Get Rich Slow: Investing For The Long Haul

As a refresher, I take the position that there are no "Get Rich Quick" techniques whose potential for gains outweighs the risks. I rely and recommend, instead, a "Get Rich Slow" technique of avoiding unnecessary investment advice fees (often 20% yield), avoiding losses, and, by investing in efficient broad based equity indexes like the S&P 500 or Russell 2000 as examples, using consistent periodic investing called dollar-cost averaging.

In a recent Wall Street Journal article, these tried-and-true investment maxims were vindicated yet again as not only valid but also extremely timely in our new economy. Burton Malkiel wrote of his research and findings:

The evidence is clear. Low-cost index funds regularly outperform two-thirds of actively managed funds, and the one-third of actively managed funds that outperform changes from period to period. Even the very few professional investors who have beaten the market over long periods of time--Berkshire Hathaway's Warren Buffett and Yale University's David Swensen, for instance--are quick to advise that investors are likely to be much better off with simple low-cost index funds than with expensive actively managed funds.

[S]omeone who invested $100,000 at the start of 2000 and, following my advice, used index funds, stayed the course and rebalanced once a year, would have seen that investment grow to $191,859 by the end of 2009. At the same time, someone buying only U.S. stocks would have seen that same investment decline to $93,717.

"Buy and Hold" Is Still a Winner

An investor who used index funds and stayed the course could have earned satisfactory returns even during the first decade of the 21st century.

By Burton G. Malkiel November 18, 2010

The Wall Street Journal Letters to the Editor, in response to Mr. Malkiel's article, came exclusively from money managers defending their industry and share the conclusion that active management is less risky and more profitable than broad based equity investing over time.

One response, from Mathew Tuttle, concludes that even simple active management strategies would have avoided the losses of 2008, and that the key to success in the markets is the obvious "avoiding large long-term losses." I appreciate the validity of the conclusion, but the active management industry did not avoid the large long-term losses its numerous defenders claim are so easy to avoid with basic management techniques.

Another Letter to the Editor, from Brenda Wenning, refutes Mr. Malikiel, claiming he does not have any "understanding of active management." The letter delves into the skill required of investment managers that use "technical and fundamental research, and pay attention to drawdowns, to drive their decision-making." The conclusion reached is that active managers using these skills advised their clients to sell off their equities in the Summer of 2008, avoiding losses they would have suffered under a broad-based equity investing technique using dollar-cost averaging for entry points.

I particularly enjoyed this letter, as it would have us believe that the investment management industry avoided all of the losses of the market correction, reaching an ultimate conclusion that investing in broad-based equity indexes is too risky when compared to entrusting your life savings to an investment manager. Another Letter to the Editor, from Anthony DuBon, perfectly illustrates the futility of active management techniques for the average investor. Mr DuBon concludes, with exuberance, that "28% of actively managed funds outperformed the market" during the great correction and that historically "25% to 30% of actively managed mutual funds beat the S&P 500." It has been some time since I debated, but defining the strength of your position relative to a 1 in 4 chance of success does not support the position that your industry is a winner. The position becomes even more untenable when the definition of "beat the market" is considered.

If the market is down, a money manager can "beat the market" and still produce a loss. The money management industry always makes money whether its customers win or lose, so there is a natural response to defend its existence when confronted with uncomfortable facts regarding its performance. The age of the information network is providing investors with specific performance results that make it more and more difficult for active money managers to justify their existence. Investors, however, are still addicted to the promise of finding their 1 in 4 sweetheart money manger that "outperforms" the market. The question remains, why are so many investors fixated on investment behavior that is extremely risky, relies entirely on money managers, and offers outcomes over which they have no control?

One consistent comment in my discussions with investors about their investment philosophy is that investing is a gamble. Not only is it a gamble with the investment choices, but also a gamble over which money manager is chosen. I conclude that the root causes of addiction to gambling apply to investment behavior as well. What stimulus causes such addictive behavior?

Due to the influence of chance, gamblers receive irregular winnings or payouts. Irregular payouts cause a much higher response than constant payouts, resulting in stronger emotional reward for continued similar behavior. In contrast, constant payouts reduce the emotional value of the smaller but regular payout. Additionally, gamblers often think they can guess when the next payout or win will occur; but, of course, this is impossible to do. Yet, the irregular payout rewards this belief system. The choice of an investment behavior with low probability of payout but potential for high payout is identical in profile to the irregular but high payouts of many gambling games. The trick is to recognize you are engaging in behavior which benefits everyone but you, and have the self-discipline to limit or eliminate that behavior.

Some forms of gambling have been described as hypnotic. If you gamble when you are angry, depressed, anxious, or frustrated, you may go into a trance-like state and temporarily forget all your troubles, as well as how much time and money you have spent. This suggests that one will only get control over gambling when progress has begun with the big worries in life. The use of "trading platforms" or day trading is identical in its hypnotic effect on the user and provides an emotional escape to deeper-seeded issues vexing the trader. I once spent 72 hours without sleeping while trading currencies, and lost all sense of time and place within the hypnosis that develops. The "Get Rich Slowly" techniques avoid all of the negative effects that such behavior can cause; but, again, you are working against what "rewards" your brain. The knowledge of these effects is the key to avoiding them.

Most people have strong values about not giving up easily, and not quitting when the going gets tough. Some people also have very strong competitive drives. These factors tend to work against gamblers, leading them to keep going until all of their money is gone. The identical behavior pattern exists with investors who stay in bad investments too long, hoping they will come back, to no avail.

When an investment strategy is failing, you must regroup, accounting for the losses as an education in what behavior not to repeat. Bad investments do not get better with age, and good investments will only yield so much before correcting. Again, the disciplined investor does not worry about these issues, having accessed the markets on a broad base over time, allowing the efficiencies of the market to work out and produce the targeted average returns over time. Knowledge of the psychology of gambling, coupled with discipline in investment technique, is more important than any amount of timing or technical analysis.

Apart from this, gambling can provide some other non-financial payoffs. For example, there can be excitement, relief from boredom and stress, and a sense of belonging and company. The same is true for investment clubs, trading platforms, or tips on the next great deal. Do you really want to be a member of the "How Much Did You Lose Club," even if it occasionally returns extraordinary returns, say, once in 100 times?

The best solution to addressing addiction is to avoid the addictive behavior. This advice seems simple enough, but the investment game is very alluring. A good alternative is to follow the same approach you use when crossing the street: Stop, Look, and Listen. Stop repeating the same behavior with the same advisors. Look for alternatives that protect you from losses while allowing upside potential without the associated fees of an actively managed portfolio.

Listen to the facts about 1 in 4 money managers "beating the market," which investment techniques have done consistently well, which investment products protected investors during a crisis, and which investors have the least anxiety with their money. As children, that advice prevented us from getting hit by a bus. As adults, it is less literal but still critical.