Financial Advisors aren’t evil (mostly)​

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I met a stranger this morning (the beauty of Facebook marketplace). He had looked me up in advance, not to be creepy (he assured me), just to make sure he wasn’t meeting a crazy person. He saw that I’m a financial advisor and wondered if I had ever met his financial advisor, whom he trusts very much. In fact, he trusts his financial advisor so much he recently handed over full discretion, meaning the advisor no longer needs his permission to make trades and move money. It was becoming cumbersome to give the okay every time the advisor wanted to make a trade. I informed him that I had not met his financial advisor, and he assured me that his advisor is a great guy.
Here’s the thing, I’m sure he is a great guy, I’m sure his intentions are (mostly) pure. Many financial advisors are really great, and they really care. But that little discretionary bit he shared with me is alarming. When it becomes cumbersome to approve every trade your advisor wants to make, that’s a problem. According to the data, financial advisors who actively trade routinely underperform the market, even advisors who are really great guys. Don’t work with an advisor only because he or she is a great person. Find an advisor who is a great person, but who also understands how the market works, how to most efficiently capture returns, how to avoid stock picking and market time and trying to beat the market, and most importantly, how to coach you. Your future depends on more than the integrity of your advisor. He may not be evil, but he may also be submarining your retirement.

5 ways your investing app is ruining your retirement

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In the last five years, we’ve seen the explosion of alternative investment avenues, especially through apps. While technological advances (computers, algorithms, the internet, you get it) certainly make investing a better and easier experience than it’s ever been, they’ve also promoted some troubling trends in popular consumer investing apps.

Here are a few ways your investing app is ruining your retirement:

  1. Investing apps are built for active trading which loses money compared to the market. In order for investing apps to be interesting, they promote active trading. No one wants or needs an app to help them buy and hold and never make trades. Unfortunately, active trading is a recipe for disaster. Even professionals lose to the market when they actively trade stocks, not because of any inherent flaws in themselves, but because it’s literally impossible to consistently beat the market.
  2. No great offerings. Because they’re designed to encourage active investing, investing apps don’t offer many great investing options. Even if you could ignore all the crap, the best funds aren’t in there. Sure, you can find some cheap ETF and index funds, which aren’t the worst options in the world, but they’re definitely not the best. And investing apps know you might try them out, but ultimately you’re going to be moving money around.
  3. Your earliest years are the most important years and you’re wasting them. Investing apps appeal unilaterally to younger people. The great thing about investing when you’re young is that money invested early will compound far more significantly over time than money invested later. Unfortunately, many young people fall prey to these investment apps which do the opposite of maximizing investment dollars.
  4. Mis-education, worthless news. In order to make active investing seem legitimate, investing apps often share news and information regarding the market. Unfortunately, the news is not helpful for investing. Instead of learning about how the market works and how to prudently invest money over time, these excerpts simply validate terrible investing strategies.
  5. Encourage bad behavior. This is the biggest problem. Instead of educating investors, investing apps take advantage of them. Active investing feels right, it seems legitimate, and investing apps only encourage that feeling. Unfortunately, the feelings of investors have no correlation with successful investing, if anything they’re negatively correlated.

So dump the investment app. Learn about important investing concepts like Efficient Market Hypothesis, Modern Portfolio Theory, the Three-Factor Model. Get a good advisor who will get you into the best funds and help you remain disciplined through scary markets. Take your purpose seriously, it’s probably something worth more than speculating and gambling with your investments.

Recession rumblings

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I’ve been hearing a lot of rumblings about the next recession recently. Just last week a podcast host went through great pains to explain why the next recession will hit within the next year. I even agree with some of the foundations of his economic arguments, but there’s always a leap of faith involved when a prediction is made, especially when it comes to an economic recession. Here are a few things to think about the next time you encounter one of these predictions:

  • No one has a good grasp on what the market will do tomorrow, let alone what it will do in the next few weeks or months, or especially years. The reason it’s so hard to predict the market is that there are trillions upon trillions of data-points that all influence how the market will move. These trillions of data-points are also constantly moving, so even if you did have a pretty good grasp of what was happening in the market, five minutes later it will have all changed. It’s simply impossible for us to get a full picture of the happenings in the market.
  • Even if you did have a solid continuous grasp of the trillions upon trillions of data points in the market as they changed, it would still be impossible to predict market movements because the market moves based on data in the future. Even if you understand the current market completely, unless you know the future you’re going to have a tough time predicting where it will go.
  • Let’s pretend for a moment that you can see the future and you know for sure that a recession is coming, that would be awesome. But there’s still a problem, not only would you have to know for sure that a recession is coming, you’d have to know exactly what day it would begin and exactly what day it would end in order to profit from that knowledge. The market moves quickly, if you miss just a few of the best days (which often come right after recessions) it would have been better for you to remain invested and ride out the storm than to pull your money out and wait to get back in. Market timing is a deceptive thing. We intuitively think the best move is to get our money out of the market when a recession is coming, but the opposite is true. Even in the face of a recession, the best move is to remain invested. Unless you can comprehend trillions of data-points and know the future with an incredible level of specificity, don’t buy into the recession rumblings.

Human capital

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What’s human capital?
To start, we need a definition. Here’s what Wikipedia has to say: “Human capital is the stock of habits, knowledge, social and personality attributes (including creativity) embodied in the ability to perform labour so as to produce economic value.” A little tricky, but basically human capital is the economic value of a person based on their skills and ability in the workplace.

So who gets paid for human capital?
In a free-market economy, everyone gets paid based on their own human capital. We each own our own skills and abilities and we collect income based on our ability and value when we work. Regardless of whether we work for a company or ourselves, we’re compensated for the value we’re able to provide.

So far so good. Now let’s tie this into investing. Without some understanding of the market, people tend to believe that they can beat the market by picking the right stocks. Consistent success (beating the market) in stock picking is actually impossible, but let’s pretend for a moment that’s not. If the market was beatable, there would naturally be people who were especially endowed with the skills and/or training to beat it. Those people would often become money managers and they would be highly sought after by the general public looking for great returns in their portfolios. But who would collect the premiums for additional returns achieved above-market returns? Stock picking would be a human capitalist skill! The brilliantly skilled money manager would collect some serious fees for his valuable ability, fees almost exactly in line with the amount of return he was able to achieve above the market. The additional return of the portfolio wouldn’t end up in the pockets of investors, it would go to the brilliant manager with the impressive human capital skills.

So here’s the point: the stock market is efficient and so it’s not consistently beatable, but even if it was, investors would not be the beneficiaries. The super-skilled money managers would rightly collect large fees, highly correlated to the additional value they were able to provide based on their human capital skills.

Fishing and diversification

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I love salmon fishing. I love all sorts of fishing, but salmon fishing is special. Instead of the romantic image of fly fishing in a river, or the flashy idea of big-time bass fishing, or even the nostalgic memory of fishing off a rowboat with your grandpa, salmon fishing is more like a battle. Forget everything you know about traditional casting and reeling, salmon fishing involves rigging up multiple fishing rods, attaching them to downriggers and various mechanisms for getting the lures down deep, and a slow troll on open water. The key to catching fish has nothing to do with technique or sport, it’s about setting a broad array of bait covering many different depths. We call it a ‘spread.’ If you only had one or two rods you’d be poorly served, it’s simply not a sufficient level of depth diversification. Ideally, you want 8 to 12, or even 15 to 18 in the case of professional charter boats. Here’s a quick visual:

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Notice how the lines are prudently spread across varying depths? Investing is the same way! Stick with me here; the water is the stock market, the lines/rods are investment dollars, and the different depths are asset classes. We don’t know which depth, or depths, will produce fish, we just know the fish swim all over the place and that if we’ve got a good spread (lines at different depths) we’re bound to catch something. Same with asset classes! We know that they all perform over time, but we don’t know which one is going to hit next year or which one will be best over the next 5 years. So we own all of them. Imagine how dumb it would be to have one line out in the water trolling for salmon, it makes no sense. Even if that one line is set at the depth that has produced the most fish over the last few weeks, it still doesn’t make sense. Fish move around all the time, why would you not want to cover the whole water column/stock market? Just like downriggers and multiple lines ‘enable the whole water column to be covered when trolling,’ diversification allows you to own the whole market when investing! No guesswork, no hoping, no predicting, no gut feelings, no casting lots, no anxiety, just well balanced, widely diversified investments. I’m not saying it’s easy, salmon fishing is a lot of work, but when you’re eating your salmon dinner at the end of it, you’ll be glad you diversified.