Richard Thaler, the recent winner of the Nobel prize for economics, is a brilliant man. Anyone interested in how the human mind works should read Nudge: Improving Decisions about Health, Wealth and Happiness, the 2008 book he wrote with Cass Sunstein.
Thaler and Sunstein make a relatively simple argument based on years of economic research about human biases. We are full of flaws forcing us to make mistakes that cost us health and wealth. We need help.
But we shouldn’t be forced into better decisions, the authors argue. Rather, we should be “nudged” toward a selection of choices that are better than doing nothing, which tends to be the default.
For instance, people should be placed automatically into retirement plans at work but given the choice to opt out. In too many cases, the default is to opt in.
Likewise, our savings contributions should be automatic — at a low level, with an opt-out choice — in order to make sure people invest at least something. Those investments should be into a broad, easy-to-follow, low-cost portfolio, rather than piling up as uninvested cash.
Once a saver sees those investments growing, the impulse becomes to save more and to stay invested. They’re already on the road toward a better retirement.
John Bogle, founder of the Vanguard Group, has long made the same arguments based his decades of experience working with investors.
He doesn’t back up his ideas with math and psychological experiments, as an economist might, so Thaler’s scientific work is rightly rewarded with the Nobel.
But Bogle’s past statements do offer an interesting window into Thaler’s way of thinking from the long-term investment perspective.
Here are five instances when Bogle nailed it, well ahead of Thaler’s recognition by the Swedish Royal Academy:
“In the long run, investing is not about markets at all. Investing is about enjoying the returns earned by businesses.”
When Bogle says the “in the long run” he means decades. Yes, stocks go up and down. That’s speculation. But over periods of years those numbers settle out to reflect business growth.
Reinvestment and compounding help to create a great return. The default should be owning, not trading, stocks. Index funds, which Bogle pioneered, help investors do just that.
“The mistakes we make as investors is when the market’s going up, we think it’s going to go up forever. When the market goes down, we think it’s going to go down forever. Neither of those things actually happen. Doesn’t do anything forever. It’s by the moment.”
You hear a lot of very heated talk in the media about when and by how much the stock market might fall. That sets up the investor to take action, literally every day, in the anticipation of an event that might not occur this year or even next.
The default should be inaction and, per Bogle, ignoring the stock market day-to-day. Turn off the financial news!
“Speculation leads you the wrong way. It allows you to put your emotions first, whereas investment gets emotions out of the picture.”
The single biggest risk to your investment success is you. If stocks fall and you react by selling, then the losses were triggered not by the decline but by your decision to exit.
If you invest with the idea of owning the business, losses should signal a chance to buy more at a lower price, not leave the business by selling. Owning a portfolio, rather than trading, reduces this risk.
“If you have trouble imagining a 20% loss in the stock market, you shouldn’t be in stocks.”
Stocks can decline, sometimes by a significant margin. The default position of any investor should be to ignore the stock market or not invest in it. If you want to split the difference, own bonds and calculate your total turn as a combination of the two.
It won’t seem so scary if stocks fall 20% but your portfolio only declines 12% because you also own bonds. However, when stocks rise you won’t get all the upside, either.
“Time is your friend; impulse is your enemy.”
Exactly Thaler’s point! We tend to do to0 much mental accounting in our investments, trying to track which stocks are up, which are down, and whether we should remain invested.
The answer is yes, stay invested. Over time, as Bogle shows us, the ultimate direction of the stock market is up, since all you are doing is owning businesses and taking out the gains from their efforts.
Investing is not the faint of heart, I know. But those who have been in the process for many years know that time heals all wounds, smooth seas follow rough and compounding is magic.
If getting your head straight on the matter means paying less attention, as Thaler and Bogle counsel us, that’s ultimately the best course.