Your Money

You Are a Terrible Investor and You Should Stop That

Brett Arends has a spot-on column about the Mom and Pop investor, and how they keep screwing up their investments:

The problem with Villa and White isn’t that they are unusual but that they are absolutely the typical American investor. Both of them are doctors, meaning they are presumably intelligent and educated. And yet they insist on investing like absolute fools.

First, their minds have been playing tricks on them all along. The crash of 2008 did not wipe out half their savings, unless they invested all their money right at the peak and sold right at the bottom. The reality is that it wiped out a lot of illusory gains and replaced them with a lot of illusory losses. Stock prices were wrong in 2007 because they were too high, and they were wrong in late 2008 and early 2009 because they were too low.

Second, as they now know, they sold out somewhere near the lows. They were not alone. According to the Investment Company Institute, the trade body of the mutual fund industry, U.S. investors flooded the market with stocks in the fall of 2008 and the winter of 2009. From September, 2008 through March, 2009, ordinary U.S. investors dumped $114 billion worth of stock funds. They sold at absolutely the worst time.

This is not a coincidence. The stock market is “us.” Share prices fall because there are more sellers than buyers. They rise because of the reverse. So mom and pop investors like the Villa-Whites rush to dump their stocks because they see the market plummeting, oblivious to the fact that the only reason it’s falling is because people like them are rushing to dump their stocks.

This is all too true. And yet, there is an easy way to avoid this, if you follow three simple rules:

1) Save at least 15% of your income

2) Put the money in index mutual funds

3) Leave it there until you retire.

This is proven, with the power of economic science, to be the best way to retire comfortably. And yet, so few of you do this. When I suggest that you should save more, many of you write me emails implying that this advice is only slightly less ridiculous than suggesting that you move to Cuba and become a tuba player in Xavier Cugat's band.

Then, because you haven't saved enough, you become very anxious about your investments. You can't just sit back and get what the S&P is returning, because that's not nearly enough to retire on! You need to actively manage your funds for higher yield.

Unfortunately, almost none of you are the kind of stock pickers who can do better than the S&P, year in and year out. (Don't feel bad: neither are the professionals. On average, after you account for management fees, actively managed mutual funds do somewhat deliver somewhat lower returns than you could get by just throwing darts at a list of stocks.)

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In fact, as Arends points out, many of you are doing even worse than that, because you buy high and sell low. Markets are herd phenomena, and you should never forget that you are part of the herd. When everyone is stampeding into a stock, that's the worst time to buy, because it means that the price is probably too high. But that's when you're going to want to buy, because--momentum! Plus it feels safer when all of your neighbors are doing it.

This is how hunter gatherers used to be able to drive 10,000 wildebeests over a cliff without any of them stopping and saying, "Hey, guys, this seems like a bad idea. Let's stop and have a think about this."

All of which is a way of saying: you can't beat the market. So stop trying. You need to replace a large portion of your income in retirement, and that will be achieved by saving a large portion of your income now, not trying to become a professional stock picker in the spare moments between getting the kids into bed, and the start of Game of Thrones. If you save a bunch of money, you don't need to worry about reaching for risky returns. You can rest assured that no matter what you do, you're covered.

Oh, I know what you're going to say: 15% is a lot of money! Wildly impractical for an average family! Impossible! And if your little family of 4 is living on $35,000 a year, I'm sympathetic.

But most of my readers aren't. You guys have enough money to save, which I can scientifically prove because your grandparents almost certainly lived on a small fraction of what you now do. And don't tell me things were cheaper, back in the good old days: in almost all cases their houses were smaller, less well heated, and entirely un-air-conditioned; their entertainment budgets were much leaner; their groceries heavier on the cheap and utilitarian and lighter on the tasty and expensive. They literally had about a quarter as many clothes as the ones bursting out of your closet. Their health care was cheaper because it sucked and they died quicker.

You have enough money to save and still live a rich, satisfying life. What you maybe don't have is enough money to save while enjoying what you have come to think of as the minimal standard of living for your peer group.

But playing the market, as so many mom-and-pop investors do, will not solve that problem. It's far more likely to make it worse.