The Nifty Personal Finance Index Card That Gets One Important Thing Wrong
The household net worth of Americans is currently north of $70 trillion. So it seems to make sense that we would hire financial professionals to help us manage this large pot of money wisely.
In reality, however, it might not necessarily be wise to pay up for financial advice. Harold Pollack, a contributor to the Washington Post's Wonkblog, believes that all the investment advice you really need fits on a 3x5 index card. He actually demonstrated that fact by grabbing a pen and writing it all down (see photo above). A strategy of following the advice on this index card is obviously a lot cheaper than paying several thousand dollars to a financial advisor or wealth manager. Let's see how the card holds up after taking a closer look.
Here's the list of recommendations along with some very brief commentary:
1. Max your 401(K) or equivalent employee contribution. Yep, this is a no-brainer. Everyone should do this.
2. Buy inexpensive, well-diversified mutual funds such as Vanguard Target 20XX funds. If he's recommending that everyone should own some index funds, then yes, I agree with that. I'm somewhat ambivalent about target funds, however.
3. Never buy or sell an individual security. The person on the other side of the table knows more than you do about this stuff. I believe he's wrong here. We'll consider this one in more detail later in the article.
4. Save 20% of your money. Sure, if you can, great. Sadly, I'm not saving this much myself at the moment.
5. Pay your credit card balance in full every month. This is wise advice. I'm able to do this now for the first time in my career.
6. Maximize savings vehicles like Roth, SEP, and 529 accounts. This seems reasonable to me, though I don't follow this advice personally.
7. Pay attention to fees. Avoid actively managed funds. Yes, and yes. Fees are killers when it comes to investing returns. And most ordinary investors will not be able to select winning, actively managed mutual funds.
8. Make financial advisor commit to a fiduciary standard. This is crucial. If your advisor isn't putting your best interests first, then you need to find a new one.
9. Promote social insurance programs to help people when things go wrong. I agree with this one too, though I recognize not everyone feels that way. We'll leave the debate surrounding this particular topic for another time.
Hedge fund managers ain't nothing
All in all, I really like the list, and feel that most people would do quite well by following most of its recommendations.
My biggest criticism relates to No. 3, however, which is bad advice in my opinion. The first part of the statement -- Never buy or sell an individual security -- implies that individual investors can't succeed by picking individual stocks. But that's just not true, as Warren Buffett argued in his classic "The Superinvestors of Graham-and-Doddsville" [link opens in PDF].
When Pollack says that ordinary investors shouldn't buy stocks, I feel he should really say something like, "many investors should stick with index funds." Clarity in language is important. As Einstein famously said, "Everything should be made as simple as possible, but not simpler."
The second part of the advice -- The person on the other side of the table knows more than you do about this stuff -- is equally flawed in my opinion. If the person on the other side is a hedge fund manager, does he or she really know more than an intelligent, ordinary investor? Remember, the U.S. stock market, according to the Financial Times, has returned eight times as much as the average hedge fund since 2009.
Or how about the average mutual fund manager -- 57% of whom have underperformed the S&P 500 over the past 10 years, according to Goldman Sachs? Do they know more than you do about this stuff? Maybe. Maybe not.
The truth is that big institutions are playing a different game than we are. Buffett, of course, knows this, and that's why he believes "a business approach to security selection, gives some opportunity for long-term results slightly above average without corresponding increase in investment risk." Saying that ordinary investors can't compete with the "smart money" sounds like well-meaning advice. But it's not accurate.
Maybe a better way of phrasing No. 3 would be: Most people will do fine with just index funds. But those long-term investors who are willing to do some research will prosper by investing in individual stocks.
It ain't bragging if you can do it
We're obviously biased when it comes to the merits of picking individual stocks. At The Motley Fool, our entire business is built on the premise that ordinary investors will do well by investing in great companies over the long term.
So far, the record shows that we are correct in that belief. The Hulbert Financial Digest recently ranked the performance of 200-plus investment advisory services over the last five years, and three Fool services were ranked 1, 2, and 3. According to Hulbert's numbers, the three services have delivered average annual returns of 18%, 16%, and 15%, compared with the 7.2% for the Wilshire 5000 index during the time frame. Hulbert also notes, "of the six Motley Fool services I currently monitor, five have beaten the Wilshire 5000 over the entire periods I have been tracking them."
We're proud of that record, but we also know that investors can achieve solid returns by picking stocks without our advice. A normal person with the mentality of a business owner and a long-term time horizon is more than a match for the hedge fund manager (who I'll concede is well-versed in all the likely moves of the Fed) across that table.
In fact, we look forward to that transaction. As Buffett says in the conclusion to his "Graham-and-Doddsville" essay, "there will continue to be wide discrepancies between price and value in the marketplace, and those who read Graham & Dodd will continue to prosper."
The article The Nifty Personal Finance Index Card That Gets One Important Thing Wrong originally appeared on Fool.com.John Reeves has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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