Over the past couple of decades, I’ve told clients many very important things. Most of them are timeless, which is why I find myself saying the same things repeatedly. Here are the top 10, and I’ve saved my most important for last.
1. You can’t have it! This response is for when the client says something like, “I just want a respectable 7% return without taking any risk.” It’s easy to find risky investments (like futures) that have low- to no-expected returns, but I have yet to find a riskless, high-return investment. In fact, until recently, I couldn’t even find an investment that guaranteed a positive real (inflation-adjusted) return since cash loses out to inflation. But TIPS now guarantee a positive real return.
2. You have a lot of funds, but you aren’t diversified. New clients often send me statements that have dozens or even hundreds of pages reflecting that they own a host of individual funds and stocks. But it’s not the number of holdings that matter; it’s the number of underlying holdings within each fund. For example, two funds, a total U.S. and a total international stock index fund, can own over 10,000 companies across the globe.
3. Factor investing was never a free lunch. It started with the Fama-French three-factor model with small-cap and value giving a higher historic return. Then came smart-beta, and there are now over 500 factors. Neither Eugene Fama nor Ken French said any factor was a free lunch, but rather compensation for taking on more risk. That risk has shown up over the past decade with small value underperforming. Combine the extra costs and lower tax-efficiency, and I tell clients to take a tad more equity allocation but go with total market capitalization index funds, which virtually assures the client will best most investors.
4. I’ve always said investing is simple; I never said taxes were. My 13-year-old book, How a Second Grader Beat Wall Street, showed how simple investing should be. But taxes are complex. Exiting from narrow and expensive holdings has tax implications. Asset location is critical as well as withdrawal strategies and Roth conversions. In fact, I’d guestimate that roughly 75% of my client work is at least somewhat related to taxes, which means I can add tax alpha.
5. High-quality bonds have less risk in a year than stocks have in a day. I admit that I was sweating this piece of advice last year. It was the worst year in the history of the bond market and, by some measure, the equivalent of the stock market plunge during the Depression. Though the 13% loss in a Bloomberg Aggregate bond fund for the year was an extreme black swan, it was less than the more than 20% loss stocks had in one day on Black Monday, October 19, 1987. Clients have many misconceptions about bonds.
6. Your instincts are wrong. Though I freely admit that I can’t predict markets, I can predict investor behavior because people are predictably irrational. We chase performance. Morningstar’s most recent Mind the Gap study revealed investors underperformed funds by about 1.7 percentage points annually. Of course, there has to be someone on the other side of any secondary trade. For instance, someone had to be buying stocks when COVID first hit and stocks fell 35% in the 33 days ending March 23, 2020. It felt horrible to buy during that period and went against every instinct I had, which was to sell. I tell clients that if an investing decision feels good it’s likely a bad sign and vice versa.
7. The size of the disclosure is inversely related to the attractiveness of the investment. Good investments are easy to understand. Complexity is a bad thing. When a client asks me to review a proposed investment and the disclosure document is a 100 pages or more, I tell the client not to bother to pay me to review it. I say something like “I’m pretty sure the lawyers and actuaries didn’t write this to protect the investor.” Similarly, I tell people that when they attend a free investing seminar, the quality of the food and booze is inversely related to the quality of the investment.
8. You have a ton of low-hanging fruit. Low-hanging fruit is the ability to earn more without taking on more risk. This doesn’t mean high, riskless returns but can equate to tens or hundreds of thousands of dollars in what I call “free money.” An example is cash earning very little at a bank or brokerage account. Recently, for several clients, I pointed out that moving cash to something like a Treasury Money Market account or short-term Treasury bill can earn over 4% interest and be state income tax exempt.
9. Dying the richest couple in the graveyard is a lousy goal. The purpose of money is to have choices in life. As William Bernstein put it, “if you’ve won the game, why keep playing?” Sure, the probabilities are that an aggressive portfolio will be just fine for many, but the consequences of a grizzly bear are high. In other words, the costs of running out of money are higher than the costs of dying with money.
10. You are paying me a lot of money to tell you that I don’t know the future, and that’s the single most valuable advice I’m going to give you. I spend quite a bit of time with clients challenging their beliefs that they know the future. Though it is obvious today why interest rates surged in 2022, the top economists have called the direction of the 10-year Treasury bond correctly about 35% of the time – less than a coin flip. The odds are strong that capitalism will survive and that taking diversified equity risk will work in the long run, but no one knows future returns. An investment plan works far better than trying to predict the future.
Every client is different and I don’t have to say all of these to every client. Yet rarely do I have a client where none of these are applicable. Even if you do not agree with all of these, some may help you steer clients to a more logical approach to investing and financial planning.
Allan Roth is the founder of Wealth Logic, LLC, a Colorado-based fee-only registered investment advisory firm. He has been working in the investment world of corporate finance for over 25 years. Allan has served as corporate finance officer of two multi-billion-dollar companies and has consulted with many others while at McKinsey & Company.