Why Too Many Choices Make Us Bad Investors
May 03, 2018

Why Too Many Choices Make Us Bad Investors

Mike Korb could eat nails. He was one of the toughest, most talented bike racers I ever knew. He never ventured far from his Victoria, B.C. home. But when world-class cyclists raced in our city, Mike often found a way to win. In the early 1990s, if I had to bet money on whether Mike could beat Lance Armstrong on a tight downtown circuit (known as a criterium) I would have put money on the local guy.

Bike racing was simple–much like investing used to be. Mike is now co-owner of the bike shop he has worked at since he was 18 years old. “Young cyclists ask me all kinds of technical questions about which bikes are the fastest and what their heart rates should be,” says Mike. “But they waste too much time obsessing about that stuff.” Investing has become a lot like that.

In 1976, Vanguard offered the world’s first low-cost index fund. If you believed a low-cost index would beat most actively managed funds, this was the only fund available. Between January 1977 and March 31, 2018, it would have turned a $10,000 investment into $734,517. That’s a compound growth rate of about 11 percent per year. It also trounced the returns of most actively managed funds.

In September 1991, personal finance columnist Scott Burns introduced the Couch Potato portfolio. It represented an equal split between Vanguard’s S&P 500 index and Vanguard’s Bond Market Index.

It was also simpler than a ham and cheese sandwich. Once a year, investors would rebalance the portfolio back to its original allocation. If you adopted the Couch Potato strategy in September 1991, a $10,000 investment would have grown to $75,330 by March 31, 2018. That’s a compound annual return of 7.89 percent.

It didn’t beat Vanguard’s S&P 500. Over the same time period, the S&P 500 would have turned $10,000 into $111,831, for a compound annual return of 9.51 percent per year. But the Couch Potato is more diversified, so it doesn’t drop as far when the stock market falls. As a result, it’s easier on the nerves. It also takes just 10 minutes a year to manage.

What’s more, it lets people focus on much bigger things. Instead of obsessing about the market or their choice of investments, people can spend more time exercising, hanging out with friends and family and maximizing strategies to save more money.

Investment waters, however, get muddier every year. In 2017, Bloomberg reported that there were more than 5000 index funds. There are factor-based indexes, total world indexes, individual country indexes, emerging market indexes, low-volatility indexes, high-dividend paying indexes and sector-specific indexes. The total list is longer than winter in Siberia.

Unfortunately, added choices don’t help. Researchers Sheena Sethi-Iyenga, Cur Huberman, and Wei Jiang examined 401(k) participation rates provided by hundreds of employers. Employees that had a greater number of funds to choose from were often paralyzed by choice. Fewer of them invested, compared to employees that were offered a lower number of fund selections.

Barry Schwartz described something similar in The Paradox of Choice Researchers displayed jars of jams in supermarkets In one version, shoppers saw 6 types of jam In another, there were 24 jams More options attracted more lookers—but not buyers. The smaller number of jams resulted in ten times the number of purchases

John Bogle also says choices hurt investors. In 2013, PBS interviewed him in a piece titled, The Train Wreck Awaiting American Retirement. He said, “The less choice the better Choice is your enemy, because you choose based on one thing: past performance Past performance does not recur.”

Bogle might be right. Every day, readers email me to ask, “Which index fund is best?” They might ask about an iShares developed market global ETF, comparing it to Vanguard’s total world stock market ETF. They ask about fundamental indexes and other smart-beta funds. They quibble over expense ratio costs, worrying that an ETF that charges 0.10 percent might change their life compared to a competitor’s index charging 0.13 percent. It won’t.

Index fund fees often lower over time. And past performance, for one type of index, isn’t a working crystal ball for that fund’s future. Instead, investors need to keep things simple. They should build a diversified portfolio of low-cost index funds. Americans should include exposure to U.S. stocks, international stocks and US bonds.

Investors from different developed world countries should own a home-country index, an international stock index (that includes the U.S. market) and a government bond market index that reflects their respective home currency.

It’s a lot like bike racing. No bike racer knows which frame, wheels or gearing will be best. The rider’s heart and mind are far more important. The investor’s heart and mind are also key. Investors need to save. They need to be tough enough to stick to a long-term plan. They can’t swerve or waver, no matter what the markets do. Smart investors don’t sweat the small stuff. That’s why my old buddy, Mike Korb, might make a great investor. It’s a heck of a lot easier than eating nails.

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This article contains the opinions of the author but not necessarily the opinions of AssetBuilder Inc. The opinion of the author is subject to change without notice. All materials presented are compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. This article is distributed for educational purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, product, or service.

Performance data shown represents past performance. Past performance is no guarantee of future results and current performance may be higher or lower than the performance shown.

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