25 September 2022

Four flavors of investment extremism

By Adrian Colarusso, CFA, CFP®

September 25, 2022

I was featured on a podcast! Thank you to the Konabos team for having me. I was told by one friend it was “genuinely enjoyable”, and another that he passed it along to his Dad, although both are biased because they got anonymized shout-outs.

I recently hosted a book club on The Psychology of Money: timeless lessons on wealth, greed and happiness. Our intergenerational dialogue hammered home the fundamentals and acknowledged the art of personal expression in each of our approaches to building wealth.

Some highlights of the book:

  • “Less ego, more wealth. Saving money is the gap between your ego and your income.”
  • “Compounding works best when you can give a plan years or decades to grow”
  • “Risk is what’s left over when you think you’ve thought of everything.”
  • “There are a million ways to get wealthy … but there’s only one way to stay wealthy: some combination of frugality and paranoia.”

And a segue: “No one’s crazy. Your personal experiences with money make up maybe 0.000000001% of what’s happened in the world, but maybe 80% of how you think the world works.”

Well-rounded wealth

To invest is to transport your money from the present to the future, ideally as safely as possible. Anything you do (or don’t do) comes with risk.

Some people narrow in on a single method for transporting their wealth to the future, forgoing the magical math of diversification that usually leads to higher returns, less risk, or both compared to a single strategy.

Four investment extremists:

  1. Cash Cowerers
  2. Bogleheads Gone Blind
  3. Touchy Feely Real Estate Moguls
  4. Risk Cowboys

No one is crazy, but everyone is biased. The goal of portfolio construction – whereby you spread wealth across different types of assets – is to prepare you for multiple future states of the world as objectively as possibly.

The definition of wealth is the ability to enjoy a high standard of living across many future states of the world for a long time.

My point isn’t that any one of these approaches is wrong. Any one of these strategies has the potential to work out swimmingly for some. I argue that they will not do so with the highest probability each on their own.

  1. Cash Cowerers

Cash is king (or queen?). There are situations where an out-sized cash position is imperative. The problem is holding excess cash out of fear, indecision, or lack of understanding of the alternatives. There’s nothing wrong with investment conservatism driven by a healthy dose of paranoia. But there is a cost to it.

Cash feels safe. Everyone knows that inflation is the big risk of holding too much cash for too long.

Inflation is a feature – not a bug – of the monetary system (today’s abnormally high inflation notwithstanding). It prods us to invest in riskier assets. The returns on those assets represent the production of real-world wealth, which both producers and consumers share.

If we all hoarded cash in hopes to save enough of it to retire on, the system wouldn’t work. We’d collapse into a deflationary spiral of foregone wealth creation that would shrink the pie for everyone. Although cash and bonds (especially long-term bonds) would be the best hedges against a deflationary depression scenario, we must size this protection appropriately.

Cash that you don’t need now (within the next 12 months, say) is meant to be invested. If you stay in cash, the market won’t appear to vaporize your wealth with short-term volatility, but inflation will slowly bleed you dry.

There are also less risky ways to invest than “the market”, and you can dollar-cost-average to wade into the cold investment waters at a more comfortable pace.

  1. Bogelheads Gone Blind

“Oh, I just buy ETFs.”

Oh yeah? What ETFs? There are more ETFs for sale than there are stocks listed on the New York Stock Exchange. There are some right answers to this question (and plenty of wrong ones). Any low-cost, plain-vanilla ETF that tracks “the market” is probably a sensible thing to own.

The philosophy is to keep frictions low, let the market do what it has always done and patiently watch (or better yet, don’t watch) your balance grow big and strong by the time you retire.Past performance is no guarantee of future results.

The person most responsible for this revolutionary investment approach is Jack Bogel, creator of the first index investment fund, and founder of Vanguard.

A cherished memory of mine: years ago, at the rowdy Princeton Reunions “P-Rade”, the Class of 1951 was marching down the route and I spotted Mr. Bogel. “JACK! JACK!” I called. He turned. “THANK YOU FOR EVERYTHING YOU’VE DONE FOR THE INDIVIDUAL INVESTOR!”. He tipped his hat. I raised my can. And I truly meant it. (RIP Jack).

The individual investor has benefited tremendously from the advent of index investing. We free load off the hard work of professional active investors who compete to price assets fairly. But it’s only one investment approach out of many possible.

Plain-vanilla stock index investing will work best in the world where things keep truckin’ along as they have (this year’s bear market notwithstanding). It’s a reasonable base-case scenario to assume. But many ETF portfolios I’ve seen are rife with overlapping exposures, unintended concentrated risks, and hardly any real diversification.

Furthermore, above a certain level of wealth, you might want to buy some protection from some alternate states of the world.

Lastly, new product innovations are starting to supplant the supremacy of the ETF structure for certain types of investors, especially those with taxable accounts. Other vehicles can provide unprecedented access to heretofore exclusive asset classes like private equity, private credit and private real estate. Not investment advice.

  1. Touchy Feely Real Estate Moguls

Certain people want nothing to do with stocks and bonds but have googly eyes for real estate. They can no doubt point to an admired mogul who’s effortlessly amassed a grand portfolio of high-profile properties and lives off rents and tax breaks.

To them, real estate has value they can see, touch, and feel. They find it harder to wrap their heads around a share of stock. I get it. Real estate stirs the soul for me, too.

There are cognitive biases at play. You’ll often hear about the successful real estate investors, but seldom the failed ones (survivorship bias). Also, someone with a comparably sized stock-and-bond portfolio will never place it on a street corner with their name on it (availability bias). Lastly, there is scarce evidence that real estate outpaces stocks over the long term, as its returns are difficult to measure.

Real estate is a career, not an investment strategy. Yes, it can be both, but I think many people underestimate or downplay the sweat equity and risk appetite required to become a successful, active real estate investor. It can be immensely rewarding for the right kind of person; there are ways to direct your productive energies into real estate with appropriate balance.

For those who aren’t looking to start a real estate side hustle and just want pure investment exposure, buying an appropriate amount of real estate in a passive pooled vehicle is a probably a better route. Not investment advice.

  1. Some people call me the risk cowboy

I’ll just drop some barely hyperbolized quotes that tell the story. I say “cowboy” and not the gender-neutral “cow-person” because, of course, all of these were from men.

“Dudemy portfolio is one-third Bitcoin, one-third Ethereum and one-third Shibu Inu.”

“I really think Tesla can 10x from here, bro.”

“My semiconductors/biotechnology/marijuana ETF is killing me this month, man”

“Homiehow much of my retirement money should I put into Gamestop call options?”

There is no judgement here. I admire the gumption.

These bets can be fun and may pay off handsomely, but they need to be sized and sourced thoughtfully. Definitely not investment advice.

A risk cowboy is someone who makes these bets with an overconfidence about their informational edge, and thereby dedicates too much investment capital to them. They are the hare and may end up less wealthy than the tortoise. Except for the few who hit the jackpot, of course, which you’ll hear all about – survivorship and availability bias again!

Do you harbor any extreme investment views? (i.e. raise your hand if you feel like, personally attacked rn).

Or do you embrace a more well-rounded approach?

This could be a fun podcast, diving deeper into these topics. If you know of anyone else who might have me, please put us in touch. I’m down with OPP – other people’s podcasts.

Thanks as always for reading and engaging.

Wealth be with you,