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Don’t Bet the Bank

Adam M. Grossman

LAST WEEK, I TALKED about Carveth Read, the English philosopher who’s famous for saying, “It is better to be vaguely right than exactly wrong.” This, in my view, is one of the most important ideas in personal finance.

My focus last week was on the “vaguely right” part of Read’s statement. But what about the second part—the importance of not being “exactly wrong”? Below are seven situations in which trying to be exactly right might, counterintuitively, carry more risk than aiming to be roughly right.

1. How to structure a portfolio. Consult market data, and you’ll find that the best-performing stocks over the long term have been value stocks. In the words of finance professor Bruce Greenwald, these are the stocks of companies that are “ugly, disappointing, boring or obscure.” They’re the opposite of the market’s most popular and well-known stocks—Apple, Amazon and so forth.

But counterintuitively, value stocks, as a group, have easily outpaced their better-known peers. According to data from Dimensional Fund Advisors, value outperformed growth by more than four percentage points per year, on average, between 1927 and 2021. Strictly according to the numbers, you’d allocate your entire portfolio to value stocks. But that’s not what I recommend, for two reasons.

First, as the standard investment disclaimer states, past performance does not guarantee future results. The future won’t necessarily look like the past. Also, when looking at historical data, there’s the possibility that the patterns we observe are just artifacts in the data. If that’s the case, and thus those patterns have no fundamental basis, there’d be no reason to expect them to repeat. For both of these reasons, I wouldn’t go too far out on a limb with value stocks—or with any other specific category of investment—to avoid the risk of being exactly wrong.

2. Whether to pick individual stocks. Years ago, I worked as an equity analyst—a stock picker. My colleagues and I would collect a mountain of data, and then sit and analyze companies for days or weeks before deciding whether to purchase a stock. The problem, though, was that there was always information that simply couldn’t be known. An unexpected product recall or a government inquiry could easily put a dent in a company’s share price.

The lesson I learned: When picking stocks, you can get the math exactly right and still be wrong. That’s why index funds, which are diversified across hundreds or even thousands of stocks, strike me as the better bet for most investors.

3. Whether to invest in private funds. The late David Swensen, who oversaw Yale University’s endowment, earned outsized returns investing across the universe of private funds—venture capital, hedge funds and private equity. Because of that, private funds have developed a certain reputation: They came to be seen as the exclusive vehicles that high net worth families use to build wealth.

But here’s the problem: Because they aren’t regulated as tightly as publicly available funds, there’s much more room for malfeasance. And because they’re opaque and tend to pursue unusual strategies, there’s more room for incompetence and organizational failure. In the past, I’ve highlighted some high-profile cases in which private funds turned sour. But those are just the cases that made the news. I have also seen investors lose seven-figure sums in private funds on more than one occasion. The bottom line: Even if a private fund has an impressive track record, I’d steer clear. It’s much easier to be roughly right with a simple investment like an S&P 500-index fund.

4. When to invest in the market. Robert Shiller, a professor at Yale University, is the father of the cyclically adjusted price-earnings ratio, or CAPE, a well-regarded metric for valuing the stock market. He has also, over the years, made more than one accurate market prediction. That made it notable when, in the middle of the post-2020 market frenzy, Shiller wrote in The New York Times, “The stock market is already quite expensive. But it is also true that stock prices are fairly reasonable right now.”

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In explaining this apparent contradiction, Shiller pointed out that there are many ways to assess the stock market. Through one quantitative lens, it might appear overvalued, but through another, it might not. The lesson: If even the creator of the CAPE ratio acknowledges that market valuation is subjective, it’s a reminder to all investors to take a long-term view. Even at times when the market looks unusually expensive or unusually cheap, there’s still no way to know what’s coming next. That makes short-term trading treacherous. But if you set your sights on the long-term, you’ll have a high likelihood of being roughly right and avoiding a penalty for being exactly wrong.

5. How to structure a retirement plan. Suppose you’re age 65. Consult a life expectancy table, and it’ll indicate a life expectancy of about 83. But here’s the curious thing: According to this same data set, the life expectancy of a 70-year-old is 85. And at 80, the average life expectancy extends to 88. In other words, the longer we live, the longer we can expect to live. This is a reminder that, when building a retirement plan, we need to be careful with statistics.

Life expectancies also differ across other demographic variables, including zip codes and education level. Because of that, in building retirement plans, I like to stretch the numbers out to age 100. Most people don’t live that long. But here again, it’s better to be roughly right than risk being exactly wrong.

6. What to think of the 4% rule. A frequent debate centers around safe withdrawal rates: Given a certain portfolio, how much can a retiree safely withdraw each year to ensure a portfolio will last? Some adhere to the so-called 4% rule, while others argue 4% is irresponsibly high. Meanwhile, the creator of the 4% rule, among others, believes that retirees can withdraw more than 4%.

The reality is, such models rest on a large number of assumptions. Just a year ago, many argued that 4% was much too high because bonds offered yields that were so meager. Today, of course, yields are much higher. This should serve as a reminder that, in building a retirement plan, we shouldn’t blindly assume that today’s conditions will prevail indefinitely. Instead, to avoid being exactly wrong, consider a range of assumptions in building a plan.

7. Whether to annuitize. If you have a retirement plan that offers you a choice between a lump-sum payment or an annuity—that is, equal monthly payments for life—you may be tempted to take the lump sum. A majority of workers do, and there are reasons to go that route. Indeed, if you do the math, you might calculate that you’d do better investing the lump sum on your own rather than relying on your employer’s pension fund manager. But as noted above, life expectancy is a key unknown, and guaranteed lifetime annuity payments can be an underappreciated benefit. This is one financial topic where it’s crucial to avoid being exactly wrong.

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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johny
johny
15 days ago

..

Last edited 15 days ago by johny
Ormode
Ormode
16 days ago

I find stock picking OK if you are willing to analyze and buy about 40 different securities, putting no more than 3% of your assets in each one. This is equivalent to a broad-based fund or EFT, but it’s companies you picked so you know they’re good…..right?

William Perry
William Perry
16 days ago

I would add to your point 3. Whether to invest in private funds an additional comment that private funds usually means receiving a K-1 tax form annually. Even if you get a current year preliminary estimate of the pass through entity taxable income items the investor should expect having to extend their personal return every year and greater tax complexity and record keeping requirements. K-1’s from typical closely held corporations & LLC’s have meaningful tax impacts and are worth the tax headaches. If no meaningful tax benefit and not an entity that you control I would avoid investments where you receive a K-1.

Andrew Forsythe
Andrew Forsythe
16 days ago
Reply to  William Perry

Excellent point. Having helped a family member with a bunch of oil & gas MLP K-1s a while back, I decided that they were just too big of a headache. Her tax return was extremely complex, with the tax preparer fees to prove it.

M Plate
M Plate
16 days ago

I look forward to reading you on Sunday mornings. I was excited that to see annuitization covered, I thought you’d show me the light. But you only summarized the issues one has to consider. Of course, you couldn’t do the impossible. With the unknown variables, there isn’t a right answer.

Martymac
Martymac
17 days ago

As always good stuff.

Michael l Berard
Michael l Berard
17 days ago

Great article Mr. Grossman, as usual. I no longer fret over having exactly the percentages recommended in various financial classes, as long as I have both foreign and domestic stock, investment grade bonds, etc ( no more or less than 75% in either stock or bonds, though, as per Ben Graham) . and some cash for shorter time frames. So, I might not have perfect diversification, but, I should be fine.

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