Most investors would benefit from something like a 3 fund model. Not just because of the low cost, diversified index funds.
But because it removes most damaging human behavior from the mix. Getting out of your own way is a huge improvement for most
— 1nquisitiveMind (@1nquisitiveMind) July 15, 2018
It’s hard to argue with the above sentiment. Investors do as much damage to their portfolios as adverse markets have ever done. The problem is that most investors don’t come to a 3-fund type of model without some prompting. The vast majority of people who engage a financial advisor do it because they have come to learn that they cannot, or don’t want to, deal with the emotional struggle of dealing with their portfolio.
Tim Hanson writing at Medium has an interesting take on the need for us to encourage young adults to become investors. Hanson thinks by encouraging young adults to become DIY investors will provide them the impetus to become lifelong savers and investors. Hanson writes:
Remember that the way the math works, the most important variables when it comes to gaining financial security through compounding are (1) the amount of money you are able to save and invest and (2) the length of time you save and invest, with the optimal conditions being more and longer. Viewed this way investing success is not in optimizing one’s risk-adjusted returns or in executing complicated tax-loss harvesting schemes. Rather, investing success is simply getting started early.
There is some research to back up this approach. A recent paper entitled “Learning by Trading” by Saumitra Jha and Moses Shayo demonstrate that novice investors who are given the opportunity to trade stocks improves their financial literacy and willingness to take risk. From the abstract:
The ability of individuals to make sound financial decisions and obtain sound advice is increasingly being questioned. Shortfalls in financial knowledge and confidence are particularly acute among women. This paper explores one easily scalable avenue for improving financial literacy and potentially attenuating this gender gap: learning by online trading in stocks. We randomly assign stocks to individuals and encourage them to trade on our platform for a period of either four or seven weeks. We provide no educational content beyond explaining how the value of their assets are determined and providing links to financial websites. Four months after the intervention, we test participants’ financial literacy. We find significant improvements relative to the control group. Importantly, the treatment reduces the gender gap in self-assessed financial knowledge for given objective financial literacy. Treated individuals claim greater familiarity with the stock market, greater willingness to invest in stocks, particularly in foreign assets, and a lower propensity to consult others for financial advice. The effects are greater for those exposed to more volatile stocks and assets that performed better during the study.
This will likely sound like an anathema to many who advocate the simplest possible investment solutions. It is my experience, and that of many others, that these type of solutions really only make sense in light of trying (and failing) to become alpha-generating investors. For example, check out the last chapter of Michael Batnick’s new book Big Mistakes: The Best Investors and Their Worst Mistakes, where he documents his own journey from frenetic trader to an advocate for simple, low-cost portfolio solutions.
No one is born a natural investor, except maybe Warren Buffett. Everyone has to learn the big investing lessons for themselves, over time. As noted in the opening tweet, it is behavior that largely defines our ability to be successful investors over the long run. For the vast majority of people, individual stocks or even sector ETFs, end up being a distraction from what matters most. Getting started early and letting compounding work in your favor. As Howard Lindzon writes:
“There is one language across all these languages that is universal and that is the language of investing/trading…Do your kids a favor and start them on the path to learning the language of investing.”
Just because someone understand the language of the markets and trading doesn’t mean they have to go out and trade every day. However understand that language provides you with the foundation to tackle many, if not most, of the big issue facing investors throughout their lives. Learning by doing, especially when the stakes are low, can be a valuable way to proto-investors lessons they could not learn in a blog or a book.