The Psychology of Money Chapter 15: Nothing's Free

Imagine it’s time for another car. The car you’d like to buy costs $50,000 new. Your options: spend $50,000 to buy new, spend $30,000 to buy used, or steal the car. Hopefully nobody reading this considers the third option, and hopefully that’s because of a moral compass. But beyond that, we’d recognize that if we tried to steal a car, the bill would come due soon enough. With prison sentences potentially reading multiple years for grand theft auto, this route likely would end up being the most expensive.

Buying a new car might come with lots of perks: promises of peak performance from the newest tech, ability to customize, more social clout. For these benefits, there’s a higher corresponding price tag. For many, the cost of a new car is within their means and the benefits are worth more than the cost, which makes it a good purchase. With investments, Housel explains that there are similar options. “Successsful investing demands a price. But its currency is not dollars and cents. It’s volatility, fear, doubt, uncertainty, and regret.” Buying the stock equivalent of a new car—purchasing a position in a single stock that has outpaced all others in recent years, seemingly promising continued outperformance, and giving the excitement that goes along with owning a new car—might be a worthwhile purchase, so long as you understand and are willing to pay the price. In this case, the price is having to watch the stock drop 20, 30, or even 50% without doing anything about it. Ironically with stocks, many try to get the new car benefits without paying the price—also known as stealing.

A used car—in investing terms a diversified portfolio—won’t have all the perks of the new buy, but it also will come with much less volatility and therefore fear, doubt, and the rest. Yes, when we hear of people buying GameStop or Bitcoin and becoming millionaires overnight we question our approach. But usually when those same people lose all their investments a week later, it doesn’t make the same headlines. There’s no free lunch, but there are shrewd buyers who count the costs (financial and non-financial) of their purchases. May we be found among them!

Success in our personal finances comes down to how we behave. So how should we behave? As Housel says:

1. Think of market volatility as a fee, rather than a fine.

2. Convince yourself that the market’s fee (volatility, fear, etc.) is worth it.

Let us know

• Do you usually buy new or used cars? Have you ever regretted a purchase?

• When have you been the most worried about your investments (Covid, Great Financial Crisis, etc.)?

P.S. As you know, there is also a dollar cost to investing. Below is a brief outline of common costs and what they pay for

• Expense ratio: this is a fee that’s built within a mutual fund or ETF and pays for the fund managers to decide what specific investments to trade at various times and quantities. Index funds or passively managed ETFs have very low expense ratios, around 0.04%, while actively managed funds usually cost anywhere from 0.4% to even as high at 1% or more. The models we often use for our clients come from Capital Group and American Funds, and their expense ratios are around 0.4-0.5%.

• Advisor fee: Advisor fees can be charged either as a flat dollar amount or as a percentage of the assets managed. The industry average for a $1,000,000 portfolio is 1%, or $10,000 per year. Unlike many financial advising offices, you can find our fees publicly on our website. Advisor services vary by office and professional, but should include a broad range of financial planning services for the common categories: investments, insurance, estate, tax, retirement, income (which means if you’re paying an advisor a fee just to manage your investments [which actually is paid for through the expense ratio above], IMHO you are overpaying and should look for a new advisor). Our tag line to summarize our services is: Helping you craft and execute the plans to fund your best life.

• Commissions: I personally don’t refer to people who work for commissions as financial advisors. There’s a legal loophole that lets them call themselves this at times, but technically they’re not giving you financial advice, they’re selling you something (unless the financial advice is “buy my stuff”...). Now, maybe it’s in your best interest to buy their stuff, but when they only make their money when you buy, it creates an obvious conflict of interest. One caveat is that there are some good financial products that unfortunately are still only available in commissionable products. If you are working with an advisor who is getting paid for their unbiased advice through a fee-relationship above, and they recommend a product with a commission, it would be worth considering as part of the larger fee-based advice engagement.

Until next time, happy reading!