“The main thing is to keep the main thing the main thing.” -Steven Covey
In some respects, the above quote from the author of the famous self-help/business book, The Seven Habits of Highly Effective People, can be a solid daily mantra to stay focused in many elements of life (e.g., routines, relationships, your golf game, etc.). For today’s purposes, however, we’re going to use it specifically as it relates to financial planning and investing.
As I read “Part 1” of this (unintentional) series, I realized there were more practical areas of this topic that I glossed over but that remain worthy of some Alt Blend real estate. Thus, for the first time ever, this is a Part 2 unforeseen at the time Part 1 was completed. I think it will be well worth our collective time as we attempt to keep an eye on the prize throughout our financial journey of life. Here we go!
Index investing: both/and?
The first add-on topic is that of index investing. Whether you are an index investor or not, let’s consider why people do it. I can make up similar answers, but a quick Google search yields reasons like low costs, instant diversification, better historical performance (citing that “most professional, active stock-pickers fail to beat major benchmarks like the S&P 500”), tax efficiency, and simplicity. I’ll add another one: FOMO (fear of missing out, as it can be difficult for some people to stomach the headlines of rising markets if they aren’t participating).
In the context of today’s topic, these reasons fall into both “maximizing returns” (e.g., low costs, better historical performance, tax efficiency) and “minimizing regret” (e.g., low costs, FOMO, tax efficiency, and perhaps simplicity) categories. In that sense, indexing may seem like a very middle-of-the-road approach.
Some big BUTs
The aforementioned are all reasonable reasons one might consider indexing, or even why some people are indexing, or at least why they think they’re indexing. BUT, this is not to say there aren’t tradeoffs. I offer you the following:
- Index performance: yes, you will get performance just like that of the underlying index (less fees), but is that always a good thing? Don’t forget that the markets tend to go through extended periods of outperformance and flat performance (aka “lost decades”). I’d encourage you to check out the table of historical returns in this Science Direct article. Whether you go back to 2013 (as the authors did) or the post-GFC 2009 bottom, we have been enjoying quite a run in the S&P 500 for the past 13-17 years, and this “outperformance” cannot continue indefinitely because it’s mathematically impossible (then it would just be called “performance”). And if you think those S&P 500 flat-return periods are bad, you should look at the NASDAQ sometime.
- Income: Indexes don’t generate a “livable wage” as they once did, at least not for those whose nest egg isn’t about 100x larger than their annual lifestyle cost. So, for retirees, that poses other questions and potential problems (see “Planning Implications” below).
- Tax efficiency: this is great in a current year when it saves you taxes (you can also throw tax-loss harvesting strategies into this); however, we see it constantly lead to poor risk management decisions in the future for those fortunate enough to have participated in what are sometimes incredible returns: most find it difficult to sell the thing(s) that have performed so well, and few investors want to sell their appreciated assets and pay the tax bill. Thus, they carry inappropriate concentrations solely because of unrealized gains that were punted over (often long periods) of time.
- Historical performance/simplicity: I’m lumping these together because both require consistency. If someone can put on the blinders and keep saving into a diversified equity index over the long-term, I think they will generally do well over the long term; after all, they will participate alongside human ingenuity via equity ownership, and that is an incredible force (again h/t Nick Murray) to drive growth over time. There will also be very difficult periods that require embracing volatility with ongoing savings and never panic selling. Simple? Yes. Easy? Not for most people.
Birds of a feather? DIY and low-cost
Most do-it-yourself (DIY) investors I come across also happen to use “low-cost” indexing solutions. That may not be a coincidence. Minimizing the cost of both investments and advice (i.e., not paying for it) sounds like a straightforward way to maximize returns, right?
I’m not saying that people can’t be their own financial advisor. They should just be willing to spend the time necessary to become an expert in investing, tax planning, estate strategy, insurance, and retirement planning…and then they still wouldn’t have the right planning tools or investment access to do it the way it should be done (perhaps I’m biased). And, in my experience, exactly zero of the DIY investors I’ve encountered had either an optimal portfolio or overall sound financial plan.
Why hire an advisor if it obviously isn’t free? For one, this Value of an Advisor study, from Russell Investments, demonstrates an extensive effort to quantify the added value of working with a financial advisor. The number they arrived at is 4.92% of annual outperformance. Importantly, however, only 0.26% of that value-add is cited as investment (asset allocation) outperformance; the remainder is a combination of behavioral coaching and financial planning (family wealth and tax). That Russell number sounds very generous (to advisors), but – even if the value is a fraction of their findings – wouldn’t it be a win, to both hire a team and create better outcomes? Maybe it’s not a Free Lunch, but it does sound like a win-win. As usual, people get what they pay for, and we wouldn’t have a business if it didn’t provide value for our clients.
Planning Implications
We did a more thorough overview of the 4% rule and the portfolio construction issues associated with passive indexing back in Brush. Rinse? Repeat – Part 2. I won’t rehash it all (I do think it’s worth re-reading), but here’s the TLDR: major indices don’t provide a “livable” wage these days (yields are too low), so a retirement portfolio requires other assets to either a) bolster income, or b) mitigate downturns (or both), and it is highly likely that both of those things will negatively impact long-term returns. Higher-yielding dividend growth investing is a friend to financial planners.
Investments aside, proper financial planning takes consistent effort over time, just like keeping our minds or bodies in shape. A plan is not the same as planning. The work (and value) is in the upkeep, the adjustments, the monitoring. [That’s also why I’m not a big believer in paying a fee-only planner for a one-time financial plan. It will become quickly outdated, and it’s unlikely that the recipient will persist through implementation of their recommendations.]
Putting a bow on it
Given the question of maximizing return vs. minimizing regret, we absolutely want to focus on regret minimization. The regret of failing to meet objectives – like not running out of money in retirement – will be FAR worse than underperforming the market in a given year or otherwise feeling like you aren’t maximizing returns. We’re here to help keep the main thing the main thing.
Until next time, this is the end of alt.Blend.
Thanks for reading,
Steve
