The soundest way to wealth is the simplest: People need to spend less than they earn, save the difference, buy a diverse portfolio and be patient as gains compound.
But that’s not how investing is taught in school, says Morgan Housel, a partner at the Collaborative Fund. Just as people chase diet fads rather than getting the right amount of exercise and eating nutritious foods for a healthy life, they also ignore simple investing advice and chase the next hot investment.
“Things that are simple and basic are not taken as seriously. … It’s like the diet and exercise part of investing,” Housel said. “The goal of investing is not to minimize boredom; it’s to maximize return. No investment recommendation is worth it if a client can’t stick to it.”
Housel spoke Wednesday at the Morningstar Investment Conference in Chicago. A common theme in his behavioral finance presentation was the way people think about risk. Usually when people think about it, they think of it as something they can’t control: that it’s something that happens to them, something the market does, some sort of economic cycle or another external factor.
But that’s what makes them their own worst enemy when it comes to investing. People’s unique experiences and their biases will color their views on life, and on investing in particular. That can have more of an impact on their portfolio return than other factors, he said.
“Behavior is the most important part of investing, and it’s the only thing you can control,” he said.
But because people can learn to control their behavior, he said he’s optimistic they can also maximize their wealth. He gave examples of how financial advisors can understand key parts of investor behavior to help guide clients to good outcomes.
1. Good investing is not about what someone knows but about how someone behaves. It’s one of the few activities in which smart people become gullible and can’t think about risk in a rational way. When high stakes are combined with the unknown causes of big events, it can cause people to lose their way.
Housel said the research he has done suggests that an individual’s risk tolerance depends on his or her life experience. “Everyone anchors to their own past,” he said.
What helps to combat that bias is talking to as many different people as possible, in different countries and in various generations, including those whose experience is different and who have different viewpoints. “You cannot assume they are not as smart as you or have more information. They might have as much data as you, be as smart, but have experienced life differently,” he said.