Why Less is More When Investing Your Money
Author: Kent Thune
Life can be simple, but we make it complex. This universal truth also applies to how we handle our money. For the past 700 years, the teachings of science often refer back to one simple idea put forth by a medieval philosopher, Sir William of Ockham (c. 1288—c. 1348), who said, “Entities should not be multiplied unnecessarily.”
This scientific philosophy would become known as “Ockham’s Razor,” which is still to this day used as a rule of simplicity to be followed for scientific hypotheses, theories, and experiments. To follow Ockham’s Razor in life and in money, you will remove the unnecessary and complex aspects and keep only the most simple, most important ones, which are commonly the most accurate and successful in application.
When it comes to money and personal finance, we are taught (and unfortunately believe) that accumulating financial wealth involves some kind of trick, gimmick or shortcut that can only be learned by purchasing and/or studying a product or service, which is often a lengthy, multi-step, multi-tiered undertaking. Put simply, money is unnecessarily made to be complex.
For example, the most accessible means of building financial wealth for the average person is investing in the stock market. Ironically, investing in stocks can also be a complex means of losing financial wealth. And the most common reason that investors fail in this regard is due to the flawed thinking that knowledge and actions are the keys to success—that success only comes by some kind of complex process only possible for those with years of education and experience.
We are taught that investing is about “beating the market.” And so the do-it-yourselfers, and especially the stock brokers and professional money managers, spend their time and energy looking for information that can give them some kind of edge over other investors.
This activity is captured in in an investing style called active investing, which is just as it sounds: The investor or money manager is actively trying to beat the market by achieving incredibly high rates of return through research and timing techniques.
But when investors apply the timeless virtues of humility and patience, an all-encompassing investment philosophy emerges, which is embodied in the virtue of simplicity. In different words, when you realize that you can’t really know or predict what the stock market will do and that time is the best friend of the investor, you can see clearly that the active investing strategy is not wise or necessary to accomplish your investing goals.
Successful investing, for most people, can be accomplished with the opposite of the active investing strategies; it can be accomplished with the powerful simplicity of passive investing.
When you invest passively, you are not trying to beat the market; you are simply investing to match what the overall market is doing over time. This passive style can be easily implemented by investing in what are called index mutual funds, and it can be successful over time because it eliminates the expensive and self-defeating behaviors that active investing often involves.
Mutual funds can be simply described as buckets. Each bucket will invest in dozens or hundreds of securities, such as stocks or bonds, within one investment. The index style of mutual funds can invest in “the market” by holding in the bucket a representative sampling of the securities within a given benchmark index.
For example, you may have seen on the news or on a website the daily performance of the Dow Jones Industrial Average or the S&P 500 Index. These are both indexes that give investors an idea of how “the market” is performing, because they represent a large number of stocks. These are the indexes that investors and money managers are trying to beat.
But the research and time required in the attempt to beat the market indexes can get expensive due to trading costs, commissions, and manager fees. Not only does this active investing strategy cost money, but the risk of making poor investment management decisions, usually due to the damaging human emotions of fear and greed, can also be costly in the form of mistakes that cause severe declines in the investor’s account value.
So how can you employ a simple and effective passive investing strategy? Once again, you can use index mutual funds. For example, the first index fund, made available to the public, Vanguard 500 Index, was (and still is) offered by Vanguard Investments, founded by Jack Bogle.
Bogle founded the company on the idea of simplicity and passiveness, which is to say that by simply buying an index fund, you can capture the returns of “the market,” and rather than losing to it, you can match it. Today Vanguard is the largest mutual fund company in the world. However, Vanguard investors are still a minority in financial terms compared to the gigantic collection of institutional banks, brokerage firms, individual investors and hedge funds that still attempt the active investing strategy.
For an example of the power of simplicity, look no further than a comparison of a Vanguard index fund, called Vanguard Balanced Index (VBINX), which consists of a balance of stocks and bonds, and the average hedge fund.
For background, consider that Vanguard funds typically have a $3,000 minimum initial purchase to invest, whereas hedge funds require investors to have high net worth, such as $1 million or higher. Also Vanguard funds have an average expense ratio (internal management expense) of 0.19 percent, whereas hedge funds are often 10 times that at around 2 percent of assets plus a 20 percent cut of profits. Therefore, you have the small, accessible, simple and passive index fund versus the big, nearly inaccessible, complex and actively-managed hedge fund.
According to The Wall Street Journal, in 2014, the Vanguard Balanced Index fund had a gain of 9.8 percent, compared to the average hedge fund’s performance of just 3 percent. To capture a broader time period for comparison, the index fund’s 10-year average return is 7.3 percent, compared to 5.1 percent for hedge funds. A simple, low-cost balance of stocks and bonds beats the complex and expensive hedge funds!
In summary, we cannot control the market, but we can control our choices. By choosing the wisdom of simply-balanced mutual funds and index funds, we give ourselves a greater chance of investing success and we make our lives simpler at the same time.
Also, the stock market can be considered a product of nature, because it is a composite of human activity and interaction, and humans are a part of nature. And when we try to interfere, control, or go against nature, the results are not usually positive, to say it in a pleasant way.
When we make our lives simple, we stop struggling against nature. And to stop struggling against nature, we become passive; we “go with the flow” rather than against it. The same wisdom applies to investing our money.
Kent Thune is a money manager and the owner of a Hilton Head Island investment advisory firm, Atlantic Capital Investments. He is also a freelance writer and is currently working on a book to be published later this year. You can follow his musings on mind, money and mastery of life at TheFinancialPhilosopher.com or follow him on Twitter @ThinkersQuill.