Avoid Moving Money From The Many To The Few

Occasionally I get asked if I know of any “good stocks or investments” to invest in. Since I am a trader by career and by nature, my answer may surprise you: most people should stay away from the stock and bond markets.

The financial markets are very efficient machines for moving money from the many to the few. The brokerage and money-management industries are very good at extracting fees and margins. They are explicitly designed to deliver “alpha” for them rather than for you.

The goal of the individual investor should be achieving high risk-adjusted returns, net of fees, taxes and inflation. It is very difficult for your average retail investor to achieve a reasonable rate of return on capital via the stock and bond markets, especially when adjusted for the risks you are taking and the taxes and fees you will pay.

There are other ways you can achieve high returns on your excess cash, without incurring the fees and risks of Wall Street. You often will not hear these options recommended by anyone who gets paid based on transactions, fees or a percent of assets, but they often offer the best risk-adjusted returns, net of fees, taxes and inflation.

Here are my standard suggestions:

Pay Off Your Personal Debts.

Most Americans have debt: mortgages, credit cards, student loans, car payments. Often, by far the best risk and tax-adjusted return you can find is paying off your debt.

For example, if you are paying 5% on your mortgage, you need to find an investment where you are earning a guaranteed return in excess of 5% after tax  and after fees in order to justify not paying your mortgage off. That type of return is very difficult to come by, especially part-time. For the academically minded, the appropriate “risk-free rate of return” for most individuals is not T-Bills, but their highest interest rate.

I have met people who have some cash savings, some stocks, some bonds and an 18% credit card balance. Sometimes with the same financial institution. Holy ****. Someone is making money there, and it ain’t them.

Living in debt is generally a poor financial decision, and severely inhibits your ability to operate as a free citizen. Prioritize paying off your debts as fast as you can, and especially pay off your debts before you invest in a mutual fund. Just do it. As Mr. Money Mustache puts it:

Your debt is not something you “work on”. It is a huge, flaming emergency!!!

Spend Less And Save More

Tadas Viskanta says that “savings is the best investment”:

It is far easier to generate additional savings through more conscious consumption than it is to generate additional returns, or alpha, from the financial markets. So starting early with a dedicated plan to live below your means is an important part of any comprehensive financial plan.

How much you have saved up for retirement is dominated by one thing: your savings rate. A study by the Putnam Institute, reviewed by Reuters, examined how a hypothetical saver would have fared over the last thirty years if they had made a variety of decisions regarding fund selection, asset allocation, rebalancing and saving. Even a “crystal ball” scenario that assumed you could see the future was outperformed by an increased savings rate:

Interestingly, even a 4 percent deferral – which represents a 1 percent increase that does not take advantage of the plan’s full matching contribution – would have had a wealth accumulation impact 30 percent larger than the crystal ball fund selection strategy, nearly 100 percent larger than the growth allocation strategy, and approximately 2,000 percent larger than rebalancing.

Fund selection, investment return and asset allocation are flies on the back of the elephant in the room compared to how much you save every month.

Build A Reserve

Beyond the usual advice to have 3-6 months of your salary saved up in case you lose your job, you should also use your free cash flow to build up supplies and surpluses of essential items. This partly helps you achieve efficiencies from buying in bulk, but also provides a real margin of safety for you and your family should the services we rely on break down. A larder full of 3-6 months of food and essentials is a better investment than most bonds.

Negotiate Discounts

Once you have some free cash flow, you can take advantage of your ability to buy in bulk and negotiate discounts. Most retailers will give you 5 – 10% discounts for buying in bulk and/or paying in cash. Saving 10% on your grocery bill in the equivalent of a 10% return on an asset, free of taxes, fees and risk. As Mark Cuban says, become an efficient consumer.

Invest In Yourself

For most people, their main income is their salary. If you can do something that gets you a 5% pay rise, then that is often a very high rate of return on the money spent. That could be a training course, it could be something that allows you to get 1 hour more sleep a night so you are more productive, it could be learning to play golf so you can become friends with the boss.

Invest In Your Family

You can get a very high rate of return on investment by spending time with your family, especially your children. Children thrive under the careful attention of well-rested adults. If you have paid off your debts, it is seriously worth considering if you or your spouse can take time away from your careers and focus on your children. The return you receive in helping them develop into self-confident, grounded and productive adults is likely to be higher than the return on a mutual fund.

The brokerage and money-management industry have a vested interest in encouraging you to engage their services. There are times when their services can be useful to you, but you should not believe that everyone needs what they have to sell.

The goal of the individual investor should be achieving high risk-adjusted returns, net of fees, taxes and inflation. There are a number of things that meet those criteria better than the standard repertoire of mutual funds and ETFs. You should do all of these things before you even consider investing and trading.

Leave a comment


    • Thank you David. As you say, it is basic stuff that many people neglect. I am repeatedly stunned by how much debt people are comfortable carrying and yet they still go to Starbucks, eat at fancy restaurants and buy the latest gadgets. There is a reason why the financial sector is so large, and it ain’t because they are looking out for you.

      Glad you are still reading after my anti-fundamental analysis and averaging down rants 😉

  1. One of the best articles I’ve read. Well said. As a fundless sponsor, the stock market baffles me. Besides liquidity, I do not see any reason why a middle income person should invest in it. Unless it’s high beta a “quality” stock. Investors are better off, like you said, paying off debt, and investing in an asset/security that can provide them with a salary-like income stream.

  2. yogikeung

     /  November 14, 2012

    You have made very good points. Take care of the basics such as reducing debt and not spend/desire frivolously is very important. Your point on “Invest in your Family” hits home even more so. I would like to extend the Family to relationships in general. “Giving back” to better someones life always yields good dividends.

  3. Realy I made 29% in the last year on my investment in Lowland (ignoring divi) – go and read benjamin graham’s inteligent investor

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