I’ve Paid For This Twice Already…

Wise Investing Made Simple Review Part 2: Debunking Common Investing Myths

For the next several weeks, I’ll be working my way through the book Wise Investing Made Simple by Larry Swedroe. The first review covers chapters 1-8, and this review is chapters 9-16.

Where we left off last week in Wise Investing Made Simple, Swedroe had explained how markets work efficiently and because of that, how it is very difficult for even the most skilled, trained, and informed of investors to consistently beat the market. Honestly, he has me convinced. In fact, I know I’m neither skilled nor informed, but I’m pretty well convinced that it wouldn’t be worth my time to try and find a broker who is - because even brokers don’t really do all that well against the market. In the next eight chapters, Swedroe goes through a number of different myths about smart ways to invest, and uses analogies and stories to show why they aren’t so smart after all. Because I found them so interesting, I am going to briefly highlight them, and also go through myhts that Swedroe debunks by examples from the market itself.

Great companies make high-return investments? No.

Basically, this section talks about how risk is rewarded, and that if a company is highly regarded as a safe investment, its price is high enough to negate the fact that it has higher earnings. He uses a number of different scenarios to illustrate this including real estate investing and WalMart vs JC Penney. I thought about it in terms of Google, because I like Google and I wish I had some Google stock. However, Google is expensive now and you can expect a low rate of return for your investment because it is pretty solid and “safe”. The people who made money hand over fist on Google were early investors who took it on when it was a huge risk. With risk can come reward (but also, can come a complete loss, which is why it is risk). That doesn’t make Google a bad investment now - but it does mean I probably missed the boat on getting astronomical profits from that investment.

That analogy can be totally off the mark, it is something I came up with while reading the chapter. Take it with a grain of salt.

Stocks are only risky if your investment timeline is short - not quite.

This section uses a number of different 20 year samples to show that stocks do not always outperform other, less risky investments over a 20 year period. Stocks generally, but not always, provide a greater level of return over a long period of time, but you have to be comfortable with your unique level of risk. Honestly, I learned something here, and I’m going to have to study the asset allocation of my spouse’s 401K more carefully and think on that some more.

Buy what you know? Confusing “information” with “knowledge”.

Again, Swedroe takes specific examples here of “great” companies and shows how if you buy them at the wrong time, you may never make your initial investment back. There are so many individual stocks, that choosing to buy them as an investment vehicle individually is a very very risky proposition. He also covers the idea that if you have a piece of information (that everyone has) about a trend or forecast, that isn’t knowledge, it is just information. Buying stocks in medical companies because the population is aging isn’t a secret idea - and the market, being efficient, is already going to reflect that in prices.

Too many eggs in one basket.

This refers to owning too much of your own company’s stock. Basically the take home lesson is - if you have $3 million invested and 75% is in your company’s stock, if instead I just gave you $3 million and you could invest it whereever you wanted, would you really make that same decision about allocation? Just… think about Enron. Don’t put all your eggs in one basket.

Strategy vs Outcome - Don’t confuse them.

You can’t judge the correctness of a strategy based on the outcome. For example - life insurance. If you buy 30 year term life insurance and you don’t die in that 30 years, was the decision to buy life insurance a bad one? No, it was a reasonable protection against a possibility. You can take the outcomes of a host of different risky investing strategies and decide that they were the best based on outcome, but you can take just as many other risky strategies and find that the outcome was awful. Just like last week’s idea that past performance is not a prediction of the future, hindsight is 20/20 and it is being able to diversify risk for the future that is key, not picking the risk that panned out in the past. Diversification is like insurance - the strategy works if you collect on the policy or not.

I have life insurance. I’m still hoping I don’t die.

Making one great shot - the investor’s worst enemy.

Like the story from last week of finding a $20 bill on the ground and then devoting the rest of your life to trying to find more $20 bills lying around, one great move can be the investor’s worst enemy - because they’ll spend decades trying to repeat it. I can think of lots of places in my life I act like this, so it makes sense to me. Human nature is an interesting thing.

Overall, I am really enjoying the book. I didn’t know all these myths before but I had heard and believed several of them, and now I have a lot more to think about. Next week we’ll look at even more myths in investing, and then in two weeks, I’ll finish the book with the “wise” investing strategy reinforced. See you then!

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