Two Huge Investor Anomalies

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Responsible and intelligent investing is easy to explain. Bill Bernstein did a great job of doing so in this brief booklet that you can read in under an hour. Here’s an extract that tells you all you need to know:

Would you believe me if I told you that there’s an investment strategy that a seven-year-old could understand, will take you fifteen minutes of work per year, outperform 90 percent of finance professionals in the long run, and make you a millionaire over time?

Well, it is true, and here it is: Start by saving 15 percent of your salary at age 25 into a 401(k) plan, an IRA, or a taxable account (or all three). Put equal amounts of that 15 percent into just three different mutual funds:

  • A U.S. total stock market index fund
  • An international total stock market index fund
  • A U.S. total bond market index fund.

Over a decade ago, i advocated the same investment strategy in The Smartest Investment Book You’ll Ever Read. I summarized exactly what investors should do in this blog.

The support for this investing strategy is overwhelming. You can find reams of data at this website and in books written by Larry Swedroe, Allan Roth and John C. Bogle, among others. Bogle’s book, The Little Book of Common Sense Investing, should be read by every investor. This brings me to the first anomaly.

Anomaly #1

Why isn’t everyone investing this way? It’s true there has been a seismic shift from active to index-based investing. However, the majority of investors still invest actively, trying to “beat the market”, by stock picking, market timing and selecting outperforming, actively managed mutual funds.The daunting odds of doing so are validated twice a year by the SPIVA reports.

When confronted with a choice between the certainty of obtaining market returns that will — as Bernstein observes —outperform 90 percent of finance professionals in the long run, and make you a millionaire over time, and the likelihood of underperformance, most investors still choose the latter.

It makes so sense to me.

Anomaly #2

Has anyone ever said this to you? Can you recommend a stock broker? I’m looking for someone who has conflicts of interest with me. They don’t have to disclose these conflicts and they can resolve them in a way that enriches them at my expense.

If you are relying on a broker for investment advice, that’s precisely your working relationship.

I don’t understand the “debate” over whether anyone who dispenses investment advice should be a fiduciary. Being a fiduciary simply means they will be required to disclose all conflicts of interest and will be obligated to resolve them in favor of the investor.

I can’t imagine why every investor wouldn’t insist on this relationship with their advisor. I fully understand why the securities industry wants to keep things exactly as they are today. It permits them to sell you expensive investment products likely to underperform, when less expensive products (like index funds) would be in your best interest.

When investors tell me their broker is a fiduciary I advise them to request a letter, on the letterhead of the firm simply stating: I agree to act as fiduciary to you in all my dealings. No one has received this letter to date.

There’s no legitimate “debate” over whether index based investing has higher expected returns than active management, or whether using a fiduciary is in the best interest of investors.

The views of the author are his alone. He is not affiliated with any broker, fund manager or advisory firm.

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