OK, it might not be a comfortable retirement in Palm Beach County, but whatever your ultimate investment objective might be, the question is, How do you make sure you get there? JACK BRENNAN has had a long distinguished career in the fund management industry. He was Chief Executive Officer of Vanguard from 1996 to 2008 and Chairman of the Board from 1998 to 2009. Here he explains the key challenges today's investors face, and how to navigate them, in order to maximise their chances of reaching their chosen destination.
In my recently published book, , I discuss the concept of “getting to Boca”. It is a metaphor, which I borrowed long ago from a newspaper columnist and refers to arriving at one’s ultimate investment objective. In the column, one retiree admitted that he didn’t know whether he’d beaten the stock market, but he cared little because his investments enabled him to end up in a beautiful community on the Florida coast.
How do you get to Boca Raton? First, recognise that your Boca is personal. It could well be living your golden years in warmer climes. Or a second home, a college education for your children, or a sizeable estate to bequeath to your heirs or favourite charities.
Second, to arrive in your Boca, you’ll need a map — a financial game plan that identifies your objectives. In the book, I quote legendary baseball catcher Yogi Berra to drive home the point: “You got to be very careful if you don’t know where you’re going, because you might not get there.”
Here are three additional rules of the road for successful investing:
Invest with balance and diversification. For balance, invest across at least two of the three major asset classes: stocks, bonds, and cash investments. For diversification, make sure your assets are not overly concentrated in any single company or industry. Mutual funds and ETFs are the simplest, most effective vehicles for executing both of these strategies.
Control your costs. Minimise your investment costs and taxes. You can’t control the financial markets, but you can control your cost to participate them. You can also control your trading activity, and keeping it to a modest level will, along with investing in tax-efficient funds and utilising tax-advantaged accounts, minimise taxes.
Maintain a long-term perspective. There will be good times and bad times during your investment career. When times are good, be grateful, not greedy. When times are bad, remain patient and disciplined.
It would be unrealistic to think that you won’t face challenges on the road to Boca. Let’s consider the difficulties in today’s environment and some self-imposed challenges, and importantly, how to navigate them.
The challenges of the markets
One of the most pronounced challenges in today’s environment is low interest rates. Rates have been persistently low for a very long period of time, leading many investors to ask: Where did my income go?
Consider a $100,000 investment in 90-day T-bills in November 2006 would have produced interest of $1,250 over three months. The same investment today — and for most of the past 10 years — generated income of $25 — a 98% decline in the productivity from an investment in the world’s safest instrument! The story is similar for 10-year U.S. Treasury bonds, which have suffered an 80% decline in income over the past 12 years.
As you can see, the implications of low rates for investors are profound, especially for those relying on income from their portfolios to meet everyday living expenses. The remedy? Consider other means of generating income by 1) reducing holdings in low-yielding money market funds and turning to short-term bond funds, ultra-short-term bond funds, or bank CDs and 2) increasing your allocation to high-quality dividend-paying and dividend-growing stocks.
Higher inflation may also be a challenge. Inflation has largely been tame, so many investors forget about it as an enemy. Bonds are particularly vulnerable because much of their return consists of interest payments, which are worth a little less each year in an inflationary period. Again, devote a healthy portion of your portfolio to stocks, which have afforded the best protection against inflation of the three major asset classes.
Before recent setbacks, the U.S. stock markets were trading at near record levels. One might not immediately see this as a challenge, but markets that appear perilously high may give some investors pause in committing additional capital to stocks or impel others to stop regular investments while waiting for a more opportune time when prices seem more attractive.
Don’t let the direction of the markets dictate your investment strategy. In the book, I recommend using time instead of choosing time. Dollar-cost-averaging — committing a set amount on a regular basis — is a simple and sensible way to invest.
Finally, temper your expectations. We’ve enjoyed an astounding run of 18.4% in U.S. stocks on an average annualized basis from March 2009 through June 2021, which is 80% above the historic average of 10.3%. Don’t presume that future returns will be as generous and resist the temptation to “panic buy” on fears of missing the next big upswing. If you have a thoughtful asset allocation based on your personal goals, time horizon, and risk tolerance, stick with it. And if you expect less bountiful returns going forward, consider increasing the amount you put away.
The challenges of the “new, new thing”
There have always been “financial innovations” seeking to part investors from their money, and today is no different. Opportunities apparently abound in alternative investments (e.g., venture capital, private equity, and hedge funds), cryptocurrencies, NFTs and SPACs.
Be sceptical and get educated. For example, alternative investments were formerly the domain of sophisticated institutions and wealthy individuals, but now are increasingly available to individuals of more modest means. These investments are complex, and even if offered by a trusted provider, one needs to understand the following dynamics:
• Cost. Most ’alternatives’ offerings are very expensive. Know what you’re paying.
• Alignment of interests. All of these investments include incentive fees for good performance. Make sure those incentives are aligned with your interests.
• Illiquidity. Most of these vehicles are illiquid, so unlike funds and ETFs, you cannot get your money back on demand. Be sure you can withstand that constraint.
• Access. The best of alternative asset providers are exceptional. The average of them, however, are not worth the cost.So, be very discerning about the sponsor.
On top of tempting alternative investments, some brokerages have built business models on encouraging frequent trading with zero commissions and gamified online trading interfaces, seeking to attract younger investors into trading stocks with video game controller ease. In the book, I recount the old Wall Street adage: “The best way to make a small fortune is to start with a large one and trade a lot.” Enough said.
The challenges within ourselves
In the book, I share the wise words of Benjamin Graham: “The investor’s chief problem — and even his worst enemy — is likely to be himself.” We are all subject to tendencies and biases that can hinder our investment progress, such as overconfidence, inertia, and loss aversion.
Herding is another behavioural tendency that is prominent today. It plays out like this: My colleague seems to be making a fortune in meme stocks, so I am going to do it. Think tech stocks 20 years ago. In investing, you may follow the crowd and they may lead you right over a cliff.
Another is the tendency to act. Even investors who understand the wisdom of buy-and-hold sometimes feeling uncomfortable doing nothing, especially when so many environmental forces are enticing us to trade or tinker with our asset allocation. The “noise” in the marketplace has never been more prevalent nor louder. Most of us are constantly barraged by market and business news through traditional and social. As you toggle through news feeds on your phone or tablet, you’ll see a myriad of posts or headlines that might compel you to act. React to them at your peril. Better yet, ignore them.
I will close by paraphrasing a well-known Irish prayer: May the road rise to meet you and the wind be always at your back... on your way to Boca.