Warren Bufffett once remarked that there would be no need for the priesthood if people figured out that the ten commandments were all you needed to live your life. A lot of people depend on complexity and confusion to pay their bills. The same is true in finance. Investing isn't hard. People make it difficult, but it really isn't. If you focus on using your money to buy ownership of good businesses (stocks) or loaning money to good credits (bonds), and you make sure that you don't overpay for each investment, centuries of market data would indicate that you should do just fine if you have a long enough time horizon to ride out the volatility.
But most investors don't do just fine. They don't even do okay. They generate pathetic returns on their money. According to one study I read, during a period when the stock market returned 9% compounded annually, the average stock investor earned only 3%. Part of this underperformance was due to selling during crashes and buying during booms, part of it had to do with frictional expenses such as brokerage commissions, capital gains taxes, and spreads, and part of it was the result of taking on too much risk by investing in assets that weren't understood. Most of these behaviors are driven by investors trying to be above average. Instead of being content with slowly growing richer each year as their dividends and interest compound, they try to hit a hole-in-one, damaging their capital with big losses.
When It Comes to Your Investments, Less Is More
This is a tragedy because, in many ways, investing is a place where the famous phrase, "Less is More" rings particularly true. An investor that spent his entire career of 40 years regularly saving money and putting it to work split evenly between a low-cost stock index fund and a low-cost intermediate bond fund would have done very well for himself and his family. Much of this performance would have been the result of almost non-existent fees such as mutual fund expense ratios that he would have paid, which most likely would have been less than 0.25% per annum.
Why don't more investors do it? Because it's boring. Let's consider the case of an investor that wanted an asset allocation asset allocation of stocks, bonds, and real estate. His entire portfolio could consist of only three mutual funds even though indirectly, he'd own hundreds of investments. The S&P 500 fund alone holds Microsoft, ExxonMobil, Apple, Wells Fargo, Berkshire Hathaway, American Express, General Electric, Procter & Gamble, Colgate-Palmolive, McDonald's, and 490 other stocks!
- Vanguard S&P 500 Index Fund (Ticker Symbol: VFINX)
- Vanguard Intermediate Term Tax-Exempt Bond Fund (Ticker Symbol: VWITX)
- Vanguard REIT Index (Ticker Symbol: VGSIX)
Running this portfolio would have all of the excitement of filling out insurance forms. You'd have $100, or $500, or $1,000 or whatever you wanted automatically withdrawn from the bank each month and divided evenly into the three mutual funds. By reinvesting dividends, interest income, and capital gains for an entire working career of 40+ years, it would be a virtual certainty that the portfolio owner would retire with millions of dollars in assets due to the power of compounding. All that would be required would be ignoring the account statements so as not to get scared by the inevitable 50% drops in market value that happen from time to time.