Build Wealth by Watching the Grass Grow

Nobel Prize winning economist Paul Samuelson once said, “Investing should be dull.  It shouldn’t be exciting.  Investing should be more like watching paint dry or watching grass grow.  If you want excitement, take $800 and go to Las Vegas.”  This perspective captures the heart of our investment philosophy at PFS.  It may be exciting to trade stocks in an online account, trying to time the market or pick the next “hot” stock to score big gains.  It may be exciting to pay an advisor to try to outperform the market by finding the “best” stocks or actively managed mutual funds in which to invest.  But it is not the most effective way to build wealth. 

The chronic failure of individual investors to beat the market has been well-documented.  In fact, individual investors are so often wrong in the timing of their stock trades that some financial analysts use individual investor activity as a signal that they should do the exact opposite (this is known as odd lot theory).  However, professional investors trying to time the market and pick winning stocks (i.e. active managers) are scarcely more successful over the long term.  Over the past 20 years, only 16% of stock and bond funds outperformed their respective benchmarks.  Some investors try to improve these odds by picking managers who have outperformed market benchmarks in the past.  However, academic research shows that among managers who have outperformed in the past, only a small fraction continue to beat their market benchmark in the future.

So, what is the alternative?  Well-diversified, low-cost investments that simply try to buy all of the stocks or bonds in a given market or asset class and do not shift assets in and out of cash in anticipation of market upturns or downturns.  This includes mutual funds or exchange-traded funds that track a broad market index, and, even better, funds that are not beholden to the composition of an index but aim to hold all of the stocks in a particular asset class, like Dimensional funds.  This type of investment strategy attempts to avoid or minimize a number of factors that contribute to underperformance by active managers, including market timing risk, individual stock risk, high transaction costs, etc.  It does not aim to outperform the market, but, by definition, earns market returns because investors are consistently invested in the entire market (or the entire field of stocks or bonds in a given asset class).  Where these types of funds do try to gain an edge over the competition is by minimizing their fees—administrative and management fees passed on to the investor. 

Diversified, low-cost investing may be the emotional equivalent of watching the grass grow, but, as Samuelson said, if you need excitement, go to Vegas.  Don’t put it all on red when it comes to your life savings.