Thoughts about risk
Sometimes, the best way to manage risk is to be stupid, just like everybody else.
Conclusion first: Smart is risky. Sometimes, instead of being smart or innovative, it’s better to take advantage of natural forces. Time and regression to the mean are powerful natural forces. So is government. Get all of them on your side by investing in an index fund like the S&P 500. Use dollar cost averaging to make it affordable and effective. Put money in every month, and don’t touch it. Over time, you’ll probably do OK. You might do better with a smarter investment strategy, but why bother?
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Philosophy is about how to live. Money is an important part of that equation. How you think about money and risk are expressed in your investment philosophy. This is an article about mine.
Don’t take my advice, and don’t sue me if you do
I’m not an investment expert or professional. You’d be dumb to take my advice about investing. That said, I’m going to pick up from Ashley’s Wednesday post about managed risk by telling the story of my proudly stupid investment strategy. I’m an index investor, and I don’t try to time the market. I manage risk by being as dumb as possible.
There are two kind of investment funds: actively managed funds that depend on people who make smart decisions, and passive funds that run on autopilot. It was not always that way. Passive funds that mimic the performance of indices like the S&P 500 came into being in the 1970s. At first, they were not popular because brokers didn’t get commissions from them. That’s still one of my favorite things about index funds — they have low management fees. Inflation and management fees count against your total return. You can’t do anything about inflation; that’s government’s job. You can do something about management fees — avoid them.
Another rap against index funds is that, be definition, they never beat the index, which is the minimum standard of acceptable investment performance in a year. Every year some investments will crush the performance of index funds. The trouble is that it’s a different group of investments almost every year. If you want to consistently beat the returns of an index, you have to work really hard, be really smart, or be really lucky. That’s too much work and too much risk for simple old me, so instead of trying to be smart, I act dumb and invest in an index fund.
Some years are a lot better than others for the S&P 500. If you bought shares in 2021 and sold them in 2022, you hate the S&P 500. If you bought shares in 1995 and kept buying them every year, especially in 2022 when stock prices went down, you love the S&P 500. That’s called dollar cost averaging, and it’s a great way to manage risk. Dollar cost averaging is when you set your investment schedule on autopilot — say $150 a month — and you keep investing no matter what the market does. Dumb investors like me dollar cost average. Smart investors try to time the market — buy low, sell high. But how do you know something is low? And how do you know it’s high? Rather than solving that puzzle, I don’t even try. I buy the same amount every month and sell when I need to.
The TL;DR for the scary chart above is that the S&P 500 has had several lost decades since 1950. Adjusted for inflation, the market hit a high around 1969 it didn’t reach again until the late 80’s, and that was temporary. Things didn’t really get better until 1995. 2000 to 2010 also sucked, but if you kept at it and kept buying through all the downs you were rewarded here in 2024. The longer you can afford to hold an investment, the more you can manage your risk. Now if you can just figure out when you’re going to need the money and when you’re going to die, you’re all set.
Why work when you can gamble
There are two ways to get money: you can get paid for your labor, or you can be rewarded for risking capital. Working is hard. It takes up a lot of time, it’s tiring, and a lot of it is dull. Investing is fun because it’s gambling. It’s gambling with much less risk and much better payouts than other forms of gambling, but it’s still a kind of gambling. We live in a society that has many built in advantages for money earned through investing and many breaks for people who loose money from investing. Other forms of gambling are not treated so kindly.
Money earned through labor has no advantages at all. All of us are severely limited by what we can earn through our labor. No one is limited by what they can earn through capital. Labor is a meritocracy. Capital is a free-for-all. The most favorable treatment — and the most political attention — is reserved for capital. Labor is always a second class citizen.
When you invest, do not try to beat the market. Say it again with me. Do not try to beat the market. Don’t try to earn better returns than you would get in some index fund. Why would you want to be in an index fund when index funds are the minimum standard of acceptable investment performance? Good question. There’s only one investment that has government ready to jump in and rescue it when things go badly. That investment is index funds.
Government is our friend
Government is the most powerful force in our society. The only thing very large companies like Google and Apple and Meta have to fear is government. (All those companies are part of the S&P 500, by the way.) Big companies stumble along for decades with mediocre management and mediocre products and they still produce great returns because of momentum. They’re like enormous rocks rolling down a hill. When you invest in the S&P 500, you’re investing in 500 big rocks rolling down a hill that’s closely supervised by the US government.
The S&P 500 represents the status quo. It’s the definition of which companies have made it into power and prominence. If the S&P 500 falls 20% or 30% or more, which it sometimes does, government eventually comes to the rescue. It’s hard for government to tolerate long periods of market stagnation because more Americans own stock now than ever before.
Over 50% of Americans own some stock. That makes it sound like stock ownership’s highly democratic, but it’s not. The richest 10% of Americans own over 90% of all stock owned by individuals. Those two things combined — the appearance of democratic ownership backed by the reality of a system built for the rich — add up to a lot of political power embedded into the S&P 500.
Government likes happy citizens because happy citizens vote to keep incumbents in power. Government likes stability, too, and it will spend a lot of money — which is how government defines working hard — to maintain the status quo. The S&P 500 is the status quo. It represents stable, politically engaged voters. The old. The rich. People on fixed incomes. All are people who have major political clout in the US.
If you try to beat the market, say by investing in an alternative asset like crypto, you’re going outside the herd. Anyone outside the herd becomes a target for smarter investors, shysters, and government. You have to protect yourself because regulators and policy makers are not watching out for you like they are if you’re in the herd with the S&P 500. You can also become a target for government because everybody likes to see a smart aleck get his comeuppance.
Dumb is better than clever
Call me a snob, but I think it’s easier to be happy when you’re dumb than when you’re clever. I’m pretty sure most dogs are happier than I am. Index funds are dumb, and that suits me fine. Being too clever has wrecked at least as many fortunes as being too dumb. The advantage dumb has over clever is that it’s simple, and that’s a big advantage. When it comes to managing risk, sometimes the best thing we can do is be dumb.
So give up trying to be smart. Don’t try to beat the market. Take a piece of your monthly income and set it up to be automatically invested in an index fund. If the S&P 500 does not grow for a few years or for 10 years, everyone knows it, and everyone in government will be working to make it grow. The same can’t be said for any other kind of investment. If the S&P 500 goes to zero, you won’t need money anymore because our lives will be chaos. That can’t be said of any other investment, either.
If you put your money in an index fund, will it grow? Nobody knows. Past performance is not an indicator of future returns. That’s true of all investments, and it’s true for every part of our lives. Everything is uncertain except one thing: politicians want to get re-elected. When we’re happy, we re-elect people. When we’re not happy, we throw them out. When the S&P 500 goes up, many people are happy. When it goes down, many people are not. Therefore, it’s in the direct interest of the people in government to make the S&P 500 go up, and government is the most powerful force in society. Invest in something where government is on your side, and don’t be greedy. But don’t take my advice because I’m an idiot.
“The advice the ancient Greek teacher gave his king seems to me not without reason: that he be splendid in furniture and plate, since those are lasting investments that pass on to his successors; and that he avoid all extravagances that flow away immediately out of use and memory.” — Montaigne
“I’ve tried saving food for a rainy day, but it’s so much easier just to beg for more.” — Margaret the Pug