Doubling Your Money With Passive Investing

Spencer Jakab has put his experience—first as a stock analyst, and now as investment columnist for the Wall Street Journal—into a new how-to book called Heads I Win, Tails I Win that helps investors figure out what they are doing wrong, and how they could “tilt the odds” in their favor.

This isn’t advice you’ve never heard before. But it is advice served up in memorable anecdotes based on Jakab’s years of experience with investors and readers alike, looking for ways to avoid blowing holes in their nest eggs.

It’s a humorous take on some of the biggest investing mistakes people make, and how to avoid them—one that goes well beyond dry stats and figures about investing.

ETF.com: You've written this book based on the idea that average investors are leaving money on the table without knowing it. What's unique about your perspective on why the odds are stacked against investors?

Spencer Jakab: The advice in the book is drawn from many sources; it’s evidence-based. But the way that it's presented is quite unique.

When you go to people and you tell them something, for example, about their health—say, the fact that smoking would be negative, or that the effect of exercise or eating vegetables would be positive—and you express things in percentage terms, or in terms of odds of being healthy or unhealthy, people understand that. And they tend to change their behavior. But when you have evidence of these things for investing behavior, despite the fact that there are so many years of history, people tend not to follow the advice.

In the book, the evidence for what to do and what not to do is presented in an anecdotal way. It looks at your probability of having a good or a bad outcome based on different types of common behavior, and different techniques, some of which are thought to be perfectly fine but are not.

ETF.com: Has your experience as a stock analyst before, and now as an investment columnist, given you a different insight into investor behavior? Anything surprising about how people make investment decisions?

Jakab: Definitely. There are lots of insights from both of my careers. Having been an investment analyst, I got paid lots and lots of money to give sophisticated investors ideas. Yet I saw how the investors operated. It became quite clear to me why even highly trained fund managers can't beat the market. Their efforts are no better than a coin flip, and that’s before their expenses are taken into account. Once their expenses are taken into account, some three-quarters of them fail—in any given year—to beat a passive index fund.

And it's because they’re prone to the same sort of decision-making mistakes that individuals are. They tend to run in herds. They tend to run away when things are cheap. They tend to crowd toward things when they're expensive.

The main shortfall investors make, aside from paying too much for services, is poor timing. And even though markets are a zero-sum game, in the sense that all the gains are distributed across all participants, some people who manage to be patient and manage to be contrarian reap a disproportionate share of the market's rewards. You can quite clearly see this if you spend enough years working with so-called professionals.

ETF.com: You mentioned paying too much, poor timing—what are some of the biggest mistakes investors—professional and otherwise—make?

Jakab: One of the really surprising findings in the book is the source of most of the underperformance: timing. Bear markets and market declines happen to everyone. If you're going to take the risk of having money in the stock market, for example, or even in the bond market, you have to accept that you're going to suffer paper losses time and again.

But the largest source of individual losses or opportunity costs to investors is what happens in the aftermath of a downturn. The problem is that investors are underexposed to the rebound that occurs afterwards.

Think about it this way: When people go on a road trip, they'll look at MapQuest, and MapQuest will tell them how long it's going to take them to get to their destination. But MapQuest doesn't take into account the fact that you might get a flat tire, or that you might forget your wallet at home and have to turn around after you got on the highway, and things like that.

The stock market has a MapQuest as well. The MapQuest of the stock market—the long returns of the stock market—do take those into account. Despite all the setbacks, it makes up for it in the end. It's like getting a flat tire that delays you half an hour, but then you get back on the interstate and drive 250 miles an hour. That's the equivalent of what the stock market does.

The problem is that when the market is racing ahead, going the equivalent of 250 miles an hour, that’s when individual investors are least likely to have their full exposure to the stock market. In the months immediately after a scary episode, they may have sold their stocks. And if they didn't sell their stocks, they didn't up their exposure to the stocks either.

It's very tempting to try to pick the bottom. But a way around that is to be as mechanical as possible about it—“This is my preferred allocation to risky assets like stocks. And no matter what's happening, even if it looks like the world is ending, this is my schedule and I'm going to get back on the schedule.”

In the aftermath of a sharp downturn, that's going to mean growing your exposure to risky assets like stocks when most other people are doing the opposite. I demonstrate in the book that doing so mechanically, and not allowing your human judgment to get into it, is a fantastic boon to your long-term returns.

ETF.com: It sounds like you’d be in favor of low-cost, passive investing as a way to fit this “mechanical,” rules-based, nonemotion-driven type of investing you suggest. Are you a fan of ETFs?

Jakab: I offer many tips in the book on ways not to lose money. I also offer a handful of tips on ways to earn something slightly in excess of the market return. The fact is that eight out of 10 individual investors would do very well just to narrow the gap between their own returns and the market return. The typical individual investor would have a nest egg at least twice as large if they simply tracked the market. That sounds like a very unexciting promise to make, but twice your money is not unexciting.

Many people think they're doing much better than they actually have been. When they're actually shown what their annualized returns have been relative to the market return, they're pretty shocked. It's a gap of several percentage points for the typical investor.

So I think passive products that exist in the market are a good tool—low-cost ETFs and low-cost open-ended mutual funds. But it's not enough that they exist, because despite the proliferation, and despite the fact that 40 years ago you had 0% of money invested in index funds, and today approximately a third of U.S. equity investment is done passively, performance really hasn't improved. Part of the problem is that people use these products, like ETFs, but still engage in poor timing.

ETF.com: Is the problem here lack of investor education about finance and investing, or is it inadequate financial advice from professionals? Is the advisory industry doing a good job?

Jakab: The advisory industry does a decent job. A fee-only advisor can be of value for those people who are very prone to panic or to irrational exuberance. It costs money, obviously, and is a drag on your return. But for those people who are especially emotional in their approach to the market, it can be worth it.

For other people, robo advisors are a very good choice, because they engage in automatic rebalancing—which I recommend—and tax loss harvesting. They do it at a much lower cost.

In the end, it's not really a matter of education; it's a matter of conditioning. Even people who are fairly educated about the market, and who are cognizant that three-quarters of active fund managers don't outperform still believe the guy they've picked is going to be the exception to the rule. It's a triumph—or a tragedy—of hope over experience.

ETF.com: Any other takeaway we should get from your book?

Jakab: One thing I find interesting is that it's the opportunity costs that really cost people money. It's the not-being in the market. One example that I give is, what would happen if you had a time machine? What's the most valuable thing you could do if you could go back 30 years one time and meet your 30-year-younger self? What's the most profitable investment advice that you could give?

I give the example of “Back to the Future,” when Biff goes back and meets his teenage self and gives him a sports almanac. What if you're given an economic history book when all the recessions would have occurred? I show definitively that having that knowledge and acting specifically on that knowledge actually wouldn't help you gain any edge over the market.

The most valuable thing you could do would be to go back in time, open up a brokerage account, put the money in there and then not allow anyone to touch it for 30 years. Because just riding out all the bull and bear markets that happened in between and allowing your money to compound for that amount of time would be far more profitable than knowing when a recession is around the corner. People find that surprising, but it's absolutely true.

Contact Cinthia Murphy at [email protected].