The other day our friend John at Married With Debt hosted a guest post from Rob Bennett of Passion Saving. You might remember John from our collaboration on the relative taxation of Presidents Obama and Bush. Rob, on the other hand, is a bit of an enigma in the Personal Finance world. On the one hand, he has very interesting theories on safe withdrawal rates and buy and hold investing based on market valuations. On the other hand? He weaves a tale which makes the stories of Alexander Litvinenko and Gareth Williams seem somehow tame by comparison. I’m not going to touch that further than describing it (Google around if you care), but there is precedence for disruptive financial theories causing anger. Let’s tackle the merits of Rob’s arguments, shall we?
Divide Yourselves Into Groups…
I really hate fence sitting, but if you get to the end of my arguments you’ll recognize I spilled lots of digital ink just to sit on a virtual fence. Bear with me as it’s going to take a couple articles to spell everything out.
A Bit On Investor Psychology
Even though I’m about to (slowly) explain why I’m undecided as to an exact course, note that people often complain when I make things too black and white (or binary, if you prefer). I get it – there are various shades of gray. I mean some of this article to be self-assessment, so categorize yourself in the correct way and draw your own conclusions on where you sit.
The way I see it, there are four types of investors: High Information/High Emotion, High Information/Low Emotion, Low Information/High Emotion and finally Low Information/Low Emotion. Here’s how they break down:
- High Information / High Emotion:You’re an investor who pours through the research, has read all the books, digests as much as you can on the internet and looks over financial reports. However, when it comes time to trade you can be too quick with the trigger – a glance at your trading history reveals panic sells, piling into rising stocks, and maybe some brief flirtations with momentum investing and technical analysis (likely with poor results). Basically, you know a lot about the market but your emotions get the better of you on the transaction side.
- High Information / Low Emotion: Like the HI/HE investor, you devour all the information that exists on stocks and valuations and alternative investments. You can hold court in any conversation about investing strategies and know your way around a balance sheet. Unlike your HI/HE buddy, you are very deliberate when it comes to buying and selling – only making moves when you can verify something using certain valuations and never selling based on emotions.
- Low Information / High Emotion: You get most of your investment ideas through conversations with friends, tips heard at various places of business, and by reading “Top 10 Lists” of stocks. You’re very into the stock market, but don’t know much about valuation, hedging, and probably wouldn’t be able to keep up on an analyst call. However, you care deeply about retirement, tend to have certain parts of your portfolio tank, and are quick to want to move to cash in a downturn.
- Low Information / Low Emotion: (I’d be surprised if many of you read this article!) You don’t know much about the stock market, mutual funds, or securities, and the funny thing is you don’t care much. You may or many not participate in a 401(k), but you can’t tell a Roth IRA from a 529 (and will walk away from someone trying to ask about them). Hi, from the rest of us above, please try to get your emotions up to ‘medium’. Thanks.
Did you identify yourself there? Good. Find which of the four categories you best fit into, because it makes a huge difference to the investments you should pick. From my anecdotal experience, I would say that most people fall into category 3, Low Information/High Emotion investors. They worry lots about having a retirement when they are too old or sick of working, but they are much better at their day jobs than investing. None of these categories are meant as an insult – the truth is, for LI investors, you probably made a conscious or subconscious decision to not increase your financial knowledge.
“You’re Unique. Just Like Everyone Else.”
Great. I just proved to you that different people are different. Here’s the point of that little exercise:
“Different Investors Require Different Approaches While Investing.” -PK
You’ve now categorized yourself in one of the four categories above, or at least found the category which is closest to describing you. Now you can figure out the general style of investing which is right for you.
- Low Information / Low Emotion: If you can’t light a fire under yourself, you should at least try to get inspired long enough to make sure you’re getting all of the investment perks available to you through work: 401(k)s, Stock Purchase Programs, Share Grants, Options, and all other forms of ‘free money’. Ask a trusted smart coworker (or if your plan comes with advice, ask there) where to put your allocations. Also consider a Roth or Traditional IRA. Thanks for reading – we’ll see you in ten years when you’ve amassed a lot and are curious about the next step. You’ll be fine.
- Low Information / High Emotion: First off, try not to worry too much about the general ups and down of the market, your real estate, and mutual funds and bonds. If there is a total 100% drop in a huge asset class like the stock market we’ve got bigger problems than our retirement savings (haha). For you, you’re best off putting some layer of separation between you and your funds. Consider a Financial Adviser or a passive strategy and a simple portfolio with some sort of stock/bond mix. Yep, buy and hold is usually a good option for an investor like you. Try not to worry too much about volatility – the market may have lost its value in the recent recession, but hey, it’s almost back.
- High Information / High Emotion: Congratulations! You have what it takes to delve into investing a little deeper; you just need to keep your emotions in check. Use your considerable knowledge of valuations to determine a good investment mix for yourself. Think serious about avoiding individual stocks or options – know that while your knowledge is considerable, you should use some mechanical system to choose your entry and exit points. Stop losses (trailing or otherwise), limit orders, and certain option trading strategies are perfect for you – just try to keep your itchy trigger finger on your mouse away from the buy/sell screen on your brokerage window! If you can’t? Consider staying away from individual stock and bonds. You can still apply your knowledge to other forms of investments…
- High Information / Low Emotion: Call it what you will, but you know this personality type when you see it – smart and indifferent. If you find yourself in this category? Congratulations. You’re set up to be a good investor. Your biggest issue is cockiness – you might have an track record which looks good, but if you blow up you’ll tend blow up hard. Limit your bet sizes, watch your arrogance while trading, and always keep learning. Of all the classes it’s most important that you never get stuck with certain biases… always keep reading and absorbing new information into your repertoire while investing.
So, About That Buy And Hold Stuff?
Isn’t it crazy the diversity in personalities represented in the stock market? We all see some aspects of ourselves in the above investors.
If you divide yourself into either of the low information categories, I would suggest sticking mostly to buy and hold principles. If you dabble too much in speculative investments or individual stocks and bonds (or worse, IPOs,futures, derivatives and options!) you’ll quickly find yourself falling behind the curve financially. Remember: on a long time frame, specifically over 20-30 years, stocks have almost always outperformed bonds. Over a career, you’ll be okay even if you give up a little bit of that maximum return. Just make more by concentrating on your job, okay?
So, high information people, still with me? The odds are, yes, you can probably optimize your portfolio to a high degree – and potentially achieve better returns than you are receiving currently. For a high information investor who is willing to put in the work, look to Warren Buffett (duh), Ed Thorp, Peter Lynch, Ben Graham, David Dodd, Irving Kahn, and Walter Schloss. Heck, even Bill Gross. I’ll get into that – and the Efficient Market Hypothesis – in my next post.
So, wait, but don’t hold your breath… I’ll get back to safe withdrawal rates and buy and hold soon.
What type of investor are you? Do you agree with my assessments? What sort of things do you do to cover for your weaknesses?