“Avoid the unforced error, nail the basics and don’t take outsized risks” might be the best advice the individual investor can follow. An often-underestimated influence on equity and bond markets is the heavy hand of luck. Frankly, you can do everything “right” and still get bad results. And since luck can’t be controlled, knowing how to react – whether that luck initially appears to be good or bad – can separate winners from losers. But just because something can’t be controlled doesn’t mean it can’t be managed.
We all know bad things happen that are beyond our control to foresee or influence. Fires, floods and financial crisis come to mind. So we buy insurance, avoiding home purchases in areas prone to flooding and create investment portfolios that are well diversified with a healthy dose of cash savings. But what else?
One of the best thinkers on this subject, and a terrific writer to boot, is Michael Mauboussin. The man knows how to think about how we think – especially as it relates to investing. I read his terrific 2012 book, The Success Equation, when it first came out. Subsequently the opportunity to hear him talk about his book in person helped to clarify some of his more nuanced arguments and observations.
One of the many surprises that will be found in The Success Equation is an important reason why individual investors should look to exchange-traded funds as their best bet to achieving financial goals when using the stock markets. Discussed in many recent posts here at Invest-Notes, by choosing to invest in indexed funds smaller investors earn the market averages over time with much less risk or cost than owning individual stocks or traditional mutual funds. Remember, for as long as equity markets have been measured, they have gone up more often than they go down.
As noted a couple of weeks ago in The Economist, 70% of U.S. stock markets are now owned by large institutions like Blackrock, Vanguard, Fidelity, pension funds and hedge funds. That percentage was just 35% in the 1980’s. This means the self-described investment professionals are competing against each other more fiercely than ever before. As Mauboussin intriguingly suggests, the more skill involved in a competition the bigger the impact of luck on the outcome. For the individual investor, luck is a bad strategy.
Put another way, you don’t have to compete against the younger incarnations of Arnold Palmer or Muhammed Ali to succeed in building wealth over time. You don’t have to go at risk trying to pick up a couple of extra points against the pros, and face the risk of being seriously hurt – also known as suffering a permanent impairment of capital.
By systematically analyzing the outcomes of investment strategies – repeatedly and over time – we can create mental models that help anticipate the unexpected (to minimize risk) while expanding opportunities (to maximize upside). You can easily improve your overall return just by minimizing costs like fees and commissions (nail the basics). You can stay calm and remain inactive during times of great stress (avoid unforced errors). You do not have to go head-to-head with the pros (no outsized risks).
As Rudyard Kipling noted a century ago, just ”…keep your head when all about you are losing theirs…”
NOTE: Apologies for the long absence from this page, but a quick look at Jazz-Notes (link in menu bar at the top of this page) will explain where I’ve been. Hope you get a chance to check out my weekly radio show, Straight Ahead, on KRTU 91.7 FM. Live on Saturday at 8:00 am central, or on-line anytime at http://stream.krtu.org/krtu-128kb/1-Sat0800.mp3