A Wealth of Common Sense

What simple, timeless principles can guide anyone to financial success? Ben Carlson's 'A Wealth of Common Sense' answers this by emphasizing clarity, consistency, and emotional awareness in investing.

1. Institutional Investors Have Unique Advantages

While it may seem tempting to mimic successful institutional investors, their strategies aren't designed for individuals. Institutions like Yale operate under very different conditions.

First, institutional investors benefit from significantly lower trading fees because of their financial clout. They can negotiate better deals with trading platforms and asset managers. Also, they employ teams of specialists who dedicate their full attention to maximizing portfolio performance, a luxury individuals cannot afford.

Further, institutions like Yale have access to different investment opportunities. As a non-profit with perpetual investments, Yale can focus entirely on long-term strategies, bypassing the short-term challenges individual investors face. Additionally, tax advantages for non-profits like Yale make their investment strategies impractical for regular individuals. For example, even if you replicated the Yale Model, your tax obligations would erode much of the gains.

Examples

• David Swensen's 14% average annual returns for Yale's endowment since the mid-1990s
• Yale's access to ultra-low-fee private investments because of its scale
• Tax exemptions non-profits enjoy, unavailable to private investors

2. Avoid Impulsive Mistakes to Succeed

Making smart investment choices begins with not making the wrong ones. Ben Carlson highlights that recognizing and avoiding common errors can significantly improve your annual returns.

Get-rich-quick schemes are a perfect example of bad investment decisions. Many fall for promises of quick rewards despite overwhelming evidence that they don't work. Overconfidence is another trap; thinking you can predict markets can lead to reckless bets. Following the herd is equally unwise, as it often means buying at inflated prices or during risky market bubbles, as seen in the 2008 housing crisis.

Lastly, successful investors learn to challenge the fear of missing out and hype-driven decision-making. They avoid being swept up in excitement that often obscures the rationality needed for sound investment strategies.

Examples

• The mid-2000s real estate bubble and its catastrophic impact
• Investors putting all their money into high-performing stocks, like tech companies, right before a downturn
• Nick Murray's assertion that avoiding these errors can improve returns by 3-4% annually

3. Emotional Intelligence is Vital for Investors

Investing successfully requires more than a high IQ. Emotional intelligence, or the ability to understand and manage emotions, often makes a bigger difference.

Emotional awareness is essential when making investment decisions. For instance, feeling overly optimistic can lead to risky choices. Similarly, despair during a market downturn may push an investor to sell prematurely. Staying calm, much like Joe Montana in the 1989 Super Bowl, is what separates winners from everyone else. Montana's composure under pressure mirrors how investors should confront market crashes.

Savvy investors also exercise caution in unfamiliar markets. For example, entering the unpredictable Chinese stock market without understanding its mechanics could result in severe losses. Emotional intelligence helps investors recognize when their perceptions might be flawed.

Examples

• Daniel Goleman's research emphasizing emotional clarity for personal growth and professional success
• Joe Montana leading the 49ers to a Super Bowl victory by staying calm under immense pressure
• The tendency of amateur investors to panic sell during stock market downturns

4. Higher Gains Mean Assuming Greater Risk

Risk and reward are inseparable in investing, and understanding this relationship helps determine your strategy. Higher gains always come with higher risks.

Stocks, with an average annual return of 6.5% (adjusted for inflation), offer the best long-term results. But they also carry high volatility, meaning short-term losses can be dramatic. Bonds, with a 1.9% annual return, are less volatile, offering steadier performance but lower growth potential. Cash, the safest asset class, delivers stable performance but only averages a 0.5% return annually—barely outpacing inflation.

Investors must understand these trade-offs to determine the asset allocation best suited to their goals and risk tolerance. Playing it too safe could mean missing out on meaningful wealth growth, while high-stakes risks test your composure when markets turn volatile.

Examples

• Historical stock market returns from 1928 to 2013 showing 6.5% for stocks compared to 1.9% for bonds
• The high fluctuation of stock prices during market downturns like 2008
• The math showing it would take 150 years to double your money with cash investments alone

5. Align Your Investment Plan with Your Personality

Investing isn't one size fits all. Your personality, risk tolerance, and goals should dictate your approach.

Start by asking yourself what kind of investor you are. Are you patient or impulsive? Risk-averse or risk-seeking? Once you identify your style, you can build a plan that reflects your natural tendencies. Such a plan will guide you during moments of doubt or instability, keeping you focused on your priorities.

The Alabama Crimson Tide football team provides an insightful analogy. By sticking firmly to a predetermined plan, Nick Saban led his players to repeated success. Sticking to a carefully laid investment blueprint offers an individual investor similar benefits, protecting against rash decisions based on temporary market shifts.

Examples

• Personality quizzes helping individuals match their investment goals with appropriate risk profiles
• Defining yourself as a "diversified asset allocator" versus a "trend follower"
• Alabama Crimson Tide's championship victories under Saban's consistent strategies

6. Diversification Protects Against Uncertainty

Investors must embrace the unknown. Since predicting market trends perfectly is impossible, diversifying a portfolio is the most reliable way to reduce risk.

Spreading your investments across different asset classes allows losses in one area to be offset by gains elsewhere. For instance, during a stock market crash, bonds often perform relatively well. This means you might miss some extraordinary gains but will ensure steadier growth over time.

Surprisingly, studies reveal that passive portfolios, or ones left untouched for years, often outperform actively managed accounts. This highlights the risk of tinkering and encourages trust in your original plan.

Examples

• Fidelity's study showing dormant investment accounts perform best
• The balanced approach of including stocks, bonds, and other assets in a portfolio
• Loss mitigation from bonds during stock market downturns like 2020

7. Avoid Herd Mentality in Investing

People often mimic popular trends in hopes of gaining quick returns. However, herd mentality frequently ends in losses.

In times of market bubbles, the fear of missing out drives many into overvalued assets, amplifying risk. The housing crisis of 2008 exemplifies this: buyers overextended themselves the moment real estate seemed infallible, unaware the bubble was about to burst.

By adopting an independent, rational mindset, you can counteract this instinct. Making decisions grounded in research rather than prevailing sentiments sets successful investors apart.

Examples

• The 2008 housing bubble's severe impact on speculative property buyers
• A sudden surge in meme stocks like GameStop creating volatile market conditions
• The success of Warren Buffett's strategy of "buying when others are fearful"

8. Emotional Reactions Can Lead to Wrong Moves

Making impulsive decisions during emotional highs or lows in the market usually results in underperformance. Whether driven by excitement or fear, such reactions neglect the long-term nature of effective investing.

Those who panic sell during a dip or make lavish purchases during a bull market often end up undercutting their own returns. A better approach is to rely on logic and a pre-established plan to guide actions.

Examples

• Investors who bailed out during the 2020 pandemic and missed the recovery
• A sudden decision based on news coverage hyping one company's stock
• The behavior of professionals focusing on steady growth over emotional reactions

9. Market Timing is a Myth

Trying to predict the highs and lows of the market often leads to losses instead of gains. It's better to focus on time in the market rather than timing the market.

The ups and downs of stocks are driven by hundreds of unpredictable factors. Rather than trying to anticipate short-term shifts, commit to a diverse, patient strategy that benefits from compounding.

Examples

• Long-term studies showing time in the market is more rewarding than market timing
• Tech bubbles that burst just as individual investors rushed in
• The success of dollar-cost averaging in steadying returns over decades

Takeaways

1. Write a clear investment plan and stick to it, no matter market fluctuations.
2. Diversify your portfolio to reduce potential losses and manage risks effectively.
3. Remember that emotions can cloud judgment—stay composed and trust your strategy.