Saturday, July 12, 2008

Thoughts on Financial Planning

I recently had occasion to discuss financial planning with several folks with a variety of backgrounds and interests. And it's really interesting to me how challenging financial planning is:
  1. Several folks had all the recommended books on their book shelves (Four Pillars of Investing[kindle edition], Random Walk Down Wall Street[kindle edition]), but had either not read them, or not understood them.
  2. Several folks understood what the right thing to do was, but just simply didn't do them. The discipline to execute is in fact one of the reasons why some people need a financial advisor, even if they're intellectually capable of understanding the fundamentals
  3. Being smart can just as easily work against you --- smart people have a tendency to want to second-guess the market. That usually works against you because there are just as many other smart people trying to do this as well, so they all cancel out and you end up not getting a good result either.
  4. Costs really matter. In many countries (in particular European countries), the financial markets are so under-developed that brokerage commissions are high, and costs are high. What I'm finding is that in Europe most people don't trust the stock markets, and turn to real estate to finance their retirements, along with all the hassle that entails.
  5. Finally, financial planning is hard because returns are measured by decades, not months or even years. This makes all the usual methods of learning (do something, see if it works, and do more if it does) fail --- the kind of discipline and devotion to learning from history that this requires ensures that there are very few Warren Buffets out there, and that you're unlikely to be one of them. It also leads to the kind of retirement planning disasters described in Nudge.
All in all, I am coming more and more in agreement with Bill Bernstein's statement:
Will, for example, small U.S. investors become ever more involved in the capital markets? This is largely a political question, dependent on whether the electorate ever wakes up to the mess of IRA/defined contribution pottage sold to them by the libertarian right. Over the past few decades, it has become apparent to even the most enthusiastic proponents of private accounts that most plan participants are about as qualified to manage their retirement portfolios as they are to do brain surgery or play left wing for the Rangers. Some autonomy needs to be stripped from them by mandating default opt-ins, lifecycle funds, annuitization, and so forth. Would it not be better simply to throw in the towel, throw out Wall Street, and establish a national pension system? Most Europeans, when they gaze upon our retirement system (and our health care system as well), laugh themselves silly.

In short, the typical person is as qualified to be his own financial planner as he is to be his own plumber (myself included). Unfortunately, unlike plumbers, where it is quite possible to find an honest and competent plumber in nearly every town, the existence of competent and honest financial planners is all but myth. That's why I ultimately end up doing all of it myself. In my travels, I find myself meeting lots of retired Americans --- almost all of them (a surprising number of them former teachers) are beneficiaries of the defined benefit system which has been phased out in recent years. I wonder if my generation will be able to travel as extensively as those whom I have met at the same age.
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