Beware of the Emotional Herd by Wade W. Slome

We are living through unprecedented times in our economic history and the urge to give into the all-consuming panic spreading across the airwaves is very tempting. Unfortunately, succumbing to the pressures of following the herd produces suboptimal investment returns over the long run. The appropriate tactic is to invest objectively and independently, not emotionally. Or in other words, buy fear and sell greed. Most people understand the concept of buying low and selling high, but their thought processes at peaks and troughs somehow regress to the belief that circumstances are “different this time.” Stocks are definitely not for everyone; however history shows that recessions are the absolute best times to buy, for long term investors.

The eventual outcomes of emotional buying or selling are self evident in the regrettable data. John Bogle, the very successful founder of The Vanguard Group, did an eighteen year study (1984-2002) showing that individual investors underperformed the “do-nothing” index strategy by more than 10%…PER YEAR. It really astonishes me how much trading, fees, and emotions can impact long-run investment returns. And we can look back, beyond the recent tech bubble of the 1990s and the real estate and credit bubbles of the 2000s, to understand how irrational booms and busts have persisted.

Take for example the Tulip-Mania that took place in the Netherlands from 1634 – 1637. People sold land, homes, and other possessions, purely to buy tulips for speculative purposes. Eventually the tulip market collapsed by about 90%, but not before tulip bulb prices peaked at about $67,000, on an inflation adjusted basis.

Just as people can get overzealous in drinking the optimistic Kool-Aid during good times, so too can individuals bury themselves in pessimism during the bad times. I believe we are in one such glumly interpreted period now. My prescription for building wealth requires a patient, then aggressively opportunistic mindset. The reason being, I firmly believe financial markets are ruled by inefficiency and emotion in the short-run and balanced by efficiency in the long-run. There is no light switch to turn off the current, ugly economic times, but our challenges shall too pass and shrewd investors will prosper.

Leaking your Way to the Poorhouse

Paying fees on your investment portfolio is somewhat like a car leaking oil. A few oil drops leaking out of your engine is no big deal. But if your car is leaving behind large puddles and the engine cannot maintain the adequate level of lubricant, eventually the engine will simply stop running – leaving behind a messy situation that precludes one from reaching the desired destination. The same principle applies to investing, when considering fees, transactions costs, and taxes.

If the last decade hasn’t been challenging enough for equity investors, some brokers have added insult to injury by charging excessive fees – not a healthy recipe for individuals’ retirement plans. I am actually very optimistic about the investment opportunities available in today’s marketplace, however less sanguine about the sucking sounds coming from some of the aggressive fee-sucking brokers (a.k.a., Hoover vacuums). I’m making every effort I can to educate investors to better arm themselves against unscrupulous behavior and augment their knowledgebase regarding fees, transaction costs and taxes.

And when it comes to the investment industry, fees come in all shapes and sizes. There are explicit fees, such as, management fees, 12-b1 fees, administrative fees, load fees, and surrender charges, among others. Unfortunately there are indirect costs that drag down returns such as excessive transactions costs and taxes, and most investors don’t consider these impact. It does no good for the investor if a gargantuan pre-tax return is achieved and then evaporated away with fees, transactions costs, and taxes. Even if you exclude taxes, the average investor is paying 2.5% annually according to Bogle (1% in management fees, 1% in sales/load fees, and .5% for transactions costs).

Consider a $150,000 investment account earning an after-tax (net of fees) return of 5% over 20 years. That portfolio would grow to nearly $398,000. Let’s assume the efficiency of a portfolio could be improved with lower-cost, tax- efficient products and strategies, resulting in a net after-tax return of 7%. What do you think that innocent 2% improvement is worth? ANSWER: Over $182,000! That’s not chump change, and that money could buy a lot of vacations, medical bills, tuition for grandchildren, or many other niceties and necessities. Most people don’t fully appreciate how direct and indirect costs impact the timing of when AND how you will retire.

Now that you have recognized the leaking oil in your engine, don’t let fees, transaction costs, and taxes seize-up your investment engine!

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

This is a guest post by Author,Investment guru (my words not his!) and founder of Sidoxia Capital Management, Wade W. Slome.  Wade’s book titled, “$20,000,000,000.00 by Age 32″ provides real investment advice not from talking heads but rather someone who survived the trenches (albeit at a young age). 

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