4 Reasons We Overcomplicate Investing

A new book, The Bogleheads’ Guide to the Three-Fund Portfolio by Taylor Larimore, makes a persuasive case that all one needs to successfully invest are three index funds. For me, this approach is preaching to the choir. I’ve written before and often that investing should be simple.

With a Vanguard Total Stock Market Index Fund (VTSMX) and a Vanguard Total International Stock Index Fund (VGTSX), you own more than 9,700 companies across the planet. And with a Vanguard Total Bond Market Index Fund (VBMFX), you own more than 8,000 of the highest-quality investment-grade U.S. bonds. Together, they maximize diversification and minimize expenses and taxes. There are, of course, similar low-cost funds offered by other companies, such as the Fidelity Total Market Index Fund (FSTMX), the Fidelity Global ex U.S. Index Fund (FSGDX) and the Fidelity U.S. Bond Index Fund (FBIDX). Schwab’s versions are the Schwab Total Stock Market Index Fund (SWTSX), the Schwab International Index Fund (SWISX) and the Schwab U.S. Aggregate Bond Index Fund (SWAGX).

I will often benchmark clients’ portfolios against the three-fund portfolio and typically see the client portfolios badly lagging the performance of these three funds, costing them thousands of dollars a year. That’s the price tag for overcomplicating one’s portfolio. Over the years I’ve learned that these are the forces that cause us to do it.

4 forces preventing simplicity

The belief we know the future. We think we know, or that there’s a way to know, what will happen to the stock market or what changes will occur in longer-term interest rates. If we don’t think we know, we think the experts do and that they know even more, such as what the hot companies or sectors will be over the next couple of years. So instead of diversifying, we concentrate on parts of the market we think will outperform. Yet research indicates this is a loser’s game.

We chase income. In my experience, most people seem to want income more than total return (income plus the change in value of the security). Focusing on income plays out like novels with consistently bad endings — buying General Electric for dividends when the stock lost more than half its value since 2016, or buying master limited partnerships (such as companies operating oil pipelines) providing so-called safe income until the sector lost nearly 35 percent in 2015 while U.S. stocks turned in a small gain. In fact, I tell people that income is their biggest risk in retirement, as high income comes with high risk.

The financial services industry. Quite frankly, my industry is not only a powerful force because it is for-profit; it is the most powerful force because it controls the narrative. Advisers probably couldn’t charge you a whole lot for this simplicity since you could likely do it yourself. So we build complex portfolios using complex jargon like smart beta, correlations, standard deviations, alpha and the like. This complexity is intimidating enough to make you dependent upon us so we can keep charging you more, year after year.

Taxes. I admit that my own portfolio is far more complex than these three funds. That’s because these funds didn’t exist when I started investing and I’d have to pay very high capital gains taxes to reach simplicity. It is for this reason that taxes can be a complicating force for many investors. I do a cost-benefit analysis in deciding what to sell, weighing the future benefits of lower costs and higher diversification against the taxes that would need to be paid if I sell. Taxes create a complexity in reaching simplicity.

My advice

It’s lonely to accept that we don’t know the future. It’s natural to want income, especially after retirement, and we want to believe that our income is safe. So much of what we hear about investing is mind-numbingly complex, which makes us afraid to go it alone. And of course, we all hate paying taxes and sometimes forget the real goal is to make more money after taxes.

Remember that investing is simple, not easy. Do not underestimate the powerful hindrance of these four forces. Though they are not easy to overcome, it can be done. Removing these roadblocks is likely to dramatically increase your return and leave you with more money in retirement. As I tell people, if you can’t explain your investing strategy to an 8-year old, you’re doing something wrong.