Simple Not Easy

I don’t think people always believe me when I tell them that investing is simple. It really is.  It’s just not easy.

The process of buying and maintaining investments doesn’t take much effort or knowledge.   There are great investment products available like index funds and ETFs.   Discount brokers like Vanguard, Fidelity, and Schwab do most of the implementation work for free.   Transaction costs have also been driven down to zero with Schwab’s recent announcement of no-fee trades, which has been echoed by its competitors.  Anyone can put together a portfolio of just a few funds and get results as good as or better than a professional. Just look at the performance history of managed mutual funds and money managers compared to passive index funds in any category over any timeframe.   Simple, low-cost investing consistently beats complex, active investing.

In fact, there are funds-of-funds that offer a diversified and well-balanced portfolio of index funds within just one fund managed for you at no additional charge.   This approach can essentially put your portfolio on auto-pilot.   One good choice can pretty much guarantee long-term investment success.  With this kind of simplicity readily obtainable, why do so many people find investing so difficult? 

I think one reason is that human beings are just not wired to deal with the emotional and psychological aspects of investing. We are prone to all kinds of mind traps that prevent us from dealing with things in a sensible manner.  Behavioral finance experts cite confirmation bias, mental accounting, cognitive dissonance, anchoring and overconfidence as just a few of the many documented behaviors that interfere with rational decision-making.  I can’t help but think this derives from our lizard brains, which see danger lurking everywhere.  How else can you explain the propensity for investors to buy high and sell low when all of the evidence suggests that the opposite would be so much better?  The fight or flight response within our DNA might have served us well when our neighbors were saber tooth tigers, but poses a serious impediment for investors today. 

The mainstream and financial media compound the problem by sensationalizing even the most routine events.   TV anchors breathlessly exclaim “The stock market was in free fall today …” and then later you learn that the Dow Jones stock average dropped only 1.5% for the day.  Really?  A 1.5% decline is a free fall?  Clearly, the media doesn’t view its job as educating the public. Garnering eyeballs and clicks takes precedence over delivering helpful information.

Don’t just look to the financial service industry to provide independent information and advice either. The industry is rife with conflicts of interest.    Sales of products like equity index annuities are the obvious example, but the problem is much more widespread.   Fiduciary advisors also thrive and prosper on misinformation and complexity.   They want you to think that investing is much too complicated for you to undertake on your own.   The message is that you are not smart enough to handle things on your own and should hire them to navigate the confounding maze of investing.  

Traditional education is not helping. K-12 education has never been big on teaching basic life skills.  Kids don’t take home economics or shop classes much anymore, and even fewer learn personal finance in school.   It seems even when investing is taught to kids it usually involves some sort of stock picking contest that teaches the wrong things about investing.  Is it any wonder that many people don’t know the difference between a stock and a bond?    Without basic knowledge, you can’t expect to know the finer points of diversification or asset allocation.

Even if you are able to navigate around these challenges, you must still deal with some practical investing obstacles. There is an overwhelming amount of information to wade through.     There are hundreds of investment companies, but only a few worth considering and thousands of products with only a few worth using.   An online search is unlikely to elicit anything remotely helpful. Most of what you see, hear and read about investing is “noise,” which should be discounted or ignored as either irrelevant or flat out wrong.

Adding to the confusion, people have different types of accounts to coordinate. Employees can have a 401(k), 403(b) or 457 plan with their employer, and some have more than one.  Then there are traditional IRAs, Roth IRAs, annuities and regular brokerage accounts.   Marriage sometimes doubles the number of accounts in a household.  How many people really understand what they own?  Many times, I’ve been well into a conversation with a client, before I realize that the account they have been calling their 401(k) is really an IRA – or vice versa! 

Differences in potential tax consequences muddle things even more. Consider that a traditional IRA is typically comprised of pre-tax dollars and the gains are tax deferred, but eventually taxable as ordinary income. Whereas a Roth IRA is after-tax dollars and the account grows totally tax free.   Non-qualified annuities and non-deductible IRAs are sort of a mixture, containing after-tax dollars but the gains are fully taxable when withdrawn.   While with a regular account the gains might qualify for lower capital gain tax rates.   How do you allocate the portfolio between accounts and later rebalance when each has a different tax treatment?  

You might think that someone with just one account would have an easier time, and they should. But even when the portfolio implementation would otherwise be simple, there are other decisions required.  The most important is how much of the portfolio should be in equity investments for growth, and how much to allocate to more stable income-based investments? That said, it doesn’t end there.   How much of your stock exposure should be in international stocks? How much in small cap stocks versus large companies?   What types of bonds and how much of each?   Most portfolios would have a mixture, which should include treasury bonds, inflation protected bonds and corporate bonds, but there might also be a place for international bonds, high-yield bonds, or municipal bonds.

It’s not like there is universal agreement about how a portfolio should be allocated. There can be major disagreement between advisors regarding the allocation between stocks and bonds.   Experts also disagree on the asset classes to include in a portfolio and/or how much weight to give each.  For example, high yield bonds provide a nice yield and are a good way to diversify the bond side of a portfolio, but some advisors say to take your risk on the equity side of the portfolio and stay clear of riskier bonds.    There is generally no right or wrong when it comes to asset allocation decisions.

Investing can be very simple. In fact, almost anyone can manage their own investments effectively if they want to. The question is do you want to, because investing is not easy and carries risk.  It is difficult enough that you might want to hire an advisor - not to delegate responsibility - but to assist with the process and provide an independent perspective.  A true fiduciary advisor can help establish an investment plan, assist with the asset allocation, rebalance as needed, and provide education and support.   At the very least, a good advisor can help make investing simple. Unfortunately, I don’t know anyone who can make it easy.