Ben Carlson, CFA, has spent his career managing institutional portfolios for endowments, foundations, pension plans and individual investors. In his recent book, Mr. Carlson tells us how to become better investors. These are excerpts which I call "Investment Gems":
Thank you Mr. Carlson!There is an assumption that complex systems such as financial markets must require complex investment strategies and organizations to succeed. This is a false premise.
Past performance has absolutely no bearing on future performance.
Simplicity is the new sophistication.
Much of the financial advice out there might as well be written in Latin because it come across as another language to most investors.
Less is always more when making investment decisions.
Complexity tends to be the default option that gets used to persuade investors to buy unnecessary investment products.
We all like to think that the more choices must be better, but as the number of choices grows, so, too, do the number of decisions and the likelihood of making a mistake.
You first have to give up on the dream of superior performance and realize only a small fraction of investors ever actually get there--and most don't stay on top either.
The problem for average investors is that when they aim for superior results, it more often than not leads to below-average performance.
It's amazing how easy it is to do worse by trying to do better.
"Intelligent investing is not complex, though that is far from saying is is easy." -- Warren Buffett
Fifty years ago, the little guy controlled the stock market, as individuals made up more than 90% of trading volume on the N.Y. Stock Exchange. Today, these roles are reversed, as institutions handle more than 95% of all trades in listed stocks.
You get what you pay for is an expensive theory, but one that all too many investors still believe in.
Deviations from benchmark returns represent an important source of portfolio risk.
Trying harder is probably one of the easiest ways to achieve below average performance.
"If you can get good at destroying your own wrong ideas, that is a great gift." -- Charlie Munger
An investor without a plan is no investor at all--he is a speculator.
Learning how to lose money is actually much more important than learning how to make money in the markets because losing is inevitable.
One of the easiest ways to give yourself a margin of safety is to practice diversification.
Emotions are the enemy of good investment decisions. -- Fear, greed, euphoria, panic, speculation, envy--these are the killers of your portfolio.
You find models that work, ways to make money, and then they blow sky-high. There's always somebody around who looks smart.
Without a firm grasp of history, investors are doomed to repeat past mistakes.
The harder you try to become the world's best investor, the easier it is to become one of the worst.
"It is difficult for people to see the beauty in simplicity when everyone else is in search of complexity." -- Charlie Munger (Warren Buffett's right-hand man)
Sometimes it takes a very intelligent person to see and experience complexity before coming to the realization that simplicity works better.
If there is an ironclad rule in the world of investing, it's that risk and reward are always and forever attached at the hip. You can't expect to earn outsize gains if you don't expose yourself to the possibility of outsized losses.
My firsts boss in the industry told me stocks are what you invest in to get rich and bonds are what you invest in to stay rich.
If you need to spend the money within five years or less, think long and hard about putting that money to work in the stock market.
The list of distractions investors are forced to deal with is also a mile long--the hottest markets, the best performing stocks, continuous economic data releases, new fund roll-outs, pundit predictions, your brother-in-law bragging about his penny stocks, and so on.
The 1929 to 1932 crash saw stocks fall in excess of 80%; the 1987 Black Monday crash saw stocks fall over 20% in a single day; the technology bubble and bust saw the NASDAQ fall over 80% from the peak in 2000, and the great financial crisis of 2007 to 2009 cut nearly every stock market in the world in half or worse. -- You can't simulate the fear and anguish that grips your body and mind during a crash like this. -- You're never going to be able to buy at the exact bottom of the market and it will always feel like things could continue to get worse.
Investors get scared and sell once they've experienced losses. "I'm in for the long haul" quickly becomes "Get me out I can't take it anymore." -- Without a plan, volatility and uncertainty will eat you alive.
"Investment wisdom begins with the realization that long-term returns are the only ones that matter." -- William Bernstein
Over the past 90 years or so, the U.S. stock market is up nearly 10% per year (stay-the-course). It includes many manias and panics, including the Great Depression, a recession roughly every five years, World War II, the tech bubble and nearly one hundred 10% corrections.
The true diversification benefit of owning both stocks and bonds comes during the down years.
From 1929 to 1950, boring old 5-year Treasury bonds outperformed the S&P 500. From 1968 to 1980 it happened yet again.
There can be painful market cycles that will eventually cause investors to question every long-standing belief they hold to be true.
From 1991 to 2014, a diversified index of commodities only slightly outpaced the return of cash (Treasury bills) but with much higher risk.
Think of housing as more of an asset that forces you to build equity over time than an investment that is likely to compound your savings.
The long-term average market performance is made up of many periods that are anything but average. Plan on experiencing uneven results, frustrating periods, volatility, and the occasional crash.
"Proper (investment) temperament will beat high IQ all day." -- Michael Mauboussin
Bernie Madoff's Ponzi scheme, the largest in history at almost $65 billion in fake gains promised to clients, finally unraveled after years of lies and deception. -- One of the biggest issues with the Madoff case is the fact that we instinctively trust someone in a position of authority.
There is no such thing as a perfect portfolio, a fool-proof system, a best-in-class asset allocation, just the right amount of risk to take, or the best time to buy and sell. Investment strategies are only perfect in a sales pitch.
The classic three-fund portfolio from Vanguard consist of some combination of the Total U.S Stock Market Index Fund, the Total International Stock Market Index Fund and the Total U.S. Bond Market index Fund. -- Rick Ferri and Alex Benke performed a study that spanned 16 years by looking at Vanguard's three-fund portfolio. -- The index fund portfolio beat the active fund portfolio almost 83% of the time. Index funds outperformed on a risk-adjusted basis as well.
A team of researchers at Dow Jones looked at nearly 2,900 active mutual funds (ending March 2010). Two measly funds were able to stay in the top 25% of performers over five straight years.
An index fund is nothing special. It's systematic, disciplined, rebalanced occasionally, transparent, low-turnover, low-cost, and low-maintenance. It's one of the reasons they're so hard to beat by even brilliant fund managers. The cost of owning the entire market is basically free.
One of the reasons that so many investors fail is because it's easy to assume that doing something, anything, is the right move in all environments. -- The more often you trade the higher the probability of incurring worse results from a combination of increased costs and poor market timing decisions.
Less is more and doing nothing can be exemplary behavior, assuming it's part of your plan. -- The products that sound the best are often the worst ones to invest in.
There are thousands upon thousands of PhDs, MBAs, and CFAs looking to eat your lunch in the markets on a daily basis. The financial industry is in the business of selling complexity. The longer it takes someone to explain their investing approach, the worse off it tends to be.
Almost 7,000 mutual funds were created from 2003 to 2013 while almost 6,200 were merged or shut down completely. That's not a very favorable track record.
Over the past decade, 91% of Vanguard funds, both active and indexed, were able to beat their peer group averages. -- Only invest in in active strategies or factor tilts if you are prepared to do worse for the possibility of doing better. -- The worst thing you can do for a good plan is strive for a perfect one.
"If there is anything in the whole world of mutual funds that you can take to the bank, it's that expense ratios help you make a better decision. The cheapest quintile of funds produced higher total returns than the most expensive quintile of funds over every time period in every single asset class." -- Morningstar
Researchers looked at the performance of 243 of the nation's largest pension plans. 90 percent of them failed to beat a simple 60/40 portfolio made up of an S&P 500 index fund and the Lehman Brothers Aggregate Bond Index.
"Instead of concentrating on the central issue of creating sensible long-term asset-allocation targets, investors too frequently focus on the unproductive diversions of security selection and market timing." -- David Swensen
If your goal is to create a perfect portfolio you have basically already lost because you're only setting yourself up for disappointment. Sticking to a disciplined process when others are losing their mind about the market is far more important than putting together the precise mix of asset classes or stocks.
The markets are constantly tempting you to make unnecessary moves in your portfolio.
If you carry an all-stock portfolio over a period of time measured in decades you can be sure that there will be at least one market crash that cuts your portfolio in half. It's something every investor should plan on over his or her lifetime.
Unless you have the ability to pick and choose when it makes sense to invest in the United States and when it makes sense to invest overseas, diversifying between the two is the prudent move.
U.S. investors spend down their portfolio in dollars, so an over-weighting to U.S. stocks for retirees could be warranted.
Just as asset allocation is worthless without diversification, diversification is worthless without rebalancing. While rebalancing can provide a nice boost to performance, the biggest benefit of rebalancing comes from controlling risk, not enhancing returns.
Asset allocation will never garner headlines, but it is by far the most important portfolio decision you will make.
It is far more important that you're able to stick with the allocation that you choose as opposed to picking the most optimized version according to the text books.
Investors have a nasty habit of extrapolating the recent past indefinitely out into the future.
Young investors should pray for a huge market crash early in their career. It will allow them to buy stocks at much lower prices and thus increase future returns. Retired investors should pray for the opposite.
The options for those nearing retirement without enough savings are less than ideal--work longer, save more money, lower your standard of living, or a combination of the three.
Earning average returns actually means you're an above-average investor when compared to other market participants. Beating your peers is much easier than beating the S&P 500.
Always remember to look at your situation from an overall portfolio level. The only way to make informed decisions is by aggregating all retirement funds, college savings accounts, and savings vehicles in one place. This allows you to determine how liquid you are, what your net worth is, what your overall performance numbers are, how diversified your portfolio is, and what your true asset allocation mix looks like.
The only benchmark that matters is achieving your personal goals, not beating the market.
Doctors, lawyers, and plumbers all require more certification and training than someone needs to become a financial advisor. -- A good advisor should be able to do many things for you, but guaranteed market performance is not one of them.
Financial professionals make their money through commissions, so they are incentivized to churn your portfolio and sell you more and more products. That's not the type of advice that works for the client's interests.
Everyone wants to outperform the market over every single time frame, both short term and long term. There's a name for this strategy--it's called impossible.
Cut away the fat from your portfolio and process. Start by minimizing the numbers of funds or holdings that make up your portfolio.
Saving money will always trump the best investment strategy. Automating the saving process is one of the best ways to build a nest egg over time, since the decision is taken out of your hands.
Never have more money in stocks than you can stand to lose. It will only lead to poor decisions at the wrong time.
Interestingly enough, the spending choice that has the biggest effect on a person's happiness is how much money they spend on others. Study after study shows that the more people invest in others, the happier they are.
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