Investment Mistakes Even Smart Investors Make and How to Avoid Them

Investment Mistakes Even Smart Investors Make and How to Avoid Them

Guest: Larry Swedroe, MBA
Episode 69
Share this article:
The Lange Money Hour: Where Smart Money Talks
James Lange, CPA/Attorney
Listen every other Wed. on KQV 1410 AM or at our radio show archives.
Note: Some events referenced in our archives have already passed.
Click to hear MP3 of this show

TOPICS COVERED:

  1. Introduction of Guest - Larry Swedroe, MBA
  2. Overconfidence Will Cost You
  3. Do the Opposite of What Others Do
  4. Do Not Panic When Bad News Roam
  5. Advice for Couples
  6. Don’t Be Afraid to Sell When You Are Ahead
  7. Confusing Familiar with Being Safe
  8. Choose Wealth Manager Rather Than Investment Advisor
  9. Have a Roadmap

retire secure book coverAVAILABLE NOW!
Retire Secure!
A Guide to Getting the Most out of What You've Got

Join our mailing list to receive updates, news and get FREE bonuses.

Sign Up Today and Get your FREE Bonus!


Welcome to The Lange Money Hour: Where Smart Money Talks with expert advice from Jim Lange, Pittsburgh-based CPA, attorney, and retirement and estate planning expert. Jim is also the author of Retire Secure! Pay Taxes Later. To find out more about his book, his practice, Lange Financial Group, and how to secure Jim as a speaker for your next event, visit his website at paytaxeslater.com. Now get ready to talk smart money.


1. Introduction of Special Guest - Larry Swedroe, MBA

Hana:  Hello, and welcome to The Lange Money Hour, Where Smart Money Talks.  I’m your host, Hana Haatainen Caye, and of course, I’m here with James Lange, CPA/Attorney and best-selling author of the first and second edition of “Retire Secure!” and “The Roth Revolution: Pay Taxes Once and Never Again.”  One small change for the new year is that the show will start at 7:05 instead of 7 pm to allow for KQV to provide the news at the top of every hour.  Jim’s guest tonight is Larry Swedroe.  Larry is a best-selling author with eleven books to his credit, and was among the first authors to publish a book explaining passive events, investing in layman’s terms.  He is a principle and co-founder of BAM Advisor Services, LLC, and the Director of Research and Principle for BAM and Buckingham Asset Management, a multi-billion dollar firm that works primarily with passively managed index funds.  He has appeared on NBC, CNBC, CNNfn and Bloomberg Personal Finance.  Larry also writes a blog for CBSMoneywatch.com.  On tonight’s show, Larry will shatter the myths about money you’ve come to accept and challenge the conventional wisdom you’ve received from friends, advisors and other so-called “experts.”  In his latest book, “Investment Mistakes Even Smart Investors Make and How to Avoid Them,” he details 77 of these mistakes, and we will discuss several of them.  Also, he will share the 78th mistake, which is not included in the book, and what he terms the great anomaly of investing.  But before I turn it over to Jim, I want to remind our listeners that the show is live, so please feel free to call in with your questions for Larry.  The number is (412) 333-9385.  Good evening, Jim, and welcome to the show, Larry.

Larry Swedroe:  Thanks for having me, Hana.

Jim Lange:  It’s a pleasure to have you, Larry.  Your book is so terrific.  You know, we rarely get somebody who writes a book that actually has a glowing testimonial from John Bogle, who is the founder of Vanguard.  But your book does have that glowing testimonial and my biggest problem in preparing for tonight is that there are so many areas and so many mistakes that I wanted to cover, and we only have an hour to cover them, but anyway, congratulations on a great book.

Larry Swedroe:  Well, thank you very much, and I’m happy to come back and we can discuss more of them.


2. Overconfidence Will Cost You

Jim Lange:  Well, that’s a very likely possibility because you and I had spoken for probably, roughly, an hour, and my only problem with that conversation was my hand hurt so much from taking such good notes from our call.  The first mistake, which I actually thought is terrific and is, I would say, an epidemic, including many of my clients, and at the risk of being more specific, many of my clients who happen to be engineers.

Larry Swedroe:  Doctors, I would say, are even worse.

Jim Lange:  Doctors are worse?  Okay, that’s fair enough.  Let’s get a couple of groups mad at us before we even start! 

Larry Swedroe:  Right.

Jim Lange:  And the question is, are you overconfident of your skills? 

Larry Swedroe:  Right, well, there’s an all-too-human trait in any area that we are overconfident in our skills.  If you ask people, and this has been done in many countries and many areas, are you a better than average driver, for example, 80 or 90% say yes, when obviously, not more than half can be above average.  It doesn’t matter if you ask them if you’re a better than average driver, a better than average lover or a better than average investor.  We’re simply overconfident in our skills, and thinking you’re a better than average driver probably is not going to get in trouble.  You’re smart enough, your brain will override that overconfidence and you won’t try to drive 90 mph in a driving rainstorm and turn a corner like that.  But if you’re overconfident in your investment skills, you’re likely to make some big mistakes.  You don’t need to diversify because you know which stocks are going to do well or which countries or which sectors.  You can time the market, which is proven to be very dangerous.  You believe that even though the evidence shows that it’s extremely difficult to identify the few active managers that will outperform, somehow you’ll do it, and you can invest in very risky companies because you know they’re not really risky. 

Jim Lange:  Well, what if you’re a really smart guy?  Like, what if you’re a Mensa person?  You know, you’re really bright, so you’re not really talking to the average guy here, but you’re talking to the guy who genuinely is bright, and if he took an IQ test, he wouldn’t do average.  He would do well above average.  In fact, he might be close to, or at, genius level.

Larry Swedroe:  Right, well, that’s making another mistake, Jim, of confusing intelligence with wisdom.  I like to say I think I’m very intelligent.  I graduated number one from one of the top MBA programs in the country, but I’m ignorant about lots of things: nuclear physics, my wife and three daughters tell me women is another subject I’m ignorant about.

Jim Lange:  You and Steven Hawking!  He said women are a complete mystery.

Larry Swedroe:  Right.  It doesn’t make me dumb.  It makes me ignorant, and ignorant is not a pejorative term.  So what I say to a doctor is, I say I think I’m smart.  Would you let me operate on your patients?  And they laugh!  And I say well, it’s the same thing.  Have you taken a single course in capital markets theory?  And the answer, almost certainly, is no.  Yet they think they can use their intelligence to generate above-market returns, and the great example that you’re referring to is one I said in the book of the Mensa club.  If anybody should be able to prove that you can use intelligence to outperform the market, it’s this group of the high IQ society top 2%, and the Mensa Investment Club is trying to prove that pooling their intelligence, more heads are even better than one, over fifteen years, they did something that I believe would be virtually impossible if you set out to do it unless you were simply churning your account.  They under-perform the market by almost 13% a year for fifteen years.  One guy said, when he was asked to explain the strategy, “It’s simple.  We buy low.”

Jim Lange:  Are you still with us?

Larry Swedroe:  Yep.

Jim Lange:  Okay.  I’m sorry, go ahead.  They buy low, and?  Oh, oh…

Hana:  That’s it.

Jim Lange:  Oh, that was it?  Oh, I’m sorry.  That was it!  Yeah, in fact, you said that with a starting investment of $5,300, they turned that into $9,300, where if they had just been in the S&P, they would have $300,000.

Larry Swedroe:  Yeah.  So, that shows you how expensive overconfidence can be, and that was over a 35 year period, so that overconfidence cost that gentleman $290,000.  I mean, that’s a pretty expensive lesson. 

Jim Lange:  It sure is.  So, I don’t know if that…I think for a lot of people, that’s still won’t really penetrate, but hopefully, it’s kind of chipping away at sometimes, people do…well, I have a lot of clients who are overconfident.  The other problem with some of the do-it-yourselfers is that they don’t get report cards.

Larry Swedroe:  Exactly, and what I would tell you that the virtual certain sure cure for overconfidence is every time your client makes a forecast, make him keep a diary and write it down, and then look back.  That’ll cure them of their overconfidence. 

Jim Lange:  Yeah, that’s one thing that I like about the money managers that I work with is that they will tell you, every month obviously you get a statement, but every quarter, they give you a report card and they say, in effect, here’s what you started with, here’s what you put in, here’s what you took out and here’s what you have now.  Here’s our fee and here’s what you have now, and then they say if you were, and let’s say just for discussion’s sake, use the S&P as a benchmark, if you had the money in the S&P, you started at the same place, you put the same money in and you took the same money out, but the investment result would be different.  There wouldn’t be a fee.  Here’s where you would be.  So you get to track how they’re doing, but a lot of do-it-yourselfers, you know, they sometimes remember the winners and don’t remember the losers, and they don’t really know how they’re doing. 

Larry Swedroe:  Exactly.  After this, I do a lot of seminars, probably about fifty a year, and I ask the question, “How many people in the audience know their rate or return?” and virtually nobody raises their hand, and the evidence from studies show that not only people don’t know their rate or return, but they dramatically overestimate it so bad that something like even 25% of the people who said they made money and outperformed the benchmark actually lost money.  So, your point is right.  They tend to remember their winners, and their ego makes them forget their losers.

Jim Lange:  Yeah.  Alright, another mistake that you write about, and again, the biggest problem with this interview is just only having the time to cover maybe seven or eight instead of the seventy that I’d like, is do you project recent trends indefinitely into the future?


3. Do the Opposite of What Others Do

Larry Swedroe:  So, here’s what happens.  This is the way I believe the vast majority of investors actually implement their strategy, if you will, although it may not be intentional.  What they do, the analogy that I use is they’re driving a car forward but they’re looking in the rearview mirror, and that’s a sure way to get into an accident eventually.  So what they do is they watch yesterday’s winners, then they buy high, then they watch yesterday’s losers and panic and sell and sell low.  Buying when prices are high, meaning valuations are high and expected returns are low, and then panic selling when valuations are low and expect their returns to high clearly isn’t a rational strategy, and yet that’s exactly what investors do.  They do it all the time.  A perfect example from 2009 through the end of 2010, the market went on one of the bull market runs in history, rising 100% from the bottom on March 9th to the end of the year, and investors were pulling out $350,000,000,000.  Instead, they should have been rebalancing their portfolios, so if you were 60% stocks and 40% bonds when the bare market started, now you’re maybe 50-50 or 40-60.  You simply buy yesterday’s losers, which in that case were stocks.  They had underperformed.  You buy when valuations are low and expect the returns are high, not because you’re making a forecast, but because you’re simply sticking to your plan, and then you watch the winners go up, outperform, you sell when valuations are high and expected returns are low.  That surely must be a better strategy, buying low and selling high, than the reverse, but we know the evidence from every study done that investors get it backwards because their stomachs take over, greed and envy and bull markets and they get too optimistic, and then fear and panic and bare markets and they panic and sell.

Jim Lange:  Well, let me ask you a question, and this might not be directly on point with that particular mistake, but I have a lot of clients, and frankly, both sides on the political fence, who think that the U.S. economy, and even the world economy, is really in the crapper, and they’re saying, “Hey, you know something?  You know, with what’s going on in Europe and what’s going on with the economy and unemployment, I really don’t want to be in the market right now.”

Larry Swedroe:  Right.

Jim Lange:  Now, I don’t know if that’s right on point, but what would you say to people like that and people who have maybe been beaten up a little bit, and they’re reluctant and they change their allocation to be considerably more conservative than they might have been, say, three or four years ago?

Larry Swedroe:  Okay.  Well, we’re getting into lots of mistakes here.  Let’s start with number one, not knowing your financial history.  Before you ever invest, you should know that the financial markets, equities, stocks in particular, are very risky.  We’ve had three 50% drops just in the last 35 years, 1973 to 1974, 2000 to 2002 and 2008, and we had a 90% drop in the Great Depression, and if you want another recent example, Japanese stocks hit 40,000 in 1990.  It’s now trading at roughly 10,000.  It’s down 75% as an index for 22 years.  So stocks are risky, and you need to be sure when you build an investment plan that you incorporate the virtual certainty that you’re going to have to live through those bare markets, and if you can’t take those risks, then you need to have a low-equity allocation.  So that’s rule number one.  Those who don’t know their history, as Santayana, a Spanish philosopher said, are doomed to repeat it.  So that’s mistake number one.  Mistake number two is they are confusing information with wisdom, or what I call value relevant information.  So, the first rule of investing is to ask yourself the question, I got all this bad news or good news about a stock, whatever it might be, it’s only of value if nobody else knows it because if everyone else knows it, that means it’s already incorporated into prices.  So, if you know, your clients call you and say well, we got all this bad news on the U.S. budget deficit, unemployment, Spain’s going bankrupt and Greece and, you know, all this stuff’s going on, and we got Iran nuclear weapons, all you have to do is ask yourself this question:  am I the only one who knows it?  Do the guys at Goldman-Sachs and Morgan Stanley and Warren Buffett and the guys who do most of the trading, the big institutions, they clearly know it and that’s why prices are where they are already.  In other words, if the news were not as bad as it is, then prices would clearly be higher.  So, in other words, the bad news is reflected in prices.  That usually means valuations are low and expected returns are high.  Now, why would you want to sell when you bought previously at a higher valuation when expected returns were low?  Again, buying when expected returns are low and selling when they’re high is clearly a foolish strategy, and that’s why Warren Buffett warns people and says, “Never try to time the market, but if you’re going to do so, then you need to do the opposite of what people do.  You need to buy when everyone else is panic selling and losing their heads. 

Jim Lange:  Well, I think that is great wisdom.  I hope some of our clients and listeners are actually taking notes and actually might even change some of their behavior. 

Larry Swedroe:  Yeah, and Jim, I would add that’s going…if you want to talk about an hour later, that gets us to the mistake #78 that I did not include in the book, but I’ll leave that to you.

Jim Lange:  Alright, well, maybe we’ll do that one for…well, I’ll tell you what.  Let’s do it right now because it’s related. 


4. Do Not Panic When Bad News Roam

Larry Swedroe:  Right, okay.  So, the 78th mistake, which I have talked about for years but have never put a term to, is when investors hear bad news, they do what I call ‘stage one thinking,’ and a great example of that is Meredith Whitney, who your listeners may recall, in December 2010 made this forecast on 60 Minutes that we’d have hundreds of billions of dollars of municipal bond default, and she gave lots of very good reasons about the state of municipal finances and the big problems with their pension plan and earning shortfalls because incomes were down.  She made the terrible mistake of stage one thinking: news is bad, and therefore, prices have to go down, okay?  The same thing was true with Europe’s economy and Greek debt, etc., as I mentioned.  Prices already reflect that.  But stage two thinking is the kind that Warren Buffett does.  He understands that you have to ask the question what then?  So in Meredith Whitney’s case, she never asked the question what then?  By law, under the Constitution, 49 of the 50 states must balance their budget.  So what happened?  States slashed spending, renegotiated contracts with unions, raised taxes and balanced their budget.  We had one of the best years ever in the municipal bond market, very low defaults and most states have dramatically improved their situations.  She would have been right if people did nothing, but that’s not what happened.  One other great example: March 2009, we have his crisis, or even earlier, we had that crisis in ’07 and ’08.  Governments don’t sit there and do nothing.  We had stimulus packages, we had tax cuts and then the federal reserve slashed interest rates to zero.  Similarly, that’s what we’re seeing in Europe with the European countries now slashing expenditures to try to balance their budgets.  You’re seeing them also European central banks slashing interest rates, and also engaging in activities to help the banks gain liquidity.  That’s what I call stage two thinking, the ability to see through the clouds and understand that actions are going to be taken.  The worse the crisis is, the more likely it is that actions will be taken with urgency and with scales.  Not a guarantee that it’ll work, but history tells us that the vast majority of time, it does, and you need to be disciplined and stay the course and not panic and sell, because you’re almost certainly going to sell at exactly the wrong time, probably just before the thing turns around.

Hana:  Okay, Larry, we’re going to take a quick break, and when we come back, we’re going to get back into the other 77 mistakes.  I want to remind our listeners out there that we are live tonight, so if you have any questions, you can give us a call at (412) 333-9385.  We’ll be right back with Larry Swedroe, author of “Investment Mistakes Even Smart Investors Make and How to Avoid Them,” and Jim Lange on The Lange Money Hour.

BREAK ONE

Hana:  Hello there, and welcome back to The Lange Money Hour.  This is Hana Haatainen Caye, and I’m here with Jim Lange and Larry Swedroe, author of “Investment Mistakes Even Smart Investors Make and How to Avoid Them.”

Jim Lange:  Welcome back, Larry.  And again, I will just say that I loved your book.  I think that there’s so much wisdom, and I’m even going to take the liberty of quoting John Bogle, founder of Vanguard Group: “Using this book as your checklist, you can not help but improve your share of the financial markets to which you are entitled.”  So anyway, one of the questions that I had, or shouldn’t say I have because they’re your questions, but one of the answers that I’m looking for is do you let your ego dominate the decision making process?

Larry Swedroe:  Yeah, I found this to be very interesting, and there’s an all too human need, I think, to be better than average and the typical investment stockbroker plays on that.  They’ll tell you if you invest in an index fund, yeah, that’s okay, it’s a good strategy, but you’ll get average returns.  You don’t want to be average, Jim.  You can do better than that, and we can help you.  I think that when one of the great ironies, Edward Johnson, who’s the chairman of Fidelity, now one of the largest providers of low-cost index funds, when Vanguard came out with what was called ‘Bogle’s Folly,’ they were saying it’s un-American to index, right?  He said, “I can’t believe that the great mass of investors are going to be satisfied with just receiving average returns.”  The name of the game is to be the best.  Well, what Wall Street doesn’t want you to understand is that indexing does not get you average returns, it gets you market returns.  So, if you invest in an S&P 500 index fund, you get that return, and because indexing outperforms the vast majority of active investors, by definition, you outperform the vast majority of active investors, so you get above average returns compared to the average investor.  Getting market returns is a good thing, and it allows you to control your risk and do so in a low-cost way.


5. Advice for Couples

Jim Lange:  Well, let me ask you a related question, and we have had a couple, let’s call them, women finance experts, and they were talking about the need and the importance of the, typically, wife who has not necessarily been on top of the family finances and particularly the investments.  What should a woman do…maybe some of the wives of these doctors or engineers who are likely to survive their husbands, and whose husband’s decisions could have potentially an enormous impact of their lifestyle, and I’ll tell you one situation I had in practice where a guy, he thought he knew everything, and he really didn’t, and he liked some, let’s call it, unconventional investments, and he basically lost his shirt, and there was a bankruptcy and it was absolutely miserable, and he had saved a million dollars and based on their lifestyle, they should’ve been fine, but in fact, they were not, and I think that in the bottom of her heart, she knew the whole time that he really was not on top of this stuff, and I think that if you would ask her, “Would you prefer a professional to take care of this in a good way?  Yes, you’re going to have to pay a fee, but you’re not ultimately going to lose our shirt.”  But that’s what happens.  How would you advise women of people who have an ego?  So let’s assume that we’re not going to change the person who has the big ego dominating the decision-making process.  What advice would you have for the spouse?  And I shouldn’t be sexist because you could have the same thing, you know, where the woman is the hotshot and the guy knows that, but let’s say, at least historically, it’s usually the other way.

Larry Swedroe:  Right, well, and the odds are great it’s the male with the big ego, and we know that from studies.  So, let’s get the facts first here.  The evidence is the following: both men and women are very poor at picking stocks.  The stocks that both of them buy go on to under-perform after they buy them on average, and the stocks they sell go on to under-perform after they sell them.  However, even though both are equally poor at picking stocks, women investors actually outperform men investors, and the reason is simple: they tend to trade less, and there’s a perfect correlation between overconfidence driven by testosterone factor, I would say, and trading.  And men simply have confidence in skills they don’t have.  Women know better, so because they’re less confident, they tend to be less active in trading, less active in jumping around trying to time the market or pick stocks, and therefore, they have lower costs and they get higher returns, and you actually see that evidence, Jim, when you look at the returns of married men and single men.  I bet you can guess which group gets higher returns.

Jim Lange:  I think so.

Larry Swedroe:  It’s the married men because their egos are tempered by their obviously superior wives.  So the answer is number one, the women should get educated.  I’ve written eleven books on the subject.  Some of them are really simple in explaining the evidence on active versus passive, and my advice is tell a husband this (or the wife if it’s the husband who’s got the problem on the other side): if you want an entertainment account, let’s take 5% of our money and you can go pick stocks and have some fun, and maybe you’ll do well, that’ll be great, and if you do poorly, it won’t bankrupt us.  On the other hand, we’re going to invest the rest of the money in the way that the evidence is overwhelming is the prudent choice, and that’s to be a passive investor, have a globally diversified portfolio, have a written plan and then stay the course.  That would be my advice.

Jim Lange:  Well, I think that’s some very good advice.  To be fair, I do want to point out that the company that you are involved with, BAM, does advocate passive index-type investing.  So you are actually doing what you actually profess, and I should also point out that I work with a number of money managers, but one of them, in fact, that’s probably one that I know that BAM works with quite a bit, is Dimensional Funds, which is, let’s call it, the passive index approach designed by numerous Nobel Prize winners.  So we are actually doing what you’re talking about, in terms of giving clients an option for passive index investing.

Jim Lange:  Exactly, Jim, and I would add one other thing.  This is a mistake people make when they choose an investment advisor.  If the advisor is not willing to show you their financial statements or their brokerage accounts or a custodial account and show you that they’re investing in exactly the same vehicles that they’re recommending to you, obviously, it’ll be in different asset allocational proportions, of course they have different risk tolerances and ability to take risks, and even maybe a different need to take risks, but they should be in the same vehicle.  If they’re not, to me, you can’t trust them and shouldn’t, and you should run pretty quickly. 

Jim Lange:  Well, I think that’s good advice also.  And by the way, throughout the book, you quoted one of my favorite authors who is Jonathan Clements, who has been on the radio show several times, but in terms of the question do you let your ego dominate the decision making process, Jonathan says, “When it comes to investing, we’re a bunch or irrational, inconsistent neurotic wimps,” which I just thought was a pretty powerful quote.

 


6. Donít Be Afraid to Sell When You Are Ahead

Larry Swedroe:  Yeah.  Here’s the last point I’ll make on this ego issue.  If you choose active investing and the manager you chose failed, you chose a mutual fund, it’s actively managed and it underperforms and you fire him, you get to blame the manager, of course.  They take the blame.  However, if they outperform, you take the credit for your genius in the analysis to choose him.  On the other hand, if you choose passive investing index funds, there’s no one to blame but yourself.  So, the ego much prefers a game where it can win.  You choose correctly, but you can’t lose because you blame somebody else.  It doesn’t like the other game where it’s either I win or lose.  So I think active investing also feeds the ego from that perspective.

Jim Lange:  Another thing that I wanted to mention, and we actually talked a couple of weeks ago with Dan Goldie and we discussed the same issue, so I’d be kind of curious about your answer to it.  Do you let the price paid affect your decision to continue to hold or sell an asset that you already have? 

Larry Swedroe:  Yeah, it’s also related…this is called the endowment effect, the price you paid for something, but it’s also related to a mistake called playing with the house money.  So, I think I’ll tell a short story about a friend of mine, a very smart guy who I worked for at one point.  He had bought some CSCO at, I think it was $8.00 a share or $10.00, and this was now 1999 and it was trading at something like $80.00, and we were playing tennis and I asked him in between sets, “Why don’t you sell some?”  He said, “What could go wrong?  I only paid $8.00 for it.”  Okay?  And I said, “Well, you know, obviously, the price could go down and you’re making a mistake like the people who sit at the crap tables in Las Vegas and are ahead.  Well, then they tend to be more risk-taking because they’re playing with the house’s money, okay?”  So that’s a mistake.  But in this case, what I see and you probably see this a lot, say the wife inherits some stock or retains it from their husband or the grandfather leaves stocks and they own if from Pfizer from fifty years ago and grandpa held it, I can’t sell the stock because grandpa wouldn’t like that.  The only right answer to the question should you hold the stock is it has nothing to do with the price you paid for it.  You ask yourself if instead of that amount of stock, let’s say it was $50,000, you should ask yourself this question: if instead I have $50,000 in cash, would I take the cash and buy that security?  If the answer is no, and it almost certainly is, because there are 11,000 or so stocks around the globe you could buy, then you should sell it.  You shouldn’t let the price you paid for it influence you, either because you paid a very low price and now it’s way up and you don’t want to pay the taxes.  I bet the people who own Lehman Brothers would have been very happy to pay the taxes instead of watching it get wiped out.  On the other hand, we also know people who make the other mistake.  They paid, say, twenty for a stock and now it’s ten, and they don’t want to sell because they’ll say, “I just want to wait until I get even.”  Well, that’s also dumb, especially in taxable accounts where you’d be better off selling and taking a loss and Uncle Sam at least shares your pain.  So you should never let the price you pay affect your decision, except in one case: if you think you’re gonna die in the near future and you got a very low base of stock, you probably don’t want to sell it because your family can inherit the stock at what’s called the step up basis, but you might want to take action ahead of the risk instead of selling it.

Jim Lange:  Well, I think that one of the things that I have seen is people put way too much emphasis on that step up and basis rules, so for example, particularly if they have a concentrated position and there are capital gains associated with it.  You know, so I have people in their sixties and seventies who are pretty healthy and say, “Oh, I can’t sell that stock.  I’ll have a big capital gain.  I’m better off waiting.”  And I’m thinking, “You mean you’re going to hang on to a stock for fifteen or twenty years because you’re afraid of paying a 15% capital gain when the risk of holding an inappropriate investment and a non-diversified investment should far outweigh the tax that you would have to pay, or eventually save if you held it that long?”

Larry Swedroe:  I couldn’t agree with you more, and that’s why I said in my comments, if you’re going to hold it in contemplation in the short-term step up and basis, and I mean very short-term, then you need to hedge the risk and there are some ways to do that, but you shouldn’t keep that concentrated risk, and that’s another mistake we talk about in the book.  You know, Bear Stearns is a great example.  Most people don’t know this, but from the time it went public until shortly before the crisis, it was the single best performing stock in the period, outperforming even Berkshire Hathaway, and very quickly, it went almost to zero.  Clearly, you would’ve been better off paying the taxes on it, and you and I could both name hundreds of stocks of some of the greatest companies ever, you know, Intel and Cisco and Microsoft and we could go on and on, Kodak is another great example that may go bankrupt, and Polaroid, once part of the nifty fifty, we could go on and on.  There’s only one thing worse than having to pay taxes, and that’s not having to pay them. 

7. Confusing Familiar with Being Safe

Jim Lange:  Well, I think that’s a good point.  Maybe one more question before we have to break again, and your question is do you confuse the familiar with the safe? 

Larry Swedroe:  Right, great question.  People do this all the time.  We see this, for example, studies found that the people in the good city of Atlanta own a disproportionate share of Coca-Cola because that’s Coke’s headquarters, so they tend to think that being familiar with it, it’s safe.  Well, obviously, it’s no safer to own Coca-Cola if you live in Atlanta or if you live in Pittsburgh, and people in St. Louis overloaded up on Anheuser-Busch.  Well, you can get lucky and have a good company, or you could live in Rochester, New York and own Kodak and watch it go basically to zero.  Evidence from studies all over the world is that people make this mistake, so U.S. investors over wait U.S. stocks and tend to have 10% or less international investing when they probably should have 40 or 50%.  Japanese investors do exactly the same thing.  French investors do the same thing, and they lose the benefits of diversification.  That’s really one of the worst mistakes that people make, and Peter Lynch compounded the problem by telling people to buy what you know.  Just because you know something that’s, the only thing it’s going to do is cause you to think it’s safe when that’s simply not true. 

Hana:  Okay Larry, we’re going to take another quick break, and when we come back, we will continue this conversation.  I want to remind our listeners out there that we are live tonight, so if you have any questions that are relevant to what Larry and Jim are talking about, please give us a call at (412) 333-9385.  We’ll be right back with Larry Swedroe, author of “Investment Mistakes Even Smart Investors Make and How to Avoid Them,” and Jim Lange on The Lange Money Hour.

BREAK TWO

Hana:  Hello there and welcome back to The Lange Money Hour.  This is Hana Haatainen Caye, and I’m here with Jim Lange and Larry Swedroe, author of “Investment Mistakes Even Smart Investors Make and How to Avoid Them.”

Jim Lange:  Larry, another one of your…and by the way, all the questions that we are asking, they come directly from your book, “Investment Mistakes Even Smart Investors Make” by Larry Swedroe.  By the way, Larry, if somebody wants to buy your book, would you recommend they go to Amazon or to your website or to the BAM website, where would you recommend?

Larry Swedroe:  Anywhere they like, you know, whatever’s most convenient.  You certainly can get it on Amazon and other book sites, as well, and you can certainly get it through us, as well.

Jim Lange:  Okay.  And I know that, by the way, we have a following of financial advisors throughout the country listening because we are streaming, and I would say that these are not only a wonderful read for investors, but also for advisors because, frankly, I am guilty of making a whole bunch of the mistakes that you are warning people not to make.

Larry Swedroe:  Well, if you didn’t, you wouldn’t be a human being, Jim, and I’ve made many of them in my life simply because I, too, am a human being.  I think, however, what differentiates the behavior of smart people and fools is once you learn it’s a mistake (and that’s why I wrote the book, to help people avoid them), you should stop repeating it.  Repeating the same mistake over and again and thinking you’re going to get a different outcome, I mean, that’s what Einstein said is the definition of insanity.

8. Choose Wealth Manager Rather Than Investment Advisor

Jim Lange:  Yeah, and by the way, I should mention to our listeners that you’re not really the kind of every day money manager, that you’re really more of a researcher and an educator and you have a unique perspective because you don’t have that, let’s say, the constant pressure of having to work with clients or to sell or to even get assets under management.

Larry Swedroe:  That’s really true.  My title is Director of Research, and I actually act as the Director of Research for over 130 firms around the country who use what I like to call the science or evidence-based investing.  All of the advice is based, not on our opinions, but on evidence from peer-reviewed academic journals.

Jim Lange:  Well, and I know that you work with both Dimensional Funds, which I also do, and I also believe that you work with some other alternatives also.

Larry Swedroe:  Bridgeway, Vanguard, funds that are passively managed on the equity side of the…and on the bond side.  They’re the only kind we will use.

Jim Lange:  So, again, your company is doing what you preach and you have the luxury, unlike me, frankly, the way I educate frankly as I do it for marketing.  So for example, this Saturday, we are having two workshops, one on the best estate plan for married couples, and another one on trusts and controlling from the grave.  But frankly, I am doing that, and I’m going to give, out of a two-hour workshop and maybe a ten or fifteen minute break, I’m gonna give all but maybe five minutes of pure education.  But frankly, again, there will be a little pitch for my services, where you, you really don’t say “Hey, come to BAM.”  You’re just saying, “Hey, this is the way it is.  I’m paid as the Director of Research, not of Marketing.  This is the way it is.”

Larry Swedroe:  Yeah, and I want to congratulate because I think another mistake, which I don’t talk about in the book specifically, is I think investors should not hire investment advisors because you can have a great investment plan that blows up for reasons that have nothing to do with investing, and that’s why you should be congratulated.  You’re talking about issues that have more to do with wealth management, estate planning, taxes and maybe insurance.  So, for example, you could have a client whose plan blows up because maybe their teenage daughter or son gets into a car accident and they don’t have an umbrella policy to protect them, or people even hire good attorneys to write trusts and then, I’m sure you’ve seen this, they don’t get funded properly, or you don’t have the proper amount of life insurance and you die early, the breadwinner dies, and you don’t live long enough to save the money and have the capital markets work in your favor.  That’s why I believe you should work with, what I call, a true wealth manager who integrates investment plans into an overall financial plan.


9. Have a Roadmap

Jim Lange:  Well, that actually leads to an issue that you brought up that, in the book, it talks more about the investments, but I think that we can broaden the issue, and that is on mistake #56 on your page 177, and what that mistake is is people not having a roadmap.  You know, in fact, the literal question is ‘Do you begin your investment journey without a roadmap?’  And I’d like to talk about that from both the investment standpoint which you talked about, and then maybe some of the things that you had just mentioned, which is, let’s say, an overall plan.  So, why don’t you maybe start with the investment part, and then I might kick in at the end on the overall plan that might tie in retirement and estate planning and Roth IRA conversions, insurance, etc.?

Larry Swedroe:  Exactly.  So, the simple analogy is I ask this question, and I think no rational person would take a trip to a place they’ve never been without a roadmap or today, you could say, without a GPS.  At least, no woman would.  Men, their egos sometimes prevent them from having directions or even asking people if they get lost, and no one would rationally start a business without investigating doing a whole business plan or thinking about contingencies if things don’t go right or exactly according to the plan.  Yet the vast majority of people begin investing without a plan at all, no asset allocation describing how much risk they’re going to take, what types of investments, how much they’re going to save every year, or a balancing table that requires them to rebalance on a regular basis, etc.  This needs to be written out, what your goals are, what’s your objectives, what you want to do with your money.  Do you want to leave it to charity and your children?  And have a plan that incorporates that.  I actually wrote a book, “The Only Guide You’ll Ever Need to the Right Financial Plan” that addresses these issues and then talks about even things like how do you transfer your values like maybe giving to charity to your children, or what I call a family wealth mission statement.  So, I’ll turn it over to you, having already given some examples like failure to have the proper amount of life insurance can lead to an investment plan blowing up.

Jim Lange:  A lot of times, I think that these are interrelated issues.  So, for discussion’s sake, on the investment side, if somebody has a pension, whether they’re a teacher or a government worker, or even a corporate pension, and they have a certain amount of money coming in, that certainly changes the investment recommended allocation of the remaining assets.

Larry Swedroe:  Exactly, because that lowers your need to take risk in the same way Social Security does.  So that, for example, a good rule of thumb for someone who’s under 65 is you need to have a portfolio that’s about 25 times, if you want to be conservative, maybe 30 or 33 times your spending.  So, if you need $100,000, you should have about a $2.5 million portfolio.  But if you estimate you’re going to get $25,000 in Social Security, now you only need $75,000, and if you had a pension that was coming in as well that was also for $25,000, now your need is only $50,000.  Obviously, you can hold more bonds because you don’t need to generate the high expected returns that stocks can generate, and that allows you to sleep better.  You definitely need to incorporate all of these issues, and again, that’s why you need a wealth manager and not just an investment advisor.

Jim Lange:  Well, for example, I was with somebody today who had a multi-million dollar estate, and I asked them how much they spent and they said, “Well, about $5,000 a month.”  And at the same time, not making any gifts.  And sometimes, it makes more sense, in my opinion, to kind of step back and say no matter how I got to where I am, what makes sense going forward?  And what we do in our office is we call it running the numbers, where we actually make financial projections.  Of course, the investment rates can vary significantly, but then we get an idea of where people will be given different possibilities. 

Larry Swedroe:  That’s the only right way to do it.  I don’t know how you can make decisions unless you do exactly what you described.  Do the same thing in the same way.

Jim Lange:  Yeah, so we ourselves are not money managers, which is why I work with a variety of money managers who actually manage the money, but then we give advice on things like Roth IRA conversions, which by the way is not as mysterious as some people make it, and it is something that you can, you know, in effect, run the numbers.  Let’s say you do a Roth conversion of $100,000, and let’s say you don’t and you run it forward for 40 years and you see is the family better off or worse off? 

Larry Swedroe:  Exactly.

Jim Lange:  I would say the same thing for gifting.  Of course, there’s going to be a wide variation in what might happen to the estate tax, but if you clearly don’t need it, are there some benefits in how much money can be saved for gifting?

Larry Swedroe:  You can save somebody literally millions of dollars by having them gift if they are, you know, have gifting and bequeath their intentions for the children or charity, obviously that would far exceed any fees you might charge as their advisor.

Jim Lange:  And actually, you just mentioned charitable giving.  So, for example, let’s say that somebody has, I’ll do a real simple example, somebody has $2,000,000 and they want to leave 50% to their family and 50% to charity, and let’s say that half of their money’s in an IRA and half of the money’s outside the IRA, what I find is wills and beneficiary designations leaving 50% to charity and 50% to family, but what I would obviously prefer is that we leave the entire IRA to charity and we leave all the, what I would call, after-tax dollars to the family. 

Larry Swedroe:  It’s exactly what my estate plan is.  My kids have been told my IRA and my wife’s will go to a family foundation that will be established, and then they will be forced to give that money away to charity so my charitable intentions and my values are being passed down to my children.  That’s obviously a much more tax efficient way for them to give than if they had to give it themselves and as far as paying estate tax before they got the money, and they get the taxable dollars which is a much more efficient way to transfer.

Jim Lange:  Yeah.  By the way, I really like that because you are…so you’re having them pick the charities, is that right?

Larry Swedroe:  Exactly, and they’re forced to under the rules of, as you know but your listeners may not, you’re forced to give a certain percentage each year.  That may change with the laws, but you’re forced to give…what’s the current law?  You’re the expert here.

Jim Lange:  Well, anyway, I would love to continue this conversation, however…

Hana:  Yeah, Larry, I’m sorry.  We’re going to have to close it.  I want to thank our listeners for joining us for another The Lange Money Hour, Where Smart Money Talks, and a special thank you to Larry Swedroe.  He joins our growing list of informative guests through the year, including Jane Bryant Quinn, Ed Slott, Roger Ibbetson and others, and again, you can find Larry’s book, “Investment Mistakes Even Smart Investors Make and How to Avoid Them.”  Catch us next time on February 1st when our special guest will be Dan Henderson, president of Cookson Peirce, and as always, you can catch a rebroadcast of this show at 9:05 on Sunday morning right here on KQV.

END

 

Learn More about Lange Financial Group, LLC

Retire Secure 3rd Edition

Fill out the form below to get timely advice or to learn more about us. You'll also receive a free summary of our latest book, Retire Secure! Third Edition.



retire secure book coverAVAILABLE NOW!
Retire Secure!
A Guide to Getting the Most out of What You've Got

Join our mailing list to receive updates, news and get FREE bonuses.

Sign Up Today and Get your FREE Bonus!

James Lange, CPA

Jim is a nationally-recognized tax, retirement and estate planning CPA with a thriving registered investment advisory practice in Pittsburgh, Pennsylvania.  He is the President and Founder of The Roth IRA Institute™ and the bestselling author of Retire Secure! Pay Taxes Later (first and second editions) and The Roth Revolution: Pay Taxes Once and Never Again.  He offers well-researched, time-tested recommendations focusing on the unique needs of individuals with appreciable assets in their IRAs and 401(k) plans.  His plans include tax-savvy advice, and intricate beneficiary designations for IRAs and other retirement plans.  Jim's advice and recommendations have received national attention from syndicated columnist Jane Bryant Quinn, his recommendations frequently appear in The Wall Street Journal, and his articles have been published in Financial Planning, Kiplinger's Retirement Reports and The Tax Adviser (AICPA).  Both of Jim’s books have been acclaimed by over 60 industry experts including Charles Schwab, Roger Ibbotson, Natalie Choate, Ed Slott, and Bob Keebler.

Learn More about Lange Financial Group, LLC

Get timely advice! You'll also receive a free summary of our latest book, Retire Secure! 3rd Edition.







Need a Keynote Speaker?

James Lange, CPA Nationally-Acclaimed Roth IRA Expert, Best-Selling Author & Keynote Speaker Training Your Financial Advisors on the Latest, Cutting-Edge Roth IRA Conversion Strategies Jim Lange - Now Available to Train YOUR Team

» Learn More

Follow Us on Facebook