Unforced Errors

In this episode of Financial Sentiments, Nick Haberling, CFP®, discusses some of the most avoidable mistakes investors make and why long-term success often has less to do with finding brilliant investments than avoiding unforced errors.

Like a turnover in basketball or an unforced error in tennis, some investing mistakes are entirely self-inflicted. Stock picking, high investment costs, market timing, and taking the wrong amount of risk can all quietly reduce the odds of reaching your financial goals.

Nick explains why even professional stock pickers struggle to consistently outperform the market, how investment fees can create a meaningful drag on returns, and why trying to jump in and out of the market can cause investors to miss some of its strongest periods.

He also discusses the difference between risk preference and risk capacity, and why the right investment allocation should reflect both your comfort with volatility and your ability to withstand it.

The goal is not to make the perfect investment decision every time. It is to avoid giving away unnecessary possessions and give your long-term plan the best opportunity to work.

Read the original article here:
https://financialsentiments.com/blog/2023/2/21/unforced-errors

Have a question or want to talk about your financial plan?
Email Nick at nhaberling@hfgtrust.com or book a meeting here: https://bookings.cloud.microsoft/book/HFGTrustNickHaberling@HFGTrust.com/?ismsaljsauthenabled=true

Transcript

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SPEAKER_01 0:00

Quick question before we get into it. What do a lazy basketball pass and a bad investment decision have in common? They're both turnovers you didn't have to give away. One of the biggest lessons I took from playing basketball as a kid was this. Minimize your turnovers. For example, let's say each team normally gets 30 possessions a game. Your team turns the ball over five times. Now you've got 25 possessions, and the other team has 35. Those extra possessions the other team has will probably decide the game. And it wasn't because the other team outplayed you. You just made it easier for them. Today we're talking about the investing version of that lazy pass. We call them unforced errors, and they're some of the most avoidable mistakes I see people make with their money. Hello and welcome to the Financial Sentiments Podcast. I'm Nick Haberling, a financial advisor at HFG Trust, and in this podcast, we explore the investment and planning decisions that actually simplify financial life, cutting through the noise to focus on what truly matters. And so actually, I can't claim credit for the term unforced error. Unforced error is actually a tennis term. If you watch a match between two lower to intermediate level players, you'll notice something. The outcome usually comes down to who makes the fewest unnecessary mistakes, not who hits the flashiest winners. And I think this idea applies almost everywhere in life, but it applies especially well to investing. With one twist. In investing, you're not really competing against another team. You're competing against an ideal future version of yourself, where every good decision is a boon to that future self, and every unforced error takes something away from them. Charlie Munger put this better than I ever could. So let's walk through some of the unforced errors we see most often. And the first one that we see is stock picking. When most people picture investing, they picture sharp portfolio managers pouring over spreadsheets, hunting for the next great company. But here's the problem. This means most investors would have been better off buying and holding an index fund instead of investing with the active managers in question. And this is not because these fund managers are incompetent. A lot of them are genuinely brilliant. The biggest reason they struggle is that markets are remarkably efficient. That fund manager is competing against thousands of other smart managers and the algorithms built by them. The moment new information hits, it gets rapidly absorbed into prices through all the buying, selling, and options activity. Now the second unforced error is somewhat tied to this one, and it's having high expense ratios in your mutual funds or ETFs. Quick refresher: the expense ratio is the fee a mutual fund or ETF charges to manage your money. So the lower the fee, the more of the return you actually keep. So this ties into our first unforced error on stock picking. Paying a bunch of analysts to comb over stocks and determine which securities to buy and sell is expensive. That price gets embedded into a mutual fund or exchange traded fund through the funds expense ratio. And here's the part that really should bother you. We already covered that roughly 90% of these actively managed funds underperform their benchmark. And that's after those fees are already baked in. So you're not just paying more, you're paying more for worse. In almost any other part of life, we'd call that a bad deal. That's really the whole principle behind avoiding this unforced error. Don't overpay for the same or worse outcome. So whenever it makes sense, we look for opportunities to swap in a less expensive fund or index-based option that gets you the same or better exposure without paying for analysts whose picks aren't beating the market anyway. I genuinely thought the era of high expense ratios was behind us, but I was wrong. I've seen plain, unremarkable mutual funds charging expense ratios as high as 2%, and entire portfolios averaging expense ratios near 1% across the board. That's a real, ongoing drag on returns, and it's completely avoidable. Our third unforced error is market timing. Buy low, sell high, everyone's heard it, but almost nobody can actually pull it off consistently. One of my favorite illustrations of this is Sir Isaac Newton and the South Sea bubble of 1720. If you know your science history, uh Sir Isaac Newton's a pretty important guy and a smart guy at that. Now, Newton got into the South Sea Company early, watched the stock climb, and sold, locking in a solid profit. Except the stock kept climbing after he sold. So Newton, watching everyone around him get rich, jumped back in near the top, right before it collapsed. This is a man who mapped the motions of the planets, and he later said, I'm paraphrasing, that he could calculate the movement of the heavens, but not the madness of people. Market timing is no less difficult and bad for our investments in the 21st century. There's a chart from Dimensional Fund Advisors called The Cost of Trying to Time the Market that makes this point with hard numbers. It takes a hypothetical $1,000 investment in the SP 500 from 2001 through 2025 and asks a simple question. What happens if you're on the sidelines for just a handful of the market's best days? Stay fully invested the whole stretch, and that $1,000 investment has grown to $8,360. Miss the best week, which happened to be in November of 2008, a time no investor remembers fondly, and your investment is worth $6,977. The last part is the key. The best days and weeks can occur in the middle of very turbulent stretches, which means the emotional instinct to step out of the market when things feel dangerous is exactly the instinct most likely to make you miss the recovery that follows. All right, and our last unforced error for today is mismatched risk allocation. Now, this is a subtle but important distinction. Risk preference versus risk capacity. Risk preference is subjective. It's your gut level comfort zone of how much risk you feel like you can handle. Risk capacity is more objective. It's what you can actually absorb. If the market drops 30%, what does that actually do to your financial plan? Does it force lifestyle changes? Age matters a lot here too. Picture a 25-year-old who's naturally risk averse and puts together a 50-50 stock and bond portfolio in their 401k. Their instinct that stocks are more volatile than bonds is technically correct, but being that conservative in your 20s, with decades until retirement, likely means shortchanging your future self out of the higher returns stocks tend to deliver over time, over that 40-year plus working career. Now flip it around. There are years when a portfolio heavily weighted toward stocks can suffer a decline in excess of 20%. This means someone who is close to retirement and is overly weighted toward stocks is taking on real risk right when a downturn could hit the hardest, just as they're about to start drawing on that money. So, stock picking, high fees, market timing, and mismatched risk allocation. None of these are exotic mistakes, and they're all avoidable ones. And that's really the whole point. You don't need to be a genius to be a good investor. You mostly need to not beat yourself. Great investing isn't necessarily about finding more winners. Sometimes it's simply about giving fewer possessions away, maximizing each possession by minimizing turnovers. If today's episode has you wondering whether there are unforced errors sitting in your own portfolio, I'd be happy to take a look with you. You can reach out to me directly by email, the address is in the show notes, or if you'd prefer, you can schedule an introduction meeting at your convenience using the calendar link, also in the show notes. Hope you have a great day.

SPEAKER_00 8:31

This podcast is for informational and educational purposes only and should not be considered financial, investment, tax, or legal advice. Opinions expressed are the representative's own and may change over time. Investing involves risk, including the potential loss of principle. Before making any decisions, please consult with your own financial, tax, or legal advisor. This podcast is produced by a representative of HFG Trust, a Washington state chartered trust company.