By: Michael Ryan, CFP®, MBA
Garrison Keillor introduced us to the mythical town of Lake Wobegon, Minnesota, a place "where all the women are strong, all the men are good looking, and all of the children are above average." It may be that not all women and men are like those in Lake Wobegon, but certainly all of our children are above average. Undoubtedly those Lake Wobegonians also consider themselves above average in other areas, like driving. In fact, when asked, almost everyone says that they are "above average" drivers, and many suspect that they are above average in a host of other pursuits. The rub is in proving these claims, and that is very hard indeed.
In Poor Richard's Almanac, Ben Franklin once said, "There are three things extremely hard: steel, a diamond, and to know one's self." How we assess ourselves affects virtually every decision we make, yet we routinely make faulty assessments of our abilities. One study found that 70% of high school seniors think they have above average leadership skills. College professors also think highly of their abilities as another study found that 94% freely admitted that they did above average work when compared to peers. Nor are lawyers immune to the "Lake Wobegon" effect as they often overestimate their ability to win the cases they are about to take to trial. And numerous studies have shown that stock pickers think that the stocks they buy will more likely be winners than those bought by the "average" investor.
All of us like to think of ourselves as just a little bit savvier than the average Joe, especially when it comes to our investing prowess. This idea may be reinforced from time to time during periods of rising markets when everyone's portfolio is going up in value. No doubt many of us have confused this phenomenon with investing acumen. As investors we also get duped from time to time by the concept of "recency." This is the mistaken belief that recent conditions will continue into the future. (Home prices always go up . . . don't they?) This “recency effect” accounts for so many folks investing at the tops of markets and selling at or near the bottoms. The US stock market has produced an annual average return of nearly 10% over the past fifty years. It may do better or worse in the future, but history shows that many investors will likely do worse than the average simply because they will trade too often, ignore expenses, and not have a consistent investment policy to guide them.
I believe investing wisdom begins when we acknowledge what we do not know. I now realize that I do not know where the market will be in a month, or a year. I do not know what stock or bond, or ten stocks or bonds to buy to insure my investing success. There may be some with the skill sets or foresight to make such individual stock and bond picks, but the vast majority of us do not have that aptitude, nor will we devote the time necessary to acquire it. I am also aware that there is much that the investment "experts” do not know. I know that sometimes less than 15% of all mutual fund managers will beat their market benchmarks in any particular year, and the ones that do so this year may well fail to do so next year; and these are men and women who devote their lifelong careers to investing and are paid handsomely for doing so.
Once we acknowledge our limitations, and the fact that most experts fare little better, index mutual funds and Exchange Traded Funds (ETFs) begin to look like much wiser investments for most of us. These are “passive” investments (as opposed to “actively managed”) with very low expenses. With these low-cost investment options, one can easily construct a well-diversified portfolio. This approach is recommended by many successful investment experts, and specifically by one of my investing heroes, John Bogle of Vanguard fame. Experience has shown that the "average" investor is more likely to find long-term investment success by using low cost investment vehicles like these and a routine investment program where costs are reduced through dollar-cost averaging. With such a program in place, the “average” investor may actually realize “above average” returns compared to his peers. The path to this discovery for many has been littered with frustration and lost opportunities, not to mention lost dollars!
Remember, money is certainly not the most important thing, but still, money matters!