The Broke Professional - Optimize Your Financial Life

Dancing is Not a Good Investment Strategy

If your investment strategy was a dancer

1/11/2019:  I thought this would be a great time to re-post this, since many people are starting to dance with their investments!  There has been some ups and downs in the stock market the last month or so, and it’s making people do weird things.  

I’ve heard many people say that they are stopping their retirement account contributions or moving some of their stock positions into bonds or money market accounts.  Don’t do these stupid dance moves! 

Making investment decisions for retirement money based on a few weeks activity is almost guaranteeing that you will retire with less money.  Just keep contributing and rebalance as you have been, and you will come out on the other side smelling like a rose.

Investing is a patient man’s game.  This applies to almost any type of investing including real estate and stocks.  In general, if you’re investing for the long term (more than 10 years), the best strategy is to have a great plan and stick to it.

Unfortunately, many impatient men (and women) are investors.  This means many plans never make it past the first big market drop.  That’s usually when panic sets in and investors do something short sighted.

A 2015 study proves exactly this.  The study shows that we are our own worst enemy when it comes to investing.  And no other reason even comes close.

Let me set the stage by showing you the study results and what we can learn from them.

People are Not Good at Investing

I recently wrote why many investors are their own worst enemy when it comes to their investment performance.  While the subject of this post is similar, after reading the results of the aforementioned study I felt a separate post was needed.

The study was conducted in 2015, and at the time the S&P 500 Index had a 30-year annualized gain of 10.53%.  That means that every year for the last 30 years, the S&P gained an average of 10.53% per year.  Some years were way more and some years were way less (think 2008).  But on average, a nice 10% return every year.

What this means is that an investor who simply held an S&P 500 index fund for the last 30 years should have returned 10.53% minus fees.  Let us say this investor had some crazy fees which brought the return down to 8%.  Paying high fees is annoying, but 8% is still not a bad overall return.

According to the study, the average investor didn’t do this well.  In fact, they did a lot worse.  The study found that the average investor returned 1.65%!

1.65%!!!???  They might as well have put all that money into an online savings account and saved themselves the stress of investing.

This means that the average investor is probably not using index funds.  And if they are, they are using the wrong ones or are just going in and out of investments way too much.  I think the latter is the culprit for most investors.

Dancing In and Out of Investments

“Since the basic game is so favorable, Charlie and I believe it’s a terrible mistake to try to dance in and out of it based upon the turn of tarot cards, the predictions of “experts,” or the ebb and flow of business activity. The risks of being out of the game are huge compared to the risks of being in it.” -Warren Buffet in his 2012 letter to Berkshire Hathaway shareholders

(The basic game is investing and Charlie refers to Charlie Munger, Buffet’s partner at BH.)

As Mr Buffett explains in this quote, “dancing” in and out of investments is very risky.  I firmly believe this is why the average investor does not even come close to the returns of the S&P 500.

But why does going in and out of investments produce such poor returns?  Shouldn’t we always be looking to get out of our investments when things get bad and find some better places to put our money?

The answer is yes, we should be looking for better places to invest.  But the best place to invest is usually in an index fund that follows the overall market.  And it’s almost impossible to find another group of investments that does better than the overall market on a consistent basis.

And by dancing in and out of investments, most people are actually buying high and selling low.  We should always try to buy low and sell high!  People usually panic and sell investments when things get bad (sell low), and then they try to buy into investments that everybody is saying is “safe” (buy high).

A great example is the recent Brexit vote that will lead to the UK withdrawing from the European Union.  It was expected that the stock market would fall after the vote was yes, and it did just that.  The day after the vote was final, the S&P 500 dropped 66 points, which was about a 3% loss.  Not a huge drop, but pretty decent.

But if you turned on any form of financial news, you would think the Four Horsemen were arriving.  Predictions that the international markets will be in turmoil for years was the theme of the day.  The S&P actually did fall about 1% more the next day, which lead to more doom and gloom.

But about 10 days after the Brexit vote, the S&P 500 was right back to where it was before.  And as of now, 2 months after the vote, the S&P 500 is about 3% higher than it was pre-Brexit!

The Big Takeaway

What this all means is that if you were one of those investors who panicked and sold some stocks after Brexit and then bought more stocks when the market rebounded, you were dancing in and out of the market which means you were selling high and buying low.

And this is why the average investor averages returns a little over 1%.  As the study showed, just owning an S&P 500 index fund for the last 30 years and not doing anything with it would get you a 10% return.

The best course of action for investors who don’t want to make stock picking their full time job is to formulate an index fund strategy that is appropriate to your investing timeline.  Pick the funds.  Rebalance the funds every year so they don’t get too out of wack.  And then leave it alone.

You will be a better investor than the majority of America.

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Don’t Laugh at the Latte Factor

If you need this every day, then you don’t value money.

Some personal finance concepts will live on forever. Pay Yourself First is one of them. Debt Snowball is another one. And of course from uncle Dave Ramsey himself, “Live like no one else so you can live like no one else.”

But the one I want to talk about today is the Latte Factor. It’s a term that has been in the personal finance lexicon for over a decade now, but it is still somehow a polarizing subject.

David Bach first officially introduced the Latte Factor in his book The Automatic Millionaire. This was actually the first personal finance book I ever read and sparked my interest in the subject. A really good book for people at any stage in their finances.

In the book he talked about the ability to give up spending money on something and redirecting that money into savings. The example he gave was of giving up your daily latte. Thus, the Latte Factor.

The numbers are actually pretty amazing. Say you spend $4 every day on a delicious latte. (I worked at Starbucks for years so I know there are many people who do this.) Now instead of spending $4 every day on a drink, take that money and put it into an investment account.

Here’s what happens. If you put that daily $4 into a retirement account that gives you a modest 6% return, you will have $1,547.60 in one year. Not bad at all!

But if you keep doing it, the numbers get crazy. After 5 years, you’ll have $8,723.97. 10 years? $20,398.60. How about we jump to 40 years? How about you have $239,509.62! Just from giving up your little $4 addiction, you can rack up thousands of dollars pretty fast.

So why do so many people have a problem with the Latte Factor?

Overly Sensitive Coffee Lovers

Like I mentioned before, I worked at Starbucks during high school and college. It was at a new store in the mall and from the day it opened, it was packed every day. To say Americans are addicted to coffee is an understatement.

I would see the same people come in day after day for an expensive coffee and a pastry. This would easily be $7 a day. And this was 15 years ago. Starbucks is more expensive and this country is more addicted to sugary coffee and snacks.

So there certainly is a large part of the population that spends close to $10 a day at expensive coffee houses. (By the way, a daily $10 habit can turn into almost $600,000 after 40 years at a 6% growth rate).

And after reading criticisms about the Latte Factor, most people just seem to be mad at the idea of taking away their lattes. They say if you enjoy your lattes and they make you happy, keep them! Don’t let some cold financial guru tell you to stop your habit.

These people are not looking at the big picture. It’s not just lattes that are a candidate for the chopping block (which they should be since most lattes have unholy amounts of sugar). It’s anything you buy that isn’t essential and doesn’t bring you happiness.

Let’s make a list: cigarettes, alcohol, donuts, expensive cell phone plans, expensive car loans, fancy groceries, fancy shaving cream, movie theater food, airplane food, soda, bank fees, non-library books, barely used gym memberships, and so on.

Long enough list for you? Most people have many little expenses like this. Imagine cutting just half of them out and putting it towards your investment plan? I hate the saying, but you’d definitely be living your best life!

Conclusion

If drinking an over-caffeinated beverage spiked with sugar every day really makes you happy, don’t let David Bach or anyone else say you can’t have it. Just realize that you love lattes and high blood sugar more than money and continue to feed the addiction.

But try to look outside yourself and find out what non essential expenses you can cut or minimize. Once you can do this, funnel that savings right into your investment accounts and watch your wealth grow year after year with the additional latte flavored rocket fuel.

And with today’s technology, it’s easier than ever. When you pass by the coffee shop and have the urge to scarf down that overpriced scone, just pull out your smartphone.

Simply sign into your investment account, transfer that $5 from your checking account, and walk away with a smile knowing you are fueling your wealth and some billionaire CEO.

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