By Jason Zweig | Sept. 18, 2017 8:22 p.m. ET
Image credit: Erastus Salisbury Field, “The Garden of Eden” (ca. 1860), Museum of Fine Arts, Boston
One of the most remarkable aspects of today’s financial markets is that, at one and the same time, individual investors have never been treated better and have never felt worse. With future returns on stocks likely to be lower than the historical average, hedge funds using predatory trading techniques, frequent “flash crashes” in which prices go haywire, and the yield on fixed-income investments so low you couldn’t find them with an electron microscope, investors often feel as if they are standing outside shivering in the cold, shaking a tin cup. But a little historical perspective is a healthy reminder that investors have come a long way since the 1970s. If you behave patiently and prudently, you have a higher probability than ever before of keeping most of the returns your portfolio generates. A decade ago, I looked back 35 years and described how the landscape had changed. The conclusions are at least as valid today.
Are You a Better Investor?
Over the past 35 years, investing has become simple, cheap and convenient. Now it’s a snap to build your wealth — or destroy it.
Money magazine, October 2007
It is Oct. 26, 1972. You turn on your transistor radio and the newscaster reads the closing-bell report from the New York Stock Exchange: The Dow Jones Industrial Average — led by stocks like Bethlehem Steel, International Harvester, Johns-Manville and Union Carbide — closed at 950.56 on an extremely heavy volume of 20.8 million shares.
The next morning you drive over to see George, your stockbroker. He recommends the Fidelity Trend Fund, which charges a sales commission, or load, of only 8.5%; most of the 400 or so load funds in existence charge 8.75%. Whenever you buy and sell a stock, George’s commission will average about 1.3% of the transaction. But so would any other broker’s.
In 1972 “the investing world was much easier to comprehend,” says Joel Seligman, a financial historian and president of the University of Rochester. You knew your broker, and he sold stocks, not funds of hedge funds. Your bank took deposits, not mutual-fund commissions. Your insurance agent didn’t come at you swinging a variable annuity like a meat ax. During a typical week in 1972, the total of all trades on the New York Stock Exchange was less than the trading volume of Microsoft shares on a typical day in 2007.
But the investing world of 1972 was also low in choice, high in cost and short on convenience and information. Nasdaq and money-market funds were less than a year old. There was no such thing as a discount broker, an index mutual fund or a municipal bond fund, not to mention an IRA or a 401(k).
If you wanted a no-load fund, “first you had to find it,” recalls fund expert Michael Lipper of Lipper Advisory Services. That meant watching for an ad, making a toll call, waiting for the prospectus, then mailing in the check — a process that could take weeks. And 7% of all stock trades in 1972 “failed to deliver,” meaning that the paper certificates for the shares did not change hands within five days, potentially voiding the transaction. To check on your investments, you waited for tomorrow’s newspaper, or next week’s — or the maiden issue of MONEY that October, which many charter subscribers signed up for as the only convenient way to track their mutual funds.
2007: A Simpler Time
Fast-forward to 2007. Your stockbroker and your banker are a swirl of electrons. Adjusted for inflation, the average commission on a retail stock trade comes to about 3% of what it cost in 1972. You can choose from among more than 8,000 mutual funds and over 500 exchange-traded funds, or ETFs. You can buy a stock without getting out of your pajamas, and you’ve never had a trade fail to deliver. And you can watch the prices of your stocks change in real time from your office computer or your iPhone.
Less cost, more choice and greater convenience: Investing has never been simpler. The birth of the index fund in 1976 enabled anybody with a couple thousand dollars to own every major U.S. stock for less than 0.2% in annual expenses. Critics scoffed when Vanguard rolled out the first index fund — “The name of the game is to be the best,” said Fidelity chairman Ned Johnson, “and I can’t conceive of investment managers not even trying to do better than average” — but year in and year out, indexing has beaten roughly three-quarters of all funds. The investor who minimizes costs maximizes returns. Period.
More recently, indexing has spread to other markets — bonds, foreign stocks, real estate — so you can minimize your costs and maximize your opportunities for profit by covering every base. Meanwhile, the electronic ease of dollar-cost averaging (automatically routing a fixed amount from your bank to your index funds once a month, every month) means you can be a committed investor without ever lifting a finger, second-guessing yourself or timing the market. Combine the two strategies of indexing and dollar-cost averaging and you can hold the entire planet in a single portfolio on permanent autopilot. Nothing could be simpler.
One thing, however, hasn’t changed over the past 35 years: human nature. In 1972, Benjamin Graham was finishing the revise of his seminal work, The Intelligent Investor, in which he reminded readers that “the investor’s chief obstacle — indeed, his worst enemy — is likely to be himself.” Then, as now, investors got in trouble by acting on impulse: either getting carried away by greed or being paralyzed by fear. And solutions like indexing have always seemed a little unsatisfying. You want investing to be more complex so you can feel special when you figure it out. And Wall Street wants it to be more complex so it can make more money off your attempts to figure it out.
Thus in the first seven months of 2007, more than 130 ETFs were created to invest in commodities, foreign currencies and single-industry sectors. You can bet on the Swedish krona, buy a basket of carbon-emissions trading credits or attempt to gain twice as much as mid-size stocks lose when they go down. There’s now a fund for every conceivable need — and for plenty of inconceivable needs too.
Three Rules to Invest By
So how do you put all the innovations of the past 35 years to the best use for you, not Wall Street? Follow these rules:
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.
High returns and low risks don’t come in the same package. As Milton Friedman said, “There’s no such thing as a free lunch.” Just this summer, bank-loan and long-short funds became the latest “low risk, high return” products to flame out.
If you are presented with too many choices, you’ll end up afraid to choose at all. Psychologists have shown that having to pick among dozens of options not only makes it much harder for us to make up our minds, but it also fills us with regret. No matter what we choose, we worry that another choice must have been better. So don’t bother scouring among thousands of mutual funds and packing your 401(k) and other accounts with 78 of them. Instead, own a handful of low-cost, diversified index funds, add to them every month and do nothing else.
The Bottom Line
Despite Wall Street’s unrelenting efforts to complicate it, investing can be simple. But it isn’t easy. In 2007 as in 1972, building wealth is very much like losing weight. Eat less, exercise more: That’s simple! But it’s not easy, because the world is teeming with chocolate cake and Cheetos. Likewise, buy a diversified basket of index funds and do nothing: That’s simple! But it’s not easy because the world is full of TV touts, cold-calling brokers and (temporarily) hot funds.
Realize that what’s good about the difference between 1972 and 2007 is also what’s bad. Lower cost is great if you trade rarely and wisely, but not if it tempts you into buying and selling constantly. More choice is great if you add a few selected good things to your portfolio in moderation, but not if you end up with an unplanned jumble of investments. More convenience is great if you use it to make your life easier, but not if you take time away from family and friends to update your stock portfolio. Lower cost, more choice and greater convenience are not means to an end, they are the end. Use them to achieve some other result, and you will fritter away the advantages the past 35 years have brought. You might as well be back in 1972, wearing plaid bell-bottoms and driving a Dodge Dart.
Definitions of DAY TRADER, DIVERSIFY, FEE, INDEX FUND, IRRATIONAL, LONG TERM, OVERCONFIDENCE, PATIENCE, RISK, in The Devil’s Financial Dictionary
Introduction and Chapters One, Eight and Twenty in The Intelligent Investor
Chapter Five, “Confidence,” in Your Money and Your Brain
Kenneth R. French, “The Cost of Active Investing,” presidential address, American Finance Association