If you follow us on Twitter, Facebook or Pinterest, you’ll know we love our quotes - wise words that reinforce the principles of sensible investing. Our highly popular series of quotes from the author William Bernstein is coming to an end, but we’re pleased to announce a new series featuring the wisdom of Morgan Housel. Morgan is a columnist at the Motley Fool and the Wall Street Journal, and is widely considered as one of the most insightful investment writers in the world.
We recently caught up with him and asked him for his take on some of the key issues facing investors today.
SITV: Morgan, thank you for your time. Our upcoming series is based on a collection of quotes, stats and lessons that you were originally compiling for a book… Is that right?
Morgan Housel (MH): Yes! So much investment writing is overly complicated. Some of the smartest investing stuff I’ve read can be summed up in a sentence or two.
There’s a tendency to think more words equals more information. But it’s often the other way around. I included a quote from investor Nick Murray: “Timing the market is a fool's game,” he says, “whereas time in the market is your greatest natural advantage." I think there’s more wisdom in that sentence than in most entire books written on the subject.
Mohnish Pabrai, a great investor, tells the story about writing a book. A physics professor gave a short lecture, and a book agent came up to him later and said, “I love your lecture. I’d like you to turn it into a book.” The professor says, “Thanks, but I don’t think I can turn it into a book. I have ten pages of notes on the subject, and there’s nothing else to say. I just said everything I know about the topic in that short talk.”
The agent says, “That’s not a problem. Writing a book is like a roll of toilet paper. You start with a dense core, then wrap it with layers of fluff.”
“I find myself routinely drowning in fluff trying to find an elusive nugget of real content,” Pabrai said. “I wish ten-page books were the norm.”
I do too. It’s why I love short, pithy quotes. They’re all core and no fluff.
SITV: One reason we like your work so much is your humility: you’re not afraid to say you don’t know where markets are heading. Why is there so much forecasting in the financial media?
MH: The history of forecasting the stock market is awful. Yet people pay big money for forecasts. Why?
I think there are a couple reasons.
One, the stakes are so high. If you know where the stock market is going next year, you can make an enormous amount of money, since you can borrow money and magnify your returns. If you can successfully forecast the market a few years in a row, you’re done. You can retire.
There is a correlation between payoffs and people’s willingness to believe nonsense. Even if I know market forecasts are all silly guesses, what if there’s a slim chance they’re right? The reward for following a correct forecast is so huge that maybe I’ll listen.
In his book Extraordinary Popular Delusions and the Madness of Crowds, Charles Mackay wrote:
"During the Great Plague of London, in 1665, the people listened with avidity to the predictions of quacks and fanatics. Defoe says that at that time the people were more addicted to prophecies and astronomical conjurations, dreams, and old wives' tales than ever they were before or since."
Here, too, the higher the stakes, the more people listen to quackery.
People also want to think the stock market is like physics: something that works in clean, predictable ways, where I can measure something now and it will tell me with precision what will happen next.
If you think stocks are like physics, you believe there must be mathematicians out there who can crunch numbers and tell us where the Dow Jones will be in six months, just as scientists can measure with precision what time the sun will rise in Tokyo in six months.
But stocks aren’t like physics. They’re like psychology – a field that works in strange, paradoxical, unpredictable, and messy ways.
To forecast the stock market we have to forecast human emotions. But we can’t do that. If someone said, “I think the average American will be in a 2.1% better mood six months from now,” people would call you insane. But that’s what analysts do when forecasting the market.
People’s desire for forecasts will never go away, no matter how bad the track record. Our thirst for predictability is insatiable.
SITV: The Dow Jones Industrial Average recorded no fewer than 34 record highs in 2014. Can you understand investors being nervous about investing in stocks just now?
MH: Since 1928, about one in every 20 trading days has been an all-time high for the Dow Jones. So having 34 all-time highs in 2014 isn’t that unusual. I think since the market suffered two big crashes over the last 15 years, people associate all-time highs with danger and bubbles. But they’re not rare, historically.
Being nervous is a function of fearing an unknown, like a market crash. But these, too, are common. You should expect stocks to fall at least 10% once a year, 20% once every few years, 30% or more once or twice a decade, and 50% or more once or twice during your lifetime. That’s what’s happened to U.S. stocks over the last century.
Investors should make themselves familiar with these kind of market-history statistics. If you’re aware of how common all-time highs and market crashes are, you won’t be as shocked when they come.
SITV: It would be a surprise if active managers perform quite as badly this year as they did last, and indeed we keep hearing that now might be a good time to give stock picking another chance. What’s your view of that?
MH: I don’t think there’s ever a time when stock picking does or doesn’t work. There are only good and bad investors, and you can be either one as a stock picker or an index fund investor.
There’s so much data showing most stock pickers don’t beat the market. But most index fund investors also drastically underperform the market, by more than the fund’s expense ratio. They do poorly because they’re not really investors. They’re short-term traders, buying when the market is doing well and selling after a crash.
People always say, “Oh, the average stock picker underperforms the market by 1% per year.” They’re right, but the SPDR S&P 500 Index fund trades, on average, 12% of its shares outstanding every single day. Jesus, I don’t want to know how awful the average investor in that index performs. It has to be disastrous.
If you’re actively buying and selling, you’re probably going to do terribly even if you own an index fund. But if you’re truly a long-term investor, willing to hold stocks for years or decades, you’ll likely do just fine owning a basket of, say, 30 individual stocks of established high-quality companies. In fact, you’ll very likely do better than the average index fund investor who’s trading in and out of markets.
That’s a longwinded way of saying: I don’t think the important question is asking whether you’re a stock picker or an index investor. Asking whether you’re a trader or an investor is what we should be paying attention to.
SITV: Though few people seem to like the name, we’ve seen a huge growth recently in the popularity of smart beta. Is it really smart, or just marketing hype?
MH: Most stock indexes are market-cap weighted (the largest companies get the most weight), which is a silly idea. If smart beta moves away from cap-weighted indexes to fundamentally weighted indexes – where, say, the cheapest companies get the most weight – I think that’s a rational move forward.
The history of investment products that sound good in theory and end up disappointing is long. So we’ll have to wait and see how smart beta does over time. Like most investment products, if it works it will attract attention, and once it attracts attention it won’t work as well.
SITV: Here in the UK and in the rest of Europe, there seems to be much less awareness than in the US of how much investing actually costs and what alternatives there are to traditional active fund management. Do you see that changing?
MH: That’s such a good point. I was in Canada a few years ago and was shocked to learn that the average Canadian investor pays more than 2% a year in mutual fund fees. Some funds charge, 2.5%, 3% a year.
What blew me away was that the average Canadian investor didn’t seem to mind. Their response to high fees was basically a shoulder shrug. Vanguard, the low-cost index provider, has been making a push into Canada for years, and as I understand it hasn’t made much progress. The message of low fees doesn’t resonate with Canadians like it does Americans.
There are big cultural differences between investors of different countries. I think Americans pay more attention to fees because we can’t rely on public pensions the way other nations can, so our personal investments are vitally important to providing for retirement.
I hope the low-fee movement catches on in Europe, but I don’t think it’s guaranteed.
SITV: A big development in recent years has been the emergence of online providers like Wealthfront and Betterment in the US, or Nutmeg, Wealth Horizon and SCM Direct in the UK. Should investors be using them, or are they better off having a real-life adviser?
MH: While speaking about payments, venture capitalist Marc Andreessen recently said: “Financial transactions are just numbers; it’s just information. You shouldn’t need 100,000 people and prime Manhattan real estate and giant data centers full of mainframe computers from the 1970s to give you the ability to do an online payment.”
It’s the same with investments. Why should I need to book an appointment and drive to my local Edward Jones adviser when I can get good investment advice online?
There are things like estate planning and taxes that will still require human interaction. Human financial planners aren’t going away. But I think they move to online platforms. I think the future is automated asset allocation advice online with the ability to speak to a qualified human over the phone, or Skype.
SITV: Finally, what part do the media and the likes of Sensible Investing have to play in giving people the information they need to invest successfully?
There’s so much financial information out there. A kid in Somalia with a smartphone can tell you exactly where Coca-Cola stock traded at 10:42 am on Feb. 7th, 1991, and can see exactly how many shares of each company Bill Ackman owns.
What we need more of are people who can make sense of all the information that’s available, guiding investors to what’s important and what’s noise.
The vast majority of financial information we have available is noise. The role of the investment media is two-fold: To shoo investors away from the noise, telling them how meaningless it is, and to steer them to the data, logic and wisdom that really matters. Both parts are equally important.