Why We Struggle

TODAY MARKS MY 200th article for HumbleDollar. Looking back, one recurring theme stands out: Managing our finances is, in a lot of ways, like managing our health.

Ask any doctor the recipe for good health and you’ll hear the same things: Exercise regularly, eat right, don’t smoke. It isn’t complicated—and yet it isn’t so simple. Environmental factors, genetics and bad luck conspire against us. Result: Even the most disciplined person isn’t guaranteed perfect health.

It’s the same with personal finance. We all know the basic formula: Start early, save consistently, keep costs low. Again, it seems simple. And yet somehow the path to financial success is far from simple. Why is that?

In 1940, a young Wall Street broker named Fred Schwed wrote a book titled Where Are the Customers’ Yachts? It was satire, but it rang true. The premise: The brokerage industry’s lavish fees allow stockbrokers to buy yachts. But because of those fees, clients aren’t able to afford yachts for themselves.

Schwed’s observation is less true today. The cost of investing has come down significantly. And yet personal finance still isn’t easy. Why is that? Fees, it turns out, weren’t the only problem. They definitely were—and continue to be—part of the problem. But I’ve noticed at least nine other obstacles that regularly get in the way of success:

1. Behavioral finance is at least as important as quantitative finance, but it’s harder to teach. In recent years, behavioral finance has received more attention and is better understood. But understanding the problem only gets us partway toward solving it. The challenge is that the behavioral finance literature, excellent as it is, offers very little in the way of solutions. What can you do? Read as much as possible about market history—Charles Kindleberger’s book Manias, Panics, and Crashes, for example. I also recommend the work of University of California at Berkeley professor Terrance Odean, an expert on investor behavior, including the paper he recently co-authored on Robinhood.

2. The financial world is almost infinitely complex. To make sense of the world, however, our minds are programmed to simplify—and often to oversimplify. When it comes to the complex world of investments, that’s a problem. What can you do? In the past, I’ve talked about Robert Shiller’s book Narrative Economics. I’ve also mentioned Chimamanda Ngozi Adichie’s concept of the single story. They’re similar ideas. I recommend reading about both to gain a better understanding of this pitfall.

3. Financial salespeople take advantage of complexity. If anyone has ever tried to sell you a whole life insurance policy, you know what I mean. The industry continues to cook up increasingly complex instruments. These products can be tricky for two reasons: It’s hard to know how a complex investment will behave under different market conditions—and complexity can obscure high fees. What can you do? Keep it simple. If someone tries to sell you a newfangled investment, challenge them to explain how it would be superior to simple investments like stocks, bonds and real estate.

4. The government hasn’t made it any easier. Our tax laws are a thicket, one that’s constantly shifting. What can you do? There’s no way to know what Congress will do next. But there’s still value in proactive planning. If you have an accountant, I recommend sitting down with him or her during the summer, when your accountant is likely less busy. Go over last year’s tax return and ask for his or her observations and recommendations.

5. No one can see around corners—but some pretend they can. Turn on the TV and you’re bound to hear an investment “strategist” talking about the market. What can you do? This one may be the easiest to address. Whenever you’re tempted to listen to an investment prognosticator, just think back to last year, when the coronavirus came out of nowhere, knocking the economy into recession. No one saw that coming. And no one can predict what will come out of left field next. Instead, build a plan that doesn’t rely on short-term market predictions.

6. Stock-picking is even more difficult than it appears. The most surprising finance paper ever to cross my desk was titled “Do Stocks Outperform Treasury Bills?” Authored by Hendrik Bessembinder, a professor at Arizona State University, the paper concluded that just 4% of all stocks accounted for all of the U.S. stock market’s gains over and above Treasury bills over a nine-decade stretch. The other 96%, as a group, have delivered returns no better than humble Treasury bills.

What can you do? In today’s market, where some investors have scored big wins on Tesla and other highfliers, you might feel like you’re missing out. If you’re ever tempted to jump into the fray, though, keep Bessembinder’s research in mind. The odds of beating the market are exceedingly small.

7. Investment markets are the master of the head fake. If markets were either fully rational or fully irrational 100% of the time, life would be easier for investors. The problem is that the market is rational just often enough to fool us into thinking it’s logical. We saw that, for example, when tax rates were cut in 2017. But just when it seems like the market makes sense, it goes completely haywire. We observed that last spring, when stock prices dropped to irrationally low levels. What to do? I always stress the importance of asset allocation. This is the only way, in my opinion, to protect yourself from a market that’s sure to deliver its fair share of curveballs.

8. Risk is a critical concept, but investors don’t even agree on how to define it. Some investors believe standard deviation is the best measure of risk. To support their view, they point to Nobel Prize-winning research. But others, including Warren Buffett, believe standard deviation is worthless. As an individual investor, this can be confusing.

What to do? I’m with Buffett—I think standard deviation is a flawed concept. But in fairness, risk does take many forms, making it elusive. My recommendation: Focus on the most important risk, which is the risk that you suffer a shortfall in meeting your financial goals. Then structure your portfolio accordingly. If you want to learn more, I recommend William Bernstein’s book Deep Risk and Howard Marks’s The Most Important Thing.

9. College tuition has become a wrecking ball. Back in 2017, I related the story of a young college graduate whose life had been hijacked by crushing student loans. In my work with clients, I see this over and over. The cost of college in the U.S. has been rising at double the rate of inflation or more for decades. What can you do? There’s still a positive return on investment for some colleges. But as a consumer, you need to be more careful than ever. If you have school-age children, I recommend Ron Lieber’s new book The Price You Pay for College to help you think more critically about the college question.

Adam M. Grossman is the founder of Mayport, a fixed-fee wealth management firm. Sign up for Adam’s Daily Ideas email, follow him on Twitter @AdamMGrossman and check out his earlier articles.

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