A Tale of Two Investors

This is a tale of two fictional investors, Paul and Mary. They approach investing very differently. I suspect you will be able to identify with one of them, and perhaps learn something from both.

Both Paul and Mary are deeply troubled by market volatility. They are still scarred by the market crash in 2008-2009. They have taken to heart the views of financial experts who state that another correction is not a matter of “if” but rather “when.” They are concerned that when the market tanks, the correction could be as bad as the one in 2008-2009, and maybe even approach the depths of the Great Depression.

Like many investors, Paul and Mary don’t trust Wall Street. They believe the stock market is rigged against small investors. They wish they didn’t have to invest at all. However, they have done their homework and understand the impact of inflation on their purchasing power. They know the average inflation rate over the past 100 years was 3.24 percent. They each have current annual living expenses of $75,000. They both intend to retire in 10 years. They were surprised to learn that in 10 years, they would need $103,167.10 in order to equal the purchasing power of $75,000 today.

They have concluded that they have no alternative other than to invest. That’s where the similarities end.

Paul’s investing approach involves efforts to predict the future, by relying on financial pundits and on “chief strategists” for the major brokerage firms. Last week, he received the following “insight” from a prominent brokerage firm: “The first quarter having gotten off to a false start, markets are trying to find their footing as investors agree to focus on fundamentals. Our outlook for this year has not changed as we expect to remain tactical in this volatile market environment.” Paul believes these “experts” have valuable insights into where the market is headed.

Paul is a voracious consumer of the financial media. He is swayed by the often-conflicting views of financial pundits who offer their views on whether stocks are likely to go up or down, or the next “hot” fund manager. He is impressed with the confidence with which these “pros” make observations like “the market is primed for a correction.”

Mary’s approach to investing could not be more different. She is a “show me” person. For her, either there is data to support an investment strategy or she is not interested in pursuing it. She finds observations characterizing the behavior of investors as nonsensical. She doesn’t understand how the mood of millions of investors all over the world can be summarized by anyone.

She checks out the track record of the “experts” making predictions about the market. One source she uses is PunditTracker.com. According to its analysis, the mean S&P estimate of six large brokerage firms at the start of each of the past three years has been considerably off target each year. She doesn’t understand why anyone would rely on the predictions of “experts” with such a poor track record.

Mary doesn’t believe she is smarter than millions of investors all over the world who have almost instantaneous access to the same information about stocks and bonds. She has looked at the data and notes that only 19 percent of actively managed stock mutual funds survived and beat their benchmark index for the decade ending December 31, 2013. Only 15 percent of actively managed bond mutual funds survived and beat their index over the same period. Mary doesn’t like those odds.

Mary’s analysis led her to index funds. She found them attractive because of their low costs and their track record compared with actively managed funds.

Mary focuses on factors she can control and ignores those she can’t. She determines her asset allocation (the division of her portfolio between stocks and bonds) with care because she understands that this is the primary determinant of returns over time. She only purchases low-management-fee index funds. She structures her portfolio to defer or avoid taxes wherever those opportunities arise. She rebalances her portfolio regularly to ensure her risk remains constant. When the opportunity for tax-loss harvesting arises, she takes advantage of it.

If you are investing like Paul, you can learn a lot from Mary.

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The opinions expressed by featured authors are their own and may not accurately reflect those of the BAM ALLIANCE. This article is for general information only and is not intended to serve as specific financial, accounting or tax advice.

© 2014, The BAM ALLIANCE

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Dan Solin

Dan Solin is a New York Times bestselling author and has published several books on investing, including his “Smartest” series. In addition, he writes financial blogs for The Huffington Post and Advisor Perspectives. Dan is a graduate of Johns Hopkins University and the University of Pennsylvania Law School.

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