Requirement 2: An understanding of your portfolio.
The vast majority of investors have little to no understanding of what they own in their portfolio, and even fewer have an understanding about why they own what they own. When you don’t know how or why you’re invested the way you are, the result is a murky, nervous, disposition towards investing. The only thing we know how to measure is the percentage marks, and any downward movement is going to be super stressful.
So an understanding of your portfolio, how and why it’s constructed as it is, could alleviate some of the stress. Unfortunately, it could also magnify the stress if you find out the portfolio is an actively managed, non-diversified disaster.
Stress-free investing involves an understanding of your own portfolio, but also an understanding of how a portfolio should look.
- An actively managed portfolio cannot reduce stress. When the bad years come, and they will come, you will necessarily feel stressed that either your money manager or yourself is not living up to the task. Not only will the bad years cause stress, but they’ll also be more frequent because actively managed portfolios routinely underperform the market over time.
- A non-diversified portfolio will cause stress because of the large increase in volatility and the possibility of random outcomes (especially if you only own a few different stocks, or worse, options). I mentioned in part 1 that over long periods of time (10+ years) the market is always up, but it’s important to remember that individual sectors of the market (like the S&P 500) could have droughts even longer than that. From 2000 to 2009 the S&P 500 averaged about -1% per year, for 10 years! And individual stocks can do a lot worse.
These two components, passive management and global diversification, work wonders to reduce the stress of investing. We understand the market has its ups and downs, but we can rest assured that the passive, globally diversified portfolio will trend up and perform best over time. Don’t be afraid to look under the hood of your portfolio.
Yes! But there are some requirements:
Requirement 1: an understanding of the market.
Stress-free investing involves an understanding of the market. Not an understanding of what the market will do in the next 10 minutes, or next 10 days, or next 10 months, that would require psychic abilities which is unfortunately unrealistic, but a real understanding of how the market works and what you can and should expect from the market.
Two main points here:
- The market is unpredictable. Prices already reflect all of the knowable information, the market moves based on future information. Since no one knows the future no one knows how the market will move in the future, despite what some financial professionals may have you believe. The misnomer that you or the professional you’re working with must have some insight into the future movements of the market is the cause of a lot of stress by itself. Thankfully, stress-free investing doesn’t require clairvoyance.
- The market is volatile but it trends upward. The volatility makes the market feel dangerous. People generally believe that they could lose most or all of their money in a market downturn (talk about stressful!). But the truth is that markets trend upwards, and over long periods of time (10+ years) the market is always up, despite whatever crashes it may have endured (including the Great Depression and the 2008 housing crash). If you’re invested well (which we’ll get to in part 2), you don’t have to worry about the market destroying your savings! You just have to ride out the dips and enjoy the long-term, upward trend. The market is only dangerous if you try to bet and predict it, it becomes your friend when you focus on owning it.
REITs (Real Estate Investment Trust) are a hot topic in 2019. Real estate is popular, it’s tangible, it’s easy to understand the profits and costs involved, and many of us already own some ourselves. REITs offer the allure of owning income-producing real estate without ever having to take a call from a grumpy tenant or running over to fix a leaky toilet in the middle of the night. It’s real estate investing without all the hassle! Well, that’s not exactly true, here a few reasons to look elsewhere for investing returns:
- A REIT is not like investing in real estate the way most of us think about real estate investing (owning rental properties). Traditional real estate investing is a great way to make money, but it’s not passive. Ask anyone who owns rental properties and they’ll tell you it’s a job, maybe a part-time job, maybe a worthwhile job, but a job none-the-less. It takes work and time and good business sense. A REIT is like a mutual fund that only owns income-producing real estate (at least 75% of the income within a REIT must come from rental income or something similar), which sounds similar to traditional investing, but a REIT is completely passive. The expected earnings on the two types of investments are very different because they’re very different types of investments.
- Investing in REITs is redundant. If you’re invested in the stock market you already own real estate. In fact, you already own the same exact companies and properties that are also in the REIT you’re thinking about purchasing. You could theoretically double down on real estate, own it both in your investment account and in a REIT, but why would you do that? There are three essential market factors that drive returns: stocks (which outperform bonds over time), small companies (which outperform large companies over time), and value companies (which outperform growth companies over time); real estate doesn’t make the cut. There’s no additional benefit to increasing your exposure to real estate, no additional returns, no additional diversification benefits, nothing. You could buy into a REIT if you have a hunch that real estate as a market sector is going to do well in the next few years but that would be market timing, a proven great way to lose money.
REITs sometimes sound exciting, especially when they’re doing well, but keep the big-picture perspective. No one knows when REITs will do well or for how long, we just know that over time they won’t beat a well-diversified portfolio, which already owns a lot of real estate anyways.
Goals are important. But everyone has goals, including people who never achieve them. The great thing about goals is that they can be whatever you want them to be, you can dream big, swing for the fences, aim for the stars, or any other colloquialism you can think of. The downside of goals is that, for some reason, most people don’t achieve them, that they more often end up dreams.
What would cause a person not to achieve their goals? The problem is rooted in action. For most of us, our actions aren’t in line with our goals. Our actions, bad habits, addiction to comfort, fear of people, put us on a trajectory that is not easily swayed, and certainly not by some fanciful ideas.
So how do we adjust our actions? Unfortunately, in order to achieve goals, our actions usually have to change in a less comfortable direction. Discomfort is really hard to get comfortable with. It’s one thing to do something uncomfortable once, it’s very difficult to make it a long term habit. Change is super hard, and there are a lot of things to go into it, but I think there’s one especially important component: identity. Deep down in the recesses of your brain are you a fat person or a skinny person? Are you a hard-working person or a ‘laid back’ person? A tough person or a weak person? A happy person or a ‘realistic’ person? Your actions can actually help you answer these questions, because what you’re doing (eating too much, working too little, etc.) is directly tied to how you see yourself, to your identity. Here’s my suggested hack: look at yourself differently. It’s far from easy, but it’s a start.
I’ve begun reading Range by David Epstein, I’m two chapters in and already suspect that it may be the best business type book I read this year. Epstein distinguishes between two types of domains: the kind, and the wicked. That sounds weird, but it’s a very helpful distinction.
A kind domain is like a game. There are constant, understandable rules and boundaries. Chess is a helpful example Epstein uses, it’s confined to the chessboard, there are unchanging rules, the game is always between two opponents, it’s a super structured and narrow environment. A person can develop superior aptness within a kind domain like chess by lots and lots of practice. Practice helps because the arena doesn’t change, you can rely on the rules and systems involved and learn to excel within them. Ideas like the 10,000 hour rule (which says a person will become an expert or reach mastery after 10,000 hours of practice) stem from this idea. Epstein argues that line of reasoning only applies within kind domains (golf, chess, music, etc.), but actually isn’t that helpful for most of us because the world isn’t kind, it’s wicked.
Wicked is the opposite of kind. Where kind domains are constant, confined, structured, wicked means that the rules are constantly changing, the boundaries are always moving, the terms are rarely the same. It means that hours of specialized practice is actually unhelpful because it entrenches a specific unattached way of thinking about the world. People who thrive in the wicked (real) world are adaptable, curious, able to bring ideas together, to look at the big picture, to think strategically. They try lots of different things, they have hobbies, they embrace varying inputs. Even most sports, while including some kind aspects, are mostly wicked. Children tend to do better by experimenting among many different sports instead of specializing in one early on because of the additional benefit of learning varying movements and strategies. The early specializers who find success (eg: Tiger Woods who excelled in golf, a more kind sport) are the exception, not the rule, and probably aren’t the people we should be emulating.
Today, the world is more wicked than ever. Specialized tasks are more and more handled by machines and computers. The ability to think widely has become more and more important. We all must specialize to some degree, we’ve got specific responsibilities, and specific things we need to get done. But don’t be afraid to experiment, detour, adapt, create, and read Range!