To succeed at investing, you need the right personality traits – laziness, cheapness and humility.
Oh, sure, it is also nice if you happen to possess an expert knowledge of the market, a detailed understanding of various companies and a discerning grasp of economic trends. All those things can help you achieve good returns. But don’t sweat it. Laziness, cheapness and humility will get you most of the way there.
To understand why, look at the accompanying chart, taken from the most recent version of J.P. Morgan Asset Management’s Guide to the Markets. It shows that many different types of assets – real estate investment trusts, gold, stocks, bonds and housing – produced decent returns over the past two decades. The one notable exception? Individual investors’ portfolios. They lagged badly behind everything else.
It is remarkable that so many of us managed to perform so miserably during a stretch when just about anybody who bought a mainstream asset, and stuck with it, fared relatively well. What seems clear is that most of us manage to undermine our own investing strategies. Especially at a time like now, when so much seems unpredictable and scary, it is important to understand how we sabotage ourselves.
The most obvious way is by paying hefty fees in pursuit of superior performance. An investor who buys actively managed mutual funds through an adviser can easily wind up shelling out more than 2 per cent of his or her portfolio every year in management expenses and other levies. Yet, there is no evidence that actively managed funds beat the market. Over 10 years, roughly nine out of 10 funds lag behind their benchmarks, according to Standard & Poor’s Global.
It makes no sense to pay high fees for the near certainty of lagging behind the market. Cheapness offers far better returns. The simplest strategy of all is to avoid active management entirely and instead buy low-cost exchange-traded funds (ETFs) that track broad market indexes. By doing so, you can get benchmark-like performance for very little in the way of fees. This can easily add an annual percentage point or more to your returns over the long haul.
Humility helps, too. Investors love to trade in and out of positions based on their views of what is hot and what isn’t. This is usually a bad idea. Terrance Odean of the University of California at Berkeley demonstrated the potential perils in a classic 1999 paper that tracked thousands of individual investors at a discount brokerage. These small investors were nearly always overconfident – sometimes comically so – and showed a strong tendency to hurt their results by trading too much.
A humble approach works much better. All that is required is to assume you don’t know more than the market and invest accordingly. One simple strategy is to put 60 per cent of your money in a broad-based stock index fund and 40 per cent in a fund that tracks a broad-based bond index. As you can see from the chart, investors who followed this simple formula did just fine over the past two decades.
But how about taking a more aggressive approach? The chart demonstrates that people who invested heavily in REITs and gold did even better than 60/40 investors over the past 20 years. In all likelihood, this was a one-off event – falling interest rates helped propel REITs higher, while the worst financial crisis in decades lit a fire under the price of gold – but it is possible this outperformance will continue.
Investors who want to bet on REITs, gold or any other sector have to be prepared to be seriously lazy, however. As a general rule, bets on individual sectors or specific commodities tend to have long periods where they don’t perform all that well. Gold, for instance, had gone nowhere for nearly 20 years before it soared in the wake of the financial crisis. If you want to make such bets, you have to be prepared to do nothing, year after year, while other assets climb around you.
Most people aren’t good at doing that, especially if the underperformer makes up a large part of their holdings. But what can work is constructing a low-cost diversified portfolio that spans stocks and bonds, with much smaller commitments to commodities and REITs. Stick with this approach, no matter what the news of the day happens to be, and you will do much better than the average investor. All that is required is laziness, cheapness and humility.