Complex investment strategies are hard to manage and lead to errors. Learn how to build simplicity into your investments and avoid unnecessary complexity.
The Value of Simplicity
Imagine there are two scenarios with exactly the same outcome. In one scenario you do a ton of work, have sleepless nights, and make mistakes along the way. In the other scenario, you have the same outcome but do significantly less work.
The extra peace you get by finding an easier path is the value of simplicity.
That extra work to achieve the same outcome is the cost of unnecessary complexity.
If you can achieve the same goal and reduce the stress of complexity, I’m all for it!
Unnecessary Complexity Defined
Unnecessary complexity is when you make a task more difficult without changing the outcome.
At best, unnecessary complexity is like swimming in place: it takes more time & energy to manage a task, but has the same outcome.
At worst, unnecessary complexity leads to execution errors and causes a worse outcome.
Avoid unnecessary complexity.
I try to avoid unnecessary complexity in as many parts of my life as possible. I can’t really help you avoid unnecessary complexity in your relationships or your job. That’s beyond my expertise.
But, I can help you avoid it in your finances.
Take the Simple Road
You are the CEO of your own finances. You get to decide how your money is managed. So, how do you decide which investments are right for you?
It turns out that investing is one of the places in life where additional effort doesn’t necessarily result in additional reward. Let’s use me as an example.
My Simple Investments
I have exactly 6 investments: Large Cap Stock, Mid Cap Stock, Small Cap Stock, International Stock, Investment Grade Bonds and High Yield Bonds. The relative amount that I have in those specific funds is chosen by me and managed by the FidelityGo RoboAdvisor. When the market moves and my portfolio gets out of balance, FidelityGo rebalances automatically.
I am 41 years old and 48% of the value of my investments is money I put in. The other 52% is value created by the returns on my investments. By the time I am 65, over 85% of my investment value will be growth, and only 15% will be money I have put in.
Sure, over the last 20 years I have tried different investment strategies. And, most of them were more complex than what I have now.
I realized that all that extra complexity didn’t improve the destination. It just made the road more difficult.
So, I choose the simple road.
Your Simple Investments
At best, unnecessary complexity takes more time & energy to manage with the same outcome. At worst, unnecessary complexity leads to execution errors and causes a worse outcome.
And, it all ends the same. I’m 41. 52% of my investments came from growth. By the time I’m 65, 85% to 90% will have come from growth. You can do the same. You can’t really do better. So, keep it simple.
You can do it too. All you have to do is fully fund a Roth IRA every year and you can retire a millionaire.
Simple Investments are Easier to Understand
One of the best pieces of financial advice Dave Ramsey gives is to never invest in anything you don’t understand.
When you buy a new phone, you spend hours researching it. But, when people buy investments, sometimes they throw their hands up in the air and let their advisor take the wheel.
Don’t do that.
As the CEO of your own finances, you need to know exactly what you are buying. And, if you are buying complex investments that you cannot understand or manage, then you will be placing too much trust in your financial advisor.
Simple Investments Make it Easier to Decide
Never trust your financial advisor to make investment decisions for you. It is your money and you are in charge.
If you have a portfolio with 100 individual stocks, a bunch of precious metals, some digital currencies, and a bunch of commodity futures, then I cannot imagine how you successfully manage it.
For every individual holding, how do you decide when to buy, when to sell, how much to buy?
I can’t imagine trying to manage something that complex.
Unnecessary Complexity Leads to Errors
With a portfolio that complex, you are going to make mistakes.
For example, actively managed mutual funds buy and sell shares in individual companies. A typical mutual fund will own shares in anywhere from a couple-dozen to a couple-hundred companies.
A mutual fund has a team of dozens of people who work full time to manage those investments.
You don’t have a team of dozens. And, neither does your financial advisor. In fact, instead of dozens of people working on your portfolio, your financial advisor has dozens of clients vying for his or her time.
So, how can you expect yourself or your advisor to manage a complex portfolio without making any mistakes? That’s just not logical.
Achieve Diversification without Complexity
The great news is that you can achieve the exact same outcome without all this complexity.
Managing a portfolio with a bunch of individual stocks and individual bonds would be a nightmare.
Instead, I own exactly 6 funds. And, those six funds give me incredible diversification. With just those six funds, I own approximately 5,700 individual stocks! Plus, I own bonds issued by around 450 companies.
I am a part owner in the 500 largest & most successful companies in the US. Plus, about 800 companies that are trying to replace those 500 at the top.
And, I am a smaller owner in about 2,000 even smaller companies. Some of these will fail, some will grow, and when they do, I’ll be there.
I also own a small percentage of about 2,400 international companies that do business on a global scale.
But wait, there’s more! I am also a lender to about 450 US companies who have borrowed money from me and pay me interest.
And, I do all of that with just 6 funds that are automatically rebalanced.
Another reason to avoid a complex portfolio is that the problem multiplies as your life gets more complicated.
A single person who is still working at their first job may only have one investment account: their employer-sponsored 401(k). But, almost nobody works at the same company for their entire career anymore. So, most people who have retirement savings have at least a current 401(k) and an old IRA Rollover.
A married couple would have one of each for both spouses. That’s two 401(k) accounts and two IRA Rollovers to manage.
Then, the couple has a few kids. Now we need to add a 529 for each kid.
At some point, if it all goes well, the couple will want to add some non-retirement investments, which means another account.
And, if they do really well, they may choose to self insure for Long-Term Care with an HSA. Each spouse gets one of those.
So, now we have a non-retirement account, two 401(k)s, two IRA Rollovers, 2 HSAs, and a couple 529 accounts. That’s 8 to 10 investment accounts to manage!
As an investor in individual stocks, how could you possibly keep all of that straight? I don’t care how much of a money nerd you are, you will not be able to properly manage 10 different investment accounts and execute the correct buy or sell strategies to keep your portfolio in balance.
And, even if you could, who would want to?
Instead, use five or six ETFs in each account (yes, the same 5 or 6 in each), and rebalance regularly. Or, if you want it to be even easier, use any of the available RoboAdvisors.
A Simple Strategy
Investing is a strategy where you get paid for having money.
Alternatively, a bet is a gamble where you will make money if some things happen or lose money if other things happen.
If you choose to buy a bunch of individual stocks, you are betting that those specific companies will do well and your shares will increase in value.
Instead, by buying a diverse portfolio with both stocks and bonds, you are able to profit from every market condition.
When the market is down, rebalancing results in selling stable bonds to buy cheap stocks.
When the market is up, rebalancing results in selling appreciated stocks to buy bonds.
Plus, if you use a RoboAdvisor, all of that happens automatically, and you don’t run the risk of letting your emotions push you toward timing the market.
That’s why this simple strategy is actually more efficient than buying individual stocks.
Worse than Just Inefficient
So far, I’ve just been talking about the case for simplicity in investments assuming you can get the same results in both a simple or a complex portfolio.
But, let’s not forget the worse-case scenario: that unnecessary complexity leads to errors.
Simple Automatic Rebalancing
Between February 19 and March 23, 2020, the S&P 500 dropped almost 35%. It was an absolute whirlwind month. The world was ending and nobody knew what to do.
I am 100% confident that if I had a portfolio full of individual stocks, I would not have slept that month. There were probably trades that needed to be made. What if I got one wrong? What if my bets that I had made all along were incorrect?
Instead, I slept like a baby. Sure, my stock holdings were decreasing. But, that’s what they’re supposed to do in that circumstance. My bonds barely budged. Then, on March 18th, the FidelityGo algorithm decided to rebalance my holdings. As a result, I sold a bunch of bonds at about 98% of their all-time high value, and bought a bunch of stocks at a 35% discount.
In the last 9 months, the FidelityGo algorithm has rebalanced two more times. Both of those times, the stock market was very high, so the result was to sell some highly-appreciated stock and buy some stable bonds.
As a result of all of this, my portfolio was up 17.45% YTD through the end of November, 2020. That, even though the S&P 500 is only up 11.1% over the same period. Here’s a screenshot with the time & date stamp.
On the other hand, what if I had built a complex portfolio full of individual stocks? As the stock market tanked, I would have had to look at every single holding, assess the impact the pandemic was having on their business, and decide whether to buy more, sell some, or hold.
I can guarantee you, I would have made a mistake.
Investing is supposed to be getting paid for having money. A good investment strategy has a plan built in for good times and for bad times. And, a good investment strategy should be simple enough to execute without fear of messing up.
Can you say that about your investments?
How well did you sleep between February 19 and March 23, 2020?
What’s the overall ROI on your total portfolio for January through November 2020? Did you actually profit from all of this volatility? Or, did a few of your bets pay off big, but those gains were offset by a bunch of other bets that didn’t?
If there are two ways to accomplish the exact same goal, why would you choose the more complicated way?
If you start early enough, by the time you retire the vast majority of your investments will be growth from the investments.
There is a way to invest intelligently that provides significant diversification and the ability to profit from all market conditions. And, it has the added benefit of being much simpler than buying individual stocks and bonds.
As your life grows and changes, it will probably become more complicated. Your investments don’t have to.
And they shouldn’t.
What to Read Next
For more information, check out these articles that offer more detail about these topics. Enjoy!
- Fully Fund a Roth IRA Every Year and You Can Retire a Millionaire
- A Review of Fidelity Go – Is Fidelity’s Robo-Advisor Ready for Prime Time?
- The Dangers of Placing Too Much Trust in your Investment Advisor
- How ETFs and Mutual Funds Build Diversification Into Your Portfolio
- How to Use an HSA to Self Insure for Long-Term Care
I hope this has been helpful! I welcome your comments with your thoughts and questions. And, don’t forget to subscribe to the newsletter to get notified whenever a new article is posted.