MANAGING MONEY is ridiculously simple—and unbelievably hard.
Figuring out what we should do with our dollars is typically straightforward: We should save regularly, diversify broadly, rebalance occasionally and so on. Instead, the tough part is getting ourselves to do what we intellectually know is right.
Take the notion of buying low and selling high. Every investor knows that’s the goal—and yet, when the S&P 500 slumped 34% earlier this year, many folks just couldn’t bring themselves to buy stocks. For these investors, the knowledge was there, but that knowledge proved no match for the instinctual fear triggered by plunging share prices and the accompanying narratives of doom.
Other examples? Here are nine basic financial strategies that many people struggle with:
1. Save diligently. What could be simpler than spending less than we earn? It’s the fundamental step on which almost all other financial success is built—and yet so many of us find it so very hard to do.
2. Rebalance occasionally. This is just a disciplined version of the buy low-sell high strategy, and many investors find it equally tough. It seems like madness to lighten up on what’s currently faring well and purchase more of what’s struggling. Yet this simple strategy keeps our portfolio’s risk level under control, while also potentially bolstering long-run results.
3. Diversify broadly. If we build well-diversified portfolios, we should always own a piece of whatever’s faring well, while inevitably ending up with some investments that currently appear to be duds.
But what will the future bring? That we don’t know—but that doesn’t stop us from extrapolating the recent past into the future, leaving us dissatisfied with our diversified portfolio and the investments that have lately fared poorly. For some, owning out-of-favor investments proves too emotionally uncomfortable and they end up ditching their laggards, often just before the market cycle turns.
4. Ignore the crowd. How many times have we been told that, to be successful investors, we need to stand apart from the mob and think independently? Whether it’s buying low, rebalancing or diversifying, we have to buck current market sentiment.
But this can be profoundly difficult. We take great comfort in doing what others are doing. If that means buying total market exchange-traded index funds (ETFs), there’s a good chance that things will turn out fine. If it means buying leveraged ETFs, not so much.
5. Focus on risk. If we gradually invest a lump sum in stocks, we take less risk, because we avoid the danger of buying all at once, only to see the market plunge.
But what about selling stocks gradually? Many folks also do that—and yet that’s the higher-risk strategy. We end up with more money in stocks for longer, thus increasing the risk we’ll get caught up in a market downdraft. So why do we sell stocks slowly? Consciously or not, it seems our overriding concern isn’t losing money, but rather pangs of regret—which we’d suffer if we made a big stock sale and the market immediately skyrocketed.
6. Take tax losses. In a regular, taxable account, the most tax-efficient strategy is to hang on to winners, so we don’t realize the capital gain, while selling losers, so we have realized losses that we can use to trim our annual tax bill. To be sure, this can potentially result in a lopsided portfolio, with too much invested in a few big winners. But most folks can keep their overall investment mix in balance by making offsetting tweaks to their retirement account holdings.
Yet many investors ignore this advice, preferring to sell their winners and keep their losers. Why? They feel a rush of pride as they turn their winners into cash. Meanwhile, they hate selling their losers, because that means admitting they were wrong, with all the associated pangs of regret.
7. Keep it simple. Both logic and the evidence make it abundantly clear that, if we buy and hold low-cost total market index funds, we’ll enjoy far better long-run results than the collective performance of folks who own actively managed funds, day-trade stocks, time the market, invest in hedge funds or pursue any of the other countless strategies considered clever.
True, some day traders and hedge fund investors will notch superior returns, so those with a fondness for lottery tickets may find themselves drawn to these long-shot strategies. But I don’t believe that fully explains the appeal of such strategies. Instead, it seems investors are drawn to complicated strategies because of their complexity. They like the sense they’re doing something “special” and they wrongly assume such “sophistication” is the key to better returns.
8. Be patient. Sometimes, we ought to act—such as fixing a badly diversified portfolio or rebalancing after big market moves. Most of the time, however, investing should be a patient buy-and-hold endeavor, as we sit quietly with our portfolios for decades and wait for the markets to reward us.
But for many investors, such patience is in short supply. During bull markets, we tend to trade too much, getting a thrill from all the buying and selling. In bear markets, we’re often consumed by a sense of crisis, and taking action can be far more emotionally comforting than simply sitting tight.
This sort of impetuousness spills over into how we spend. Indeed, I see a parallel between short-term trading and impulse shopping. Both deliver immediate gratification, but that gratification often later turns to regret.
9. Change when the facts demand it. As I noted in an earlier article, the financial world has changed substantially over the past three-plus decades, but often we’re far slower to change our thinking. Economists talk about the sunk cost fallacy—that, once we’ve put money into an endeavor, we’re reluctant to declare it a loss and walk away. But it isn’t just the money involved. We also become emotionally invested.
Examples? We assume active managers will save us from danger in a way index funds won’t, even though there’s no evidence active funds provide better bear market protection. We persist in favoring larger mortgages, despite the fact that the mortgage-tax deduction has all but disappeared. We continue to view bonds as a way to generate income, even though yields are now miserably low. We persist in worrying that stock market valuations will revert to their historical averages, despite the fact that valuations have been far above average for much of the past three decades. Still clinging to these ideas? Maybe it’s time to let them go.