Nick Foy, CFP®
As a 13-year old, my 7th grade science teacher use to get (understandably) pretty upset with me. Mr. Morris was easily in his 60’s, with well-groomed grey hair, and polos that typically fit too tightly around his bulging biceps.
He also taught 7th grade PE, and would frequently find the need to recite this phrase to me, for one reason or another. He’d look me straight in the eye, as I sat in the back row of science class, or as I did something other than what was required of me on the field during PE:
“Nick, don’t do dumb stuff.”
He must’ve said that to me one hundred times during my 7th grade year, maybe more.
It was short, succinct, and to the point. Nothing else needed to be said. He’d typically reserve the phrase for times when I was, in fact, doing dumb stuff. It got my attention, and now I find myself using that phrase with some regularity with my six-year old son.
It wasn’t until a few years back that I realized that, had Mr. Morris decided to do something other than make a career out of corralling middle school students, he could’ve made a great financial advisor.
Much of my time is spent attempting to prevent my clients from doing dumb stuff, either with their portfolios or their cash flow. The trouble is, unlike science and PE, there is no formal instruction in personal finance for students, from kindergarten through the end of graduate school. So, knowing what stuff is dumb can be difficult work.
Avoiding the Dumb Stuff
When it comes to investing, we’ve got a pretty good idea about how to define the dumb stuff by now. Decades of research have given us an insight into what traps to avoid, and what types of strategies are worth pursuing.
Originally published in February 1998, Charles Ellis’s classic Winning the Loser’s Game equates wise investing to amatuer tennis. As Ellis wrote way back in 1975, citing a study by statestician Simon Ramo:
If you choose to win at tennis–as opposed to having a good time–the strategy for winning is to avoid mistakes. The way to avoid mistakes is to be conservative and keep the ball in play, letting the other fellow have plenty of room in which to blunder his way to defeat, because he, being an amateur (and probably not having read Ramo’s book) will play a losing game and not know it.
For investors, keeping the ball in play means focusing on a few key principles:
It’s an overused and often misunderstood word, but diversifying our investments across the world is a useful endeavor. Luckily, thanks to the advent of passive portfolio management, it’s now cheap and easy too. A well-diversified portfolio has assets that aren’t all zigging and zagging in the same direction, in the same amount, at the same time.
It’s what John Bogle calls the Relentless Rules of Humble Arithmetic. His message is simple: “Gross return in the financial markets, minus the costs of financial intermediation, equals the net return actually delivered to investors.”
If you spend more money on a car, you’ll (hopefully) get a nicer car. If you spend more money on investing, you’ll probably receive less in return. Study after study has given us an understanding of the inverse relationship between costs and expected return. Portfolio cost is the first thing we look at when determining whether or not an investment is appropriate.
It’s really easy to pay $0 in taxes: earn $0. While this isn’t ideal for most, taxes can be limited simply by focusing on the location of the assets you hold. Tax-efficient assets in taxable accounts, tax-inefficient investments in tax-advantaged accounts.
Few individual investors get this. Tragically, few advisors do either. But, asset location is a powerful tool to increase the after-tax return of a portfolio without adding any additional risk.
In my experience, investors don’t focus enough on liquidity. Once you’ve maxed out your retirement contributions for the year, make sure your additional investments are made into liquid assets. Especially if you don’t need additional income, there’s no need to hold a low-growth, tax-laden, high-cost asset like a residential real estate rental. One house is likely enough, and your assets are probably better off invested in a liquid, growth oriented, diversified portfolio.
In a future post, I’ll focus on what dumb stuff to avoid with your cash flow and mindset, which serves as a complement to proper portfolio investment methodology.