Mullooly Asset Management

Fiduciary Fee-Only Financial Planner | Investment Advisor in Wall, NJ

personal finance

You Invest Against Yourself

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My dad used to tell me before my baseball games, “ya know Case, you play baseball against yourself”. I didn’t really get it at first. But the more he said it and explained it to me, the more I understood. You play baseball to the best of your abilities. If you do that, it doesn’t really matter what the outcome of the game is.

Coach Gaines, from Friday Night Lights, says this very well in his speech to the team during halftime of their state championship game.

“To me, being perfect is not about that scoreboard out there. It’s not about winning. It’s about you and your relationship to yourself and your family and your friends. Being perfect is about being able to look your friends in the eye and know that you didn’t let them down, because you told them the truth. And that truth is that you did everything that you could. There wasn’t one more thing that you could’ve done.”.

If I were giving a halftime pep talk or talking to my son about investing for the future I would say.. “successful investing is not about obtaining the most money or having the highest rate of return. Successful investing means having the ability to do the things that bring you happiness. As long as you do everything in your power to work towards those things, you’re a successful investor in my book.”

I like to think about wealth this way:

Wealth = Capacity to fulfill priorities

Priorities = Goals + Values

Most people view wealth in a different way, that’s where the problem is. Google defines wealth as: an abundance of valuable possessions or money; the state of being rich

One of the best explanations I’ve come across for why we think of wealth as something material came from Naval Ravikant on The Knowledge Project podcast.

“Socially, we’re told, “Go work out. Go look good.” That’s a multi-player competitive game. Other people can see if I’m doing a good job or not. We’re told, “Go make money. Go buy a big house.” Again, external multi-player competitive game. When it comes to learn to be happy, train yourself to be happy, completely internal, no external progress, no external validation, 100% you’re competing against yourself, single-player game. We are such social creatures, we’re more like bees or ants, that we’re externally programmed and driven, that we just don’t know how to play and win at these single-player games anymore. We compete purely on multi-player games. The reality is life is a single-player game”

Much of our desire for wealth comes from the need for external validation, which is the “multi-player” concept Naval speaks of. We want to be seen as wealthy by our peers because that signals we’re “winning”. But does this limitless desire for greater wealth actually make us happy?

The idea of accumulating wealth as a way to keep score against others doesn’t make a ton of sense because not everybody is playing the same game as you. You invest against yourself, and that means you get to define the game and make the rules. Do so under your own terms in a way that leads you to happiness.  

 

 

Don’t Invest Like the Rest

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To conform is human. During the Stone Age, our ancestors learned to fit in with their tribe. If they didn’t adopt the tribal culture, they were banished. Being banished was essentially a death sentence, so humans learned that fitting in was a pretty solid survival technique. This desire to conform has since baked itself into human biology. Sometimes social proof provides a helpful shortcut when we’re uncertain of ourselves. But, it can also be used to our detriment.

The biggest reasons why we use social proof are uncertainty, similarity, expertise and number. We are prone to use social proof when making investment decisions because the stock market is loaded with these principles.

  • Uncertainty – The stock market = uncertainty, nobody has a crystal ball, nobody knows which way the market will move next.
  • Similarity – Your friend has had their entire account in FAANG stocks over the past few years. His account is up 2 bijjilion percent. So I should do this with my account too, right? Michael Batnick wrote about why this might not be the best idea. My Friend is Beating Me
  • Expertise – There are “financial experts” on TV all day long telling us what we should and shouldn’t be doing with our money. We should listen because they’re experts, right? Ben Carlson wrote about this topic recently. Expert Judgement Or Lack Thereof
  • Number – Well if everyone is investing in this area of the market, I should too, right?

Paying attention to outside noise can distract you from what really matters. What really matters is whether you’re on track to meet your goals or not. These outside pressures can lead to overall poor investing behavior.

So how do we combat these pressures and focus on what matters?

The first step is self-awareness. You NEED to know what kind of investor you are.

As Nick Maggiulli said in his post “Know Thy Investing Self”, “Knowing yourself as an investor will be far more important for your long term results than even the most perfect portfolio.”

You also need to be aware of your “why”. Why are you investing this money? For most people their “why” is a comfortable retirement, as defined by their current lifestyle. Making as much money as possible is not a specific enough “why” to truly guide an investment process. Once you have your “why”, you can work backwards to find your “how”.

Which is where the second part of this approach, reasoning from first principles, comes into play. I first heard about reasoning from first principles in a podcast called, Invest Like the Best. Reasoning through first principles is breaking down a problem to the fundamental truths and working your way from the ground up.

Investors need to reason from first principles because as we now know, reasoning through analogy or using social proof is not an ideal way to make investment decisions.

First Principles used in Financial Planning

  •  the cost of living will increase over time
  • neither cash nor bonds keep up with the cost of living
  • stocks are the only asset class to outpace the cost of living
  • letting compound interest work for you.

So once you have your “why” (dollar amount needed to fund your goal) you can use these first principles to determine what actions to take. Using your specific dollar amount needed you can figure out how much you will need to save each year, what rate your savings will have to compound at and how much time you have to accomplish this all. After that is all fleshed out, then and only then is it time to decide what areas of the market to invest in.

If this sounds like too much for you to handle on your own, get in touch with us. This is what we do for a living!

Successful investors define their destination, know themselves, and reason from first principles. These integral traits help them avoid faulty decision making methods like using social proof.

 

Escaping the Financial “Upside Down”

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Last Friday, Netflix released the highly anticipated Stranger Things 2. In the show a group of middle schoolers start to investigate the disappearance of one of their friends, Will Byers. Their investigation leads to the discovery of some dark secrets. Most importantly, they discover another dimension exists in their town, which they call the “Upside Down”.

The “Upside Down” is an alternate dimension existing in parallel to the human world. It contains the same locations and infrastructure as the human world, but it is much darker, colder and obscured by an omnipresent fog. Some truly evil creatures live in the “Upside Down”.

The majority of people are stuck in what I’ll call the financial “Upside Down”. The financial “Upside Down” consists of widely held beliefs that are destructive to building wealth. Below are a few examples of those damaging behaviors and perceptions.

“Upside Down”: Everything the financial media puts out is true and/or relevant to you.

The financial media tries to get as many clicks, views, watchers as possible because that’s how they make money. The media preys on emotions such as fear, greed and happiness.

“Upside Down”: Belief that all “advisors” have your best interests in mind.

This one is tricky because a lot of  “advisors” are actually financial sales people. They only want to make themselves rich.  Here are some good questions to ask before working with an advisor.

“Upside Down”: More action in investment accounts leads to better performance.

Ripping up the script every time an investment goes down to chase the latest hot stock is a recipe for disaster. This leads to the exact opposite of the one thing everyone knows about investing; buy low, sell high. Less action usually means more success. Investments need time to work. To quote Nick Murray “Timing the market is a fool’s game, whereas time in the market is your greatest natural advantage”.

“Upside Down”: Complexity is good.

In reality, complexity sounds good. I’m paraphrasing something Phil Huber wrote recently when I say: investors want advice that sounds good, but what they really NEED is sound, good advice. If you can’t sum up your investment philosophy in a sentence or two, it’s probably too complex.

“Upside Down”: The more something costs the better it is.

Unfortunately for investors, complexity and cost go hand in hand. Consider this from Jason Zweig: “If there’s a cheap way and an expensive way to solve an investing problem, stick with the cheap one. The typical hedge fund gouges clients but produces mediocre returns. As for mutual funds, a recent study found that each 1% increase in annual expenses reduces performance by 1.6%; managers may be taking on more risk to overcome the drag of higher costs.” – Are You a Better Investor?

“Upside Down”: Investment returns are the most important factor in creating wealth.

An individual’s savings rate is vastly more important than the investment rate of return is. Check out my brother Brendan’s post on this topic.

“Upside Down”: This is what investment advisors do:

trading floor

Most people’s perception of their investment advisor is that they are “Wall Street”. This is such a dangerous perception. An investment advisor’s main job is to manage their client relationships. All advisors need to know their stuff. But, the most important traits of an advisor are: good listening skills, empathy and preventing clients from making big mistakes.

Investors would do well to escape the financial “Upside Down”, it’s a dangerous place to be.

The Right Conditions

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I’ve grown very fond of a feature within The Weather Channel app. It’s called the GoRun Index. The index uses a 1-10 scale to rate running conditions. 1 indicates difficult conditions and 10 indicates prime conditions.

What I like about the GoRun Index is that it’s identified four important factors that affect conditions. These factors are simple enough to not overcomplicate things, but also significant enough to make a noticeable difference.

The index default settings equally weight the effects of temperature, humidity, precipitation, and wind, but you can also tweak those factors to your preferences if you want. In my experience, mild temperatures, with low humidity, wind, and precipitation tend to be rated highest.

GoRun Index

While I don’t let this score completely dictate whether I run or not on any particular day, I have noticed that my runs are more pleasant when conditions are strongly rated.

In the same vein, I’ve thought of my own set of criteria that rates how ready somebody is to focus on investing. To be extremely uncreative, we’ll call it the GoInvest Index.

At my firm, we frequently see individuals who are looking to optimize their investments. While this is a worthwhile endeavor, often several important steps have been bypassed. This is natural behavior because investing is the “exciting” part of a financial plan. However, “skipping to the good part” isn’t exactly a recipe for success. The GoInvest Index identifies four areas that individuals should look to sure up before focusing time and effort on investment optimization.

GoInvest Index

Cash Flow – Focusing time and effort on investments before ensuring that your cash flows are positive is kind of like trying to row faster in a boat that’s taking on water. Eventually you’re going to sink and you’ll be tired from all the rowing. Going through cash flows can be uncomfortable, but it’s a reading that needs to be taken.

Savings Rate – As I made clear in a previous post, I believe that your savings will do the heavy lifting during the accumulation phase. It makes sense to spend as much time optimizing your savings rate as you spend researching investment ideas. Take care to save as much as you reasonably can, but also consider where your savings will be best applied.

Debt Management – If you’ve ensured your cash flows are positive and that you’re saving enough money, I’d take a careful look at your debt. Before focusing on investing, high interest credit card debt should be completely paid off. You may not need to completely pay off other debts (mortgage, student loans, car loan, etc.) before investing your savings, but that’s a more personal decision. You ultimately want to make sure that your debts are being managed to an extent that makes sense and makes you comfortable.

Emergency Fund – Becoming a forced seller is never good. This is why you’ll want to have an emergency fund. Depending on your situation and feelings, anywhere from 3-12 months of living expenses should be banked somewhere safe and accessible. This will hopefully enable you to not tap into long term investments for short term emergencies.

These are four simple factors that I believe will significantly improve investor outcomes. These factors may be less interesting than investments, but I think they’re fundamental to success. Just as it’s easier to run on a mild, low humidity day, it’ll be easier to succeed with your investments if your personal financial conditions are right.  

The Heavy Lifting

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Last weekend I went on an annual trip with my brothers and friends. Every August for the last six years, we’ve gone on what we call the Canoe Trip. We spend a long weekend camping and canoeing on the upper Delaware River. It’s a lot of fun, and there’s extremely spotty cell service. Unplugging from the world in the presence of good company is always refreshing.

Out on the river, somebody noted that its average speed this summer was roughly 3 mph. We figured that with an 18 mile trip, it would take us 6 hours to finish. After taking into account a brief lunch break and pit stops along the river’s edge, that estimation ended up being pretty accurate.

It’s funny because I’d always assumed that our paddling made a huge impact on travel time, but the math begs to differ. I guess we’re not the Harvard crew team after all. The biggest determinant of our success was simply being on the river and having sufficient time to finish our journey. Obviously, our paddling kept us headed in the right direction and away from rocks and other obstacles. I learned that this matters, but not to the extent I thought. In other words, the river did the heavy lifting.

Realizing all of this about our Canoe Trip reminded me of something I discuss with people all the time: the impact of your savings rate vs. the rate of return your investments achieve.

The chart below shows results over a 20 year time horizon with varying rates of return and savings amounts. Generally, the difference in ending values is much greater from left to right than it is from bottom to top.

Savings Rate Heavy Lifting

When it comes to accumulating money, your savings rate is likely to have a bigger impact than your investment returns. Your savings do the heavy lifting.

Nick Maggiulli from Of Dollars and Data came up with a good rule of thumb for investors wondering if they should focus on saving more or investing better:

Save More or Invest Better
https://ofdollarsanddata.com/saving-is-for-the-poor-investing-is-for-the-rich-3ae6189698f

Nick’s point is that if you can save more in a year than your assets are likely to earn, you should be more focused on saving. He goes on to explain that his rule provides guidance on a spectrum. It is not meant to imply that you can ignore your investments or your savings rate.

On our Canoe Trip, my friends and I obviously relied upon the river’s current a great deal, but we also would’ve been in trouble if we didn’t steer and paddle through rapids. Both aspects were important, but one had a disproportionate effect on our outcome. It’s cooler to believe our heroic paddling and expert steering techniques got us to where we needed to be, but realistically they didn’t matter all too much.

For many investors, especially those in their early years, their savings rate will carry the load. Investment returns matter, and matter more as the nest egg becomes bigger, but their importance is dwarfed by saving money. It’s more interesting to discuss investment strategies that are designed to increase long term returns, but without a solid savings rate, they won’t matter much at all.

Morgan Housel put it perfectly in a recent post:

“Building wealth has little to do with your income or investment returns, and lots to do with your savings rate. Fortunes can be blown as fast as they’re earned – and often are – while others with modest incomes can build up a fortune over time. Wealth is just the accumulated leftovers after you spend what you take in. And since you can build wealth without a high income but have no chance without a high savings rate, it’s clear which one matters more.”

On our Canoe Trip, the current was a bigger deal than our paddling. For investors, their savings rate is likely to be a bigger deal than their investment returns. Try to identify which factor in any equation performs the “heavy lifting”, and make it your focal point.