Inspired by an article written by Tom Bradley here, Tom highlighted what academics and investing gurus have witnessed for years: investor returns remain far worse than the products they invest in.
Why the heck is that?
There remains a ‘Behavior Gap’ investors simply struggle to overcome. This is because investors are irrational and flawed human beings, and we’re all guilty of it to some degree.
I’ve learned to change my investing behaviour over time and largely stay with the same plan I developed seven years ago. This plan is simple to understand and straightforward but simple doesn’t always mean easy.
After reading Tom’s article I decided to respond to some of the points he encouraged readers figure out. Here are my responses.
- Have a plan
My approach to investing has been listed below on this site for many years and has not changed.
Dividend Investing. I invest in many Canadian and U.S. dividend paying stocks that provide income. We intend to live off some of that income within 10 years – the income will pay for the majority of our living expenses. (It can already pay for our property taxes and all utility bills for the rest of our life).
Index Investing. I invest in low-cost, diversified index Exchange Traded Funds (ETFs) for diversification. We believe indexing is great for long-term growth.
We believe this hybrid approach to investing will help us, as Tom puts it, navigate the multi-decade investing road trip.
- Develop a routine
Tom wrote “most aspects of your life have a pattern…investing should be no different.” My friend Preet Banerjee likes to say that investing is 90% psychology and 8% math. He says the missing 2% in this equation is to justify the relative unimportance of the math.
Our routine is – we don’t really care what the markets are doing. We save and invest money every month. When we invest we invest in financial products that keep our money management fees very low. It’s a simple routine: save, invest and re-invest.
- Stop overpaying
Are we paying for commissions and fees for advice we are not receiving? No. I am My Own Advisor.
Do we own funds that charge large active money management fees? Heck no. The most expensive fund I own costs me less than 20 basis points. Including our transaction costs to purchase our stocks and ETFs a few times per year, the cost of running our portfolio is less than $400 per year. Compare that to $100,000 invested in bank mutual fund that charges 2% MER (management expense ratio) and that fee jumps to $2,000 per year for every year you own that fund.
Don’t want to DIY invest like I do? No problem. Consider this low-cost robo-advisor here.
- Be prepared for jolts and extremes
Just being honest.
I know the market goes up then down then up again. The challenge is never giving into this cycle below (image courtesy of Behavior Gap):
I haven’t perfected investing but I’m continually maturing my investing brain.
- Avoid the cash drag
Not a problem here Tom. I can appreciate when investors are worried, they hold more cash. However, I’ve learned lots of money in cash, although comforting, is a long-term loser to inflation. We absolutely believe in an emergency fund and we keep that fund around here. However, beyond this amount (since we are in our asset accumulation years) we believe in investing money when we have it. The sooner we can put our money to work, the better; for dividend income and for capital appreciation.
Bad investing behaviour is like any other bad habit – you need to kick the cycle. We’ve come a decent ways over the years but there’s always more work to do. I’m not a perfect investor at all – far from it. But I have learned from my mistakes and we’re becoming wealthier for it. I hope the same for you.
Let me know in a comment what investing behaviour you want to overcome. Thanks for reading.
Cannew, diversifying into the US market is certainly a step in the right direction, but you could reduce your risk and increase the probability of an optimal outcome if you were to diversify further into international developed and emerging markets, particularly now with favourable valuations in these markets. This is what Mark does using ETFs.
Here’s a comment from a Financial Advisor, or at least he writes about investing: “In any SMART portfolio, there are different layers that make up a strong, well-structured growth opportunity. At the bottom, you have your core holdings; they’re not the most exciting stocks, but they’re consistent and predictable. At the top, you have the “high-flying” stocks, which provide far more volatility (both positive and negative).”
If I read it correctly he suggests that a Smart Investor will diversify across the border, investing in both good and risky stocks, in order to obtain growth. Personally, I prefer to avoid the riskier stocks all together. That’s the Casino mentality, hoping to hit the big jackpot.
I read that this morning too. I prefer to just have the good companies myself and that one is one I have in three of the seven portfolios. It’s a keeper as far as I’m concerned.
Well, like you, I prefer to avoid the riskier stocks. Unless the company has paid a dividend for many years, preferably a few generations, I don’t own it.
Otherwise I index invest but I know what you think of that. That said you probably like the holdings in HDV:
Say you hold $100k of HDV, that’s $80 in fees per year. Not bad actually.
Mark:”Say you hold $100k of HDV, that’s $80 in fees per year.” Fee is 0.08% or $800 on $100k.
1% of $100k is $1,000 so 0.08% of $100k can’t be $800. I know how you feel about ETFs – no problem – you’ve been VERY successful with your approach. That’s the key – what works for you in the end!
The 0.08% is just 0.02% from 1%, so yes it’s $800.
No, that’s not what I’m saying though.
If you have a MER (fee) of 1%. That means for every $100k the cost to you is $1,000.
If the fee was 10%. The cost to you is $10,000.
If the fee was 50%, one half of $100k, that’s $50,000 in fees (one-half of $100,000).
MERs for some products are 0.08% so not even 1/10th of 1%.
Personal opinion: Don’t worry about Asset Allocation, Full Diversification and Re-balancing. Invest in the best, hold the best and add to the best when they are value priced (or dollar cost with smaller amounts).
Nice comments Mark.
Full diversification is likely important for most investors – but folks like yourself have a proven strategy that work – so you understand the risks. Still trying to add money when I can, not easy, too many temptations to spend on vacations and other things!
Cannew, I think that is a risky strategy. The more concentrated portfolio you have the wider dispersion of returns you can expect, with a lower probability of an optimal outcome. In other words, you are taking on increased risk without an increased expected return. Just because a risky strategy has done well in the past does not mean it will do well in the future. Thinking that way is confusing strategy with outcome.
Grant:”you are taking on increased risk without an increased expected return.”
There is risk with any strategy, but I’ve found success by sticking with a select group of Large, Stable companies, ones with a long history of paying and increasing their dividend, and avoiding high yielding, and cyclical stocks the risk has been minimal, while returns and especially the growing income great. I get confirmation the strategy is still working each month, as the companies continue to pay and increase their dividend.
Cannew, certainly I’m not arguing that your strategy has not been successful, but considering that Canada is only about 3% of the world market cap, it would be safer to diversify beyond a segment our small market as the future is unknowable.
Grant: Last year by owning US stocks one did extremely well. Our goal is to have our income grow every year over the prior year by at least double inflation. We’ve exceeded that goal yearly by quite a margin, even during 2007/2008, and the income more than exceeds our expenses. Could we do better with a more diversified portfolio, maybe or maybe not, but our restricted portfolio is working fine and continues to do so even owing just 18 Cdn holdings.
Thankyou for curbing my fears of asset allocation, full diversification and rebalancing. I”m a lazy investor, I admit it. But I INVEST!
I invest in the best, hold the best, add to the best (not always when they are value priced) and kind of just eye ball the rest.
If it wasn’t for your blogs (all of you) and your comments (all of them) I would be lost ………and that I give you all thanks!
Continued success on your journey Bonnie.