Category: Blog

The fastest way to lose half of your money is not a stock market crash but a divorce, separation or a poor business decision (so it’s a good idea to make sure you’re on the same page with your partner when it comes to joint finances.)

Many have felt disheartened by the stock market in recent times, especially with the historic GameStop trading fiasco. It’s easy to feel confused and assume the market is rigged against the smaller investors.

However, the small-time investor could have a ton of advantages over the pros. They don’t need to pay attention to short-term performance or benchmarks or made-up risk-adjusted return metrics. They can play the long game and not worry about all the stuff professional investors are forced to obsess over.

In Ben Carlson’s book, Everything You Need To Know About Saving For Retirement, he talks about how the stock market works. This is an edited extract from chapter eight.

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After getting engaged my wife and I began having some deeper philosophical conversations about how we would run our joint finances. We were in our mid-to-late 20s at the time so I informed her I would like to put the majority of our retirement savings into the stock market.

My wife, like most normal people, did not know much about the stock market except for what she heard on the news or saw on TV and in the movies. She did not give much thought to investing in stocks. So when I told her we would be saving the bulk of our retirement money in stocks (especially when we were younger) she was initially concerned.

What follows is more or less what I told her (and despite going through this exercise she still agreed to marry me if you can believe it).

The stock market is the only place where anyone can invest in human ingenuity. It is a bet on the future being better than today. Stocks can be thought of as a way to ride the coattails of intelligent people and businesses as they continue to innovate and grow. Short of owning your own business, buying shares in the stock market is the simplest way to own a slice of the business world.

The greatest part about owning shares in the stock market is you can earn money by doing nothing more than holding onto them. When companies pay out dividends to shareholders, you get cold hard cash sent to your brokerage or retirement account which you can choose to either reinvest or spend as you please.

Many people compare the stock market to a casino but in a casino the odds are stacked against you. The longer you play in a casino, the greater the odds you’ll walk away a loser because the house wins based on pure probability. It’s just the opposite in the stock market.

The longer your time horizon, historically, the better your odds are at seeing positive outcomes. Now these positive outcomes don’t guarantee a specific rate of return, even over longer time frames. If the stock market were consistent in the returns it spits out, there would be no risk.

If there were no risk, there would be no wonderful long term returns. And because there is risk involved when owning stocks, your returns can vary widely depending on when you invest in the stock market.

It has been possible to lose money over decade-long periods in the past. Even 20 to 30 year results can see a big spread between the best and worst outcomes. However, it is worth noting that even the worst annual returns over 30 years in the history of the U.S. stock market would have produced a total return of more than 850%. This is the beauty of compounding. The worst 30 year return for the S&P 500 gave you more than 8x your initial investment.

$10,000 dollars invested in the S&P 500 in the year:

• 2010 would be worth $37,600 by September 2020
• 2000 would be worth $34,200 by September 2020
• 1990 would be worth $182,300 by September 2020
• 1980 would be worth $918,500 by September 2020
• 1970 would be worth $1,623,500 by September 2020
• 1960 would be worth $3,445,000 by September 2020

I’m ignoring the effects of fees, taxes, trading costs, etc. here but the point remains that over the long haul, the stock market is unrivaled when it comes to growing money. And the longer you’re in it the better your chances of compounding.

Having said all of that, there is an unfortunate side-effect of this long term compounding machine. Stocks can rip your heart out over the short term. If there is an ironclad rule in the world of investing, it’s that risk and reward are always and forever attached at the hip. You can’t expect to earn outsized gains if you don’t expose yourself to the possibility of outsized losses. The reason that stocks earn higher returns than bonds or cash over time is because there will be periods of excruciating losses.

The stock market is fueled by differences in opinions, goals, time horizons and personalities over the short term and fundamentals over the long term. At times this means stocks overshoot to the upside and go higher than fundamentals would dictate. Other times stocks overshoot to the downside and go lower than fundamentals would dictate. The biggest reason for this is because people can lose their minds when they come together as a group. As long as markets are made up of human decisions it will always be like this. Think about how crazy fans can get when their team wins, loses or gets screwed over by the refs. These same emotions are at work when money is involved.

How you feel about investing in the stock market should have more to do with your place in the investor’s lifecycle than your feelings about volatility.

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Remember, the stock market isn’t the only way to invest money, but it helps us with portfolio diversification, a well-practised strategy for protecting our future wealth.

One of the challenges of financial planning is its complexity. Not only is it mathematically layered, but it’s also fraught with bias and emotional influence. For most of us, we only scratch the surface of about seven areas of financial planning and allow experts to make recommendations and decisions that will hopefully create a better financial position for us in the future.

When it comes to investing (just one area in about seven), there are loads of biases that can either help or hinder the protection and growth of our assets. This makes asset management and investment planning a constantly evolving landscape and requires several types of niche specialists.

Anchoring is a cognitive bias that often comes into play when we are trying to establish the value of something.

This doesn’t only apply to investing – it applies to commodities and services across the board. Every day, we rely on the anchoring bias to help us form a perception of value, from standing in the fresh foods aisle to standing in a second-hand car lot or calling around to find a plumber to fix a leak.

“People make estimates by starting from an initial value that is adjusted to yield the final answer,” explained Amos Tversky and Daniel Kahneman in a 1974 paper. “The initial value, or starting point, may be suggested by the formulation of the problem, or it may be the result of a partial computation. In either case, adjustments are typically insufficient. That is, different starting points yield different estimates, which are biased toward the initial values.”

This means that we tend to rely too heavily on the very first piece of information we learn, which can seriously impact the decision we end up making. And, living in a world where we have far more access to information than ever before, complicates our decision-making exponentially.

So – can we avoid it? Well, according to Investopedia, not entirely. Here are some ideas they offer to manage our anchoring bias.

Studies have shown that some factors can mitigate anchoring. Still, it is difficult to avoid altogether, even when we are aware of the bias and deliberately try to avoid it. In experimental studies, telling people about anchoring, cautioning them that it can bias their judgment, and even offering them monetary incentives to avoid anchoring can reduce, but not eliminate, the effect of anchoring.

If you are selling something or negotiating a salary, you can start with a higher price than you expect to get as it will set an anchor that will tend to pull the final price up. If you are buying something or a hiring manager, you would instead start with a lowball level to induce the anchoring effect lower.

Ultimately, if we can’t avoid anchoring, we should at least try to use it to our advantage. In financial planning, we have a process called due diligence. This helps us obtain as much relevant information as possible to a specific decision to help us create a close-to-accurate anchor.

One of the early appeals for cryptocurrencies was that they would not be taxed as they are not fiat currencies (yet), in that they are not owned by a country or used for trade inside of geographical tender regulations.

However, as these platforms grow and develop, we are seeing that this is most likely not the case. According to several governments, cryptocurrencies, such as Bitcoin, are classified as “intangible assets” – as opposed to, say, property or currency. 

These definitions differ slightly in different regions, but for the most part, gains or losses related to cryptocurrencies can be classified into three categories or scenarios, each of which could result in different tax consequences:

1. A cryptocurrency can be acquired through so-called “mining”. Mining is conducted by the verification of transactions in a computer-generated public ledger, achieved through the solving of complex computer algorithms. The “miner” is rewarded with ownership of new coins by verifying these transactions, which become part of the networked ledger. This gives rise to an immediate accrual or receipt on successful mining of the cryptocurrency. This means that until the newly acquired cryptocurrency is sold or exchanged for cash, it is held as trading stock, which can be realised through either a normal cash or barter transaction.

2. Investors can exchange local currency for a cryptocurrency (or vice versa) by using cryptocurrency exchanges, which are essentially markets for cryptocurrencies, or through private transactions.

3. Goods or services can be exchanged for cryptocurrencies. This transaction is regarded as a barter transaction. Therefore the regional barter transaction rules apply. 

While the initial receipt of cryptocurrency from mining is classified as income for tax purposes, revenue services may apply a distinct set of tax rules to the cryptocurrency’s subsequent disposition. Short-term trading to generate daily wages is considered income for tax purposes, but long-term investments (usually exceeding three years) are subject to capital gains tax. 

We are already reading reports of treasuries extending their cryptocurrency audit and detection services by many global media outlets. In addition, some have publicly listed employment opportunities geared explicitly towards cryptocurrency tracking.

According to recommendations, taxpayers who treat cryptocurrency transactions in a way that is inconsistent with their respective tax laws may face penalties. As a result, you must stay up to date on the newest developments in crypto tax legislation if you own crypto.

Dualistic thinking assumes a universe where there are only two opposing, mutually incompatible options or realities. This type of thinking is either/or, good/bad, negative/positive, and has a significant impact on our beliefs and behaviours.

Our development is stymied by dualistic thinking. The sooner we can break free from this either/or mindset, the sooner we can nurture greater success in the workplace and in our personal lives.

This either/or mentality contributes to our fears and concerns by presuming the false restriction that no other choices exist. We might feel confined, perceiving little freedom when we think in this way.

We may feel trapped or powerless in a circumstance when our options, choices, and determination appear to be limited. We tend to react emotionally in such cases, sometimes not even aware of the reasons why. 

Dualistic thinking hinders our personal and professional progress because we rarely allow for a range of options. We rate the situations and people around us on a binary scale. We reduce our capacity to see alternative possibilities by limiting ourselves to only two options.

Our psychological bias is a significant hazard of dualistic thinking. The “snake bite” effect, for example, occurs when an investor has a bad experience with an investment that causes them to be more cautious in future investment decisions, lowering their return potential.

The fear of regret and feeling like we have made a decision that is inherently ‘wrong’ leads to this bias. One way to counter this effect is to adopt a strategy that closely adheres to predetermined investing criteria and eliminates most of the decision-making process on what to purchase, when to purchase, and how much to purchase.

Using rules-based trading techniques decreases the likelihood of an investor making a discretionary decision based on previous investment success.

We create unrealistic expectations when we consider simply “good” and “bad”. Whatever decision you make will have implications, some of which will be unexpected.

Those implications may appear to be a choice between what you leave behind against what you get, or there may be aspects of both that you appreciate. It’s crucial to recognise that it’s often impractical to expect our actions to only have two possible outcomes; we should always look for a third outcome to help balance our expectations.

Once we have realised this, we can concentrate on what appears to be the best course of action for our personal circumstances.

One long-held belief is that lemmings purposefully run off cliffs in their millions. This myth has become a metaphor for the behaviour of crowds of individuals who follow each other blindly, regardless of the consequences. Herd instincts are prevalent in all parts of life, including the financial industry when investors follow what they feel other investors are doing rather than conducting their own research.

A herd instinct is a type of behaviour in which people react to and follow the activities of others. This is comparable to how animal groups react to danger – whether real or imagined.

Following the crowd or herding can lead trends to amplify well beyond fundamentals. Prices can skyrocket when investors flood into ventures for fear of losing out or because they have heard something positive but haven’t done their own due research.

This unreasonable optimism can lead to asset bubbles that eventually burst.

In the opposite direction, sell-offs can lead to market crashes when people rush to sell simply because others are doing so, a phenomenon known as panic selling.

If most people are heading in one direction, an individual may feel as if they are making a mistake by walking in the opposite direction. They may also be afraid of being singled out for refusing to join the bandwagon. Although herding is instinctive, there are strategies to avoid following the mob, especially if you believe you will be making a mistake. It necessitates self-discipline as well as a few considerations:

• Doing your own research is essential; study the facts and data and draw your own conclusions. Once you’ve completed your due diligence, then you can look at other people’s interpretations.

• Inquire about how and why individuals are doing things. Are they making decisions based on the movement of the herd? If you believe it is the wrong decision for you, don’t be afraid to go against the grain.

• If you’re distracted or emotionally charged, whether from stress or external factors, postpone making decisions.

Making investing decisions based on logical, objective criteria and not allowing emotions to take over is a solid strategy to avoid herd instinct. Another option is to use a contrarian approach, in which you purchase when others are panicking, taking advantage of bargains, and selling when excitement leads to overvaluation. As Jonathan Sacks once said, “The wisest rule in investment is: when others are selling, buy. When others are buying, sell.”

At the end of the day, it’s human nature to want to fit in, so resisting the impulse to stray from your plan might be challenging. This is where financial planners step in, serving as a sounding board for your decision-making process.