This is not financial advice
10 personal finance reminders for myself
Every once in awhile I get a request from a friend or family member for financial advice.
"Is now a good time to buy the market?" they want to know. "Do you think I should buy Apple? What about Amazon?" they ask. "Should I put money into emerging markets?" they wonder.
I guess it makes sense that they ask me. I have worked in finance for over twenty years. I have an MBA in finance. I passed the most ridiculously hard financial exams on the planet (after, ahem... failing them multiple times and then writing a book about it). So... yeah, okay. I can see why they're asking me.
But they never like my answers. The problem is that I know too much. And once you learn what I've learned, you don't dole out "hot" stock tips or tell people that "now" is the time to buy or sell. Because, as I'll discuss below, that’s a fool's game.
I'm not totally immune to it. I still get caught up in the fear and greed sometimes. "I have to buy some Bitcoin" I might think, not wanting to miss out on the “next big thing.” Or, "I have to sell stocks because everyone knows that the market will tank if (name your candidate) wins this election."
But when I do get caught up in it, it is exactly then that I lose money. Like clockwork.
And I have to step back and remind myself what I've learned.
So here are ten things that I’d like to remind my future self of when it comes to finances:
Everyone is guessing — I have bad news. All of those experts you see on CNBC? You know the ones who use fancy finance terms and are extraordinarily confident? Yeah, them. They have no idea what they are talking about. Not a clue. Every single person on CNBC or Bloomberg or Fox Business is completely guessing. No one knows if a stock is going up or down. Or what the market will do over any given period of time. No one. Some people are more eloquent and convincing in the explanation of their guesses. But that is all they are. Guesses. Every single one. "But they said they have a price target of $100 for that stock!" you might say. Yes, do you know what a price target is? It's a guess, based on a discounted cash flow (DCF) model. And do you know what that is? It's a spreadsheet where “experts” can put in a bunch of other guesses for inputs so that it spits out a price target of their choosing. Notice when Apple gets to $100 all of the Wall Street analysts now say their price targets are $120 when they were $90 the week before? How do they do that? By changing some already completely arbitrary guesstimates in their DCF models. Seriously, there is no science here. Everyone is guessing. I know we desperately want to follow experts. But they don't exist. Sorry.
Markets don't make sense — Guess what happens every day in markets? They move in crazy directions and no one has any idea why. The financial TV networks try to create a narrative as to why, of course. Because, my god, it would be madness if we didn't know why stocks and bonds were moving in the directions they were, right? But, again, sorry. Everyone is completely guessing. Those TV networks will look at the day’s headlines and then try to explain the market’s movements based off of them. The market might be up 0.2% and the headline will read: Market rallies on COVID vaccine optimism. Then 30 minutes later, the market will be down 0.4% and the headline is now: Market falls on election worries. Guess what? They have no idea why the market is moving up or down. What they do have is a blank screen that needs to be filled with words and BREAKING NEWS alerts, so they fill it, even if they have no idea what’s happening. Of course, such narratives are woefully incomplete representations of what is actually happening each day to the thousands of companies that comprise stock and bond indexes. But we need a narrative! We won't be comfortable unless we can wrap our arms around what is happening! Why did the market go down? I need to know. "Sure," says CNBC "it's because of the weak jobs report. That tide you over?" When Trump won the 2016 election, everyone was convinced that markets would crater. So what did they do? Rallied to new highs. A global pandemic breaks out, a world-wide recession. So obviously markets... go up? Seriously, don't make the mistake of thinking there is some rational narrative to latch on to here. There are way too many factors impacting way too many companies to draw neat conclusions on why the market is moving up or down.
Timing is nearly impossible — Given #1 and #2, this one might be obvious, but just to make it explicit, you really can't time markets. So it's a really bad idea to even try. Is now a good time to buy the market? I have no idea. I can tell you a really good story about how, yes, now is EXACTLY the time to buy. I would impress you with my eloquently worded rationale. I would mention P/E ratios and EV/EBITDA valuations. I would talk about the point of the economic cycle we were in, and explain to you how both the fundamentals and technicals were highly supportive of markets right now. I would even tell you in great detail why the market should go up exactly 20% from here in the next three months. Of course, I could also tell you the complete opposite story in equally impressive language. And guess what (see #1), I'd be guessing. No single investor on the planet has every consistently timed markets well. Not one. Not even Warren Buffett. You think he day trades? Do you think if you asked him if Apple will go up this week, month or even year he would have an answer? Of course not. And he is widely celebrated as the single best investor of all time. He thinks in decades and you should, too. (You meaning me, because, remember, this is an article written to myself).
Focus on the long term — The only, and I mean the only, way to consistently make money in stock and bond markets is by focusing on the long term. I've already told you how markets don't make sense and how timing is impossible. The only thing we can say with some level of certainty is that markets tend to move higher over long periods of time. Like decades. So that's what we should be thinking about for our investment horizons. And risk-taking can and should change as you get older. There's a traditional idea that a portfolio should be about 60% stocks / 40% bonds. And that's great if you're, say, a middle-aged person with average characteristics for income needs, job security, etc., etc. But in reality, no one’s situation perfectly aligns with this average theoretical person’s scenario. How much risk you should take depends on your own situation. The most obvious characteristic to look at is your age. If you are twenty-five years old with a 40+ year investment horizon, there's no reason you can't put 100% of your investment portfolio into stocks. But if you're sixty-five and about to retire, you should be closer to that conservative end (all other things equal). That means a greater percentage of lower risk/lower return investments. You still want some "risky" exposure (aka stocks) because you may live to 100 and don't want to run out of money, so you need to own something that grows over time, but you also probably can't afford to take a huge loss if you’re living off of this portfolio. In order to avoid unnecessary stress about this, you need to...
Stop looking at your portfolio — I watch markets all day long. I write about stocks and bonds for a living. For a living! I am highly attuned to what is happening day-to-day in capital markets. Guess how many times per year I look at my personal portfolio? Maybe four. Why would I? So I could get mad when markets are down when I've lost money? Or overconfident when markets are up when I've made money? Daily, weekly, and even yearly movements in my own personal portfolio are irrelevant to me. I am in my early 40's. I do not plan to touch any of the money I have invested for at least another twenty-five years. Guess how much is going to happen in twenty-five years? A lot. Guess how much it matters if the market goes down even 20% in a single year? Not much. How about the movement of the market in a single day? Completely meaningless. It will not even be a rounding error in the long run. Hey, if CNBC or Bloomberg TV is your hobby and you like keeping track of the latest trends, good for you. But if it's causing you anxiety in the way that cable news can on the political front, what's the point? You don’t need to look at it.
Get help — I’ve already patted myself on the back for all of my own investment credentials, so I must just manage my own money, right? Nope. I have a financial advisor. Why? A few reasons, really. One is to save me from myself. As I mentioned, I’m not immune to the human tendencies toward fear and greed so having another adult in the room (sometimes to talk me out of bad ideas) is a helpful check. The other reason is that I’m not an expert in personal finance. Specifically, I’m not an expert in tax efficiency—or the art of not paying more taxes than we need to. Look, I pay my fair share but having a skilled financial advisor who can advise me on why I need a Roth IRA vs. a traditional IRA (or vice versa) or why I should sell this position now for tax purposes is massively helpful. Investment returns are always uncertain but taxes are something that we can be proactively smart about, and thoughtful tax planning compounded over decades can make a drastic difference in the ultimate size of your nest egg.
Keep it simple and cheap — There’s an allure to complicated financial instruments. We may not totally understand options, but we know our friend made a killing selling calls or buying puts. We hear about the fortunes being minted in venture capital and private equity or by investing in hedge funds. And we think we might have an edge when it comes to forecasting which way commodity or precious metal prices might move. Listen, all of these asset classes have their pros and cons. They can, in fact, be lucrative investments if managed wisely by sophisticated investors. But they can also be expensive (in the form of fees), complicated, and not necessarily better-returning than “plain vanilla” equity index funds. Despite all of these wonderful financial innovations and asset classes, the one thing that we actually control when it comes to our ultimate returns is the fees we pay. We can guess on the returns of hedge funds or venture capital. We *think* they might be greater than stocks or bonds, but we *know* they will be more expensive in the form of higher fees. Again, everyone is different and many of these asset classes have a place in a portfolio, especially the more sophisticated the investor. But you would not do yourself a disservice—or I believe—be too far from your optimal returns, if you focused on keeping costs low. This likely means keeping it simple. Finding a financial advisor who doesn’t charge you an arm and a leg. And focusing your portfolio mostly on low-cost or no-cost ETFs (exchange-traded funds). Again, this is different for sophisticated investors where paying an additional fee for access to unique asset classes or actively managed investment talent makes sense, but for the vast majority of people out there, just keeping the costs low will do you wonders over time.
Diversify — You've probably heard it before but diversification is critically important when it comes to investing. It is so hard to predict which companies, sectors, or asset classes might do well over time, so the best way to combat that is to diversify your portfolio and avoid being too heavily concentrated in any one area. You may love gold or oil or Peloton's stock but do you love any of them so much that if you're wrong you're okay with losing your nest egg? When you diversify your bets, sure you're not going to make as much money as you would if you had one or two concentrated bets that you were right on. But, you're also not going to lose nearly as much money if you're wrong. Plus, having a diversified portfolio, especially one where not all assets are correlated, can help you weather tough years. If the US stock market gets hit, maybe emerging markets will hold up. If stocks have a bad year, an allocation to bonds may help soften the blow. We also need to be careful of having too much exposure to any single stock. Often, people who work for publicly traded companies will earn stock as a part of their compensation. That's great, but it's easy to let that become a disproportionately large part of one's portfolio. Look at it this way, your job security is already tied to the success of that company, do you want your financial portfolio to be as well? That's risky. I saw this first-hand when I worked at Lehman Brothers for the first eight years of my career. All of the managing directors were loaded to the gills with Lehman stock. I remember being on the trading desk in August 2008 and watching them buy more. "It was like yesterday that the stock was at $150," they said. "It has to be a screaming buy here at $20." Spoiler alert. It wasn't. It had exactly 100% downside from $20. And as the company went bankrupt, many of my older colleagues lost fortunes they had grown for 20, 30 or 40 years. All because they failed to diversify. Don't make that mistake.
Only speculate with money you can afford to lose — At a basic level, we need to save more than we spend. Easier said than done, I know from experience. Did I mention I have three kids? If we can figure out a way to save more than we spend, and have a stash for a rainy day, well then, we should be able to start investing. And when I say the word "investing" I mean, by default, long-term investing. That means planning to not touch the money for a significant period of time—decades would be an appropriate thought here. They say that compounding is the 8th wonder of the world. Someday, I'll write a piece on how the human mind can't grasp the concept of exponential growth. But in the meantime, just know that if you let your investments grow over many years, you not only benefit from the original investment growing—but also from the growth of what you’ve earned on that investment. Sort of a second derivative effect. (Confused yet? I kind of am). It's like magic if you have patience. However, human nature (fear and greed) sometimes won't let us be so patient. And this is where the temptation to speculate comes in. We just HAVE to buy some of the "hot" stock our friend says is amazing. If that is the case, it's fine, but you should know that that is true speculation. That is like going to Vegas and getting on the roulette table type speculation. Again, it's fine to do. But you have to do it in moderation. And, most importantly, only with money you can afford to lose. No one likes losing money, but if you lose that money, will you not be able to pay rent? Or will you have to pull your kid out of school? Or would you need to skip that vacation? In that case, you can't afford to speculate, so don't.
Don't day-trade — Remember how I said there were no real experts? How everyone is guessing? Well, that's true. But, remember, there are thousands of people making their living analyzing stocks and bonds, and while they may be guessing, their guesses are probably more educated than yours. Day-trading stocks is basically the same thing as showing up at the World Series of Poker, giving the other (professional) poker players a chance to view some of their cards in advance, and then trying to beat them. Good luck. You may think you have an edge. "Well, my buddy says Apple is going to sell 50 million iPhones this quarter so the stock will surely go up." Yeah, but the dozens of Wall Street analysts who cover this stock are talking directly to Apple's investor relations team; they're talking to all the companies that sell Apple parts that go into the iPhone, and they may even be looking at satellite images of factories in China to understand exactly how many iPhones are currently being shipped. Oh, and by the way, they understand what "expectations" are, because they're also all talking to each other and to the largest investors in the world on a daily basis. You may be right that Apple sells 50 million iPhones, but if "consensus" expectations were that they'd sell 75 million, that stock is going to get crushed. And you'll have no idea what just happened. Again, if this is your hobby, fine. But just go into it eyes wide open. If you decide to day-trade, your working assumption should be that you will shortly be losing 100% of the money you are speculating with. Just like Vegas, you may have a good time doing it, but don't expect to come home with any winnings. Markets tend to be quite efficient at separating day-traders from their money.
You got all that, future self? Maybe a little conservative, but hey, that's how I see it.
Photo credit: Fabian Blank @ Unsplash.com
Disclaimer: The above commentary is representative of the author’s personal views alone and no one else. It is not meant to be taken as financial advice. I mean, didn’t you see the title?