Here’s a conundrum. If you compare investors’ returns in funds to the returns of the funds themselves, they should be the same, right?
Well, no. You see, “studies find that the returns investors have earned over time are much lower than the returns of the average investment,” writes Carl Richards, the Sharpie-wielding Bucks blogger at the New York Times in his new book, The Behavior Gap. Investors “moved their money in and out of stock funds. Their timing was miserable — and it cost them dearly.” Human nature induces us to buy high and sell low. When times are good, nothing can go wrong again, and when they’re bad nothing can go right. The net result is that we’re constantly leaving money on the table. So how do we get over that?
That’s the question Richards explores at length in The Behavior Gap, which came out a few weeks ago (with a blurb from me used on some of the promotional materials). The basic idea is to set a strategy and tune up on occasion if you’re way off the mark. Otherwise? Turn off Jim Cramer and stop thinking that anyone has insights into what a stock will do in the future. “We want someone to tell us what to do. But in the end, we have to recognize that the future is unpredictable,” Richards writes. And not only is it unpredictable, big chunks of it are completely out of our control. It really doesn’t do any good to worry about what the situation in Libya means for your portfolio because, well, what are you going to do about it? You surely can’t change the situation in Libya. And what are you going to do with your portfolio — go all to cash? Probably not a good idea either.
On some level, it’s hard to write a book telling people to do nothing. Or even rehashing the advice to buy a very diverse, balanced portfolio and hold, even if there is much coaching on how to be Zen about it. But what makes Richards‘ book fun to read is that he’s very engaging, and his Sharpie-on-a-napkin drawings are quite funny. I don’t know why there is something appealing about being told you’re an idiot with a chart. But there is. “Simplicity is both beautiful and functional,” he writes. “People are often disappointed when I propose a simple solution to their investment or financial planning problems. Such solutions can often be reduced to a simple calculation on the back of a napkin.” Instead, people want “a sixty-page doorstop packed with charts, graphs, bullet points, and calculations.” And that is why we keep losing money.
(photo courtesy flickr user 401K)
We’ll look into this one. My husband recently read and like What Investors Really Want by Meir Statman on a similar topic. We gave a copy to our nephew who likes investing and anything that explains funny Freakanomic kinds of things. They might both like this book, too.
Joy: yes, it’s an engaging little book. I think it is always a struggle to come up with new things to write in the financial space, because the advice really never changes. Live within your means and save regularly. Buy low and hold. Diversify. Snore. It’s the same with diet advice. Eat less and exercise more. And yet, on such wisdom are whole shelves in Barnes & Noble based!