability to see that which disconfirms it, and social proof, exacerbated by increasingly incessant noise (literal and figurative), this presentism is exceedingly hard to escape. In our lives and world, the relentless now may not be all that matters, but it matters far more than it should. If we are going to succeed, we’re going to have to do better at thinking longer-term.
Diversify. The theory supporting diversification is simple: Don’t put all of your eggs in one basket. A single holding has huge potential for gains if the right instrument is selected, but even bigger risks (because investing “home runs” are so hard to come by). In general, the greater a portfolio’s diversification is, the lower its risk. Lower risk is a good thing, but only if the portfolio’s potential return is healthy enough to meet the client’s needs. Fortunately, a well-diversified portfolio captures most of the potential upside available with much lower volatility, thus providing higher risk-adjusted returns.
A diverse portfolio ensures that at least some of a portfolio’s investments will be invested in the market’s stronger sectors at any given time – regardless of what’s hot and what’s not and irrespective of the economic climate. At the same time, a diverse portfolio will never be fully invested in the year’s losers. For example, according to Morningstar Direct, about 25 percent of U.S. listed stocks lost at least 75 percent of their value in 2008 but only four of over 6,600 open-ended mutual funds lost more than 75 percent of their value that year. Thus, a diversified approach provides smoother returns over time (even if not as smooth as desired!). As my friend Brian Portnoy quips, diversification means always having to say you’re sorry.
Reduce friction. Not making errors matters more — demonstrably more — than being right when a combination of luck and skill determines success. As Charley Ellis famously established, investing is a loser’s game most of the time, with outcomes dominated by luck rather than skill and high transaction costs. If we avoid mistakes we will generally win. Accordingly, reducing or eliminating various frictions (costs, trading, tax inefficiencies, even watching financial news) increases your chances of success markedly.
Don’t go it alone. American virologist David Baltimore, who won the Nobel Prize for Medicine in 1975 for his work on the genetic mechanisms of viruses, once told me that over the years (and especially while he was president of CalTech) he had received many manuscripts claiming to have solved some great scientific problem or to have overthrown the existing scientific paradigm to provide some grand theory of everything. Most prominent scientists have drawers full of similar submissions, almost always from people who work alone and outside of the scientific community. Unfortunately, these offerings didn’t do anything remotely close to what was claimed, and Dr. Baltimore offered some fascinating insight into why he thinks that’s so. At its best, he noted, good science is a collaborative, community effort. On the other hand, “crackpots work alone.” We all work better with help, advice, support, correction, criticism, and accountability. A good financial advisor not only can provide a good financial plan with excellent investment choices. He or she can also provide needed guidance for perhaps the hardest work to be done in finance: providing accountability by managing expectations, behavior, and our inevitable mistakes. Beware trying to go it alone in the investment world.
Invest in others. Tony Bennett won the NCAA basketball championship this year at the University of Virginia. When offered a substantial raise and a contract extension, Bennett took the extension but declined the raise. Instead, he asked that the money be invested in his staff and other school programs. Coach Bennett and his wife also pledged $500,000 toward a career-development program that’s been launched for current and former UVA men’s basketball players. “I have more than I need,” said Bennett. “I’m blessed beyond what I deserve.” Investing in others, the way Coach Bennett does, may not lead to greater financial wealth, but it will lead to greater personal wealth. In the midst of your success, don’t neglect investing in others.
Investing successfully over the long haul is really, really hard. There is certainly no certainty. There is no technocratic Nirvana, no quant-generated (or otherwise generated) safe harbor. Historical interrelationships between valuation and price, various correlations, and ongoing market cycles are neither consistent nor uniform. Good ideas work for a while. Great ideas persist but bumpily and uncertainly. Our best strategies, approaches, and ideas work…but only until they don’t anymore.
Great interpretations of difficult data sets, especially those involving human behavior, require more sculpting than tracing. Portfolio optimization is a wonderful scientific ideal. But portfolio optimization alone pays insufficient attention to the needs, desires, and vagaries of the investor who owns it. Your mileage can and will vary. Keep your attention focused squarely on specific needs, goals and what you can actually expect to control about your portfolio and its results.
As AQR founder Cliff Asness stated succinctly, “The great strategy that you can’t stick with is obviously vastly inferior to the very good strategy you can stick with.” If we can’t cope with our human failings and shortcomings, we can’t and won’t get very far. That’s why these “greatest hits” are so important and so universal and why we should keep playing them. Over and over again.
* The opening episode of The Americans, the best television show ever, featured an amazing segment using Fleetwood Mac’s Tusk. It was an eight-minute remix that ran throughout the pilot’s jaw-dropping opening espionage sequence. An amazing sequence in season three used The Chain.