Nothing's Free
By: Mark F. Toledo, CFASeptember 29, 2020
Estimated Reading Time: 4 minutes
Nothing’s Free
A friend recently recommended the book The Psychology of Money by Morgan Housel. Housel examines personal finance through the lens of human behavior1. In chapter 15 he presents an effective way to think about the price of higher returns.
He notes that investors too often view a decline in the immediate liquidation price of securities as a fine for doing something wrong versus a fee to earn higher expected returns. People generally accept paying fees, but avoid fines- traffic tickets, IRS penalties, etc. The natural response for anyone who watches their wealth decline and views the drop as a fine is to avoid future fines.
Investors who view market volatility as a fee, rather than a fine, have a higher probability of investing in equities long enough to be rewarded. The adage that “time in the market” beats “market timing” has worked for investors. People do not enjoy the feelings that result from a 20% decline in the value of their portfolio. If they view these feelings as a fee for higher returns, rather than a fine for a mistake, they have a higher likelihood of long-term success.
Housel states that “market returns are never free and never will be. They demand you pay a price, like any other product.” Volatility and uncertainty represent the price that equity investors pay to earn higher returns than available from cash and bonds.
This concept also applies when looking at the returns for a portfolio relative to a benchmark. To earn a higher return than the benchmark, the portfolio must be invested differently than the benchmark. The discomfort felt during periods of time when the performance lags behind the benchmark represents the cost of expected higher long-term returns.
Unfortunately, we do not know what the price for higher returns will be in advance. Uncertainty about the unknown future cannot be accurately quantified. Scott Sagan in his book The Limitation of Safety notes that “things that have never happened before happen all the time”2. Paying the price for higher expected returns requires living through first. Accepting firsts as part of the price helps to maintain commitment to a plan.
The challenge is to estimate a reasonable price that you are willing to pay, and then accepting that the price may be higher or lower than your estimate. Over time, you can make adjustments to your plan based on new information. However, you never want to forget the adage that “time in the market” beats “market timing.”
Mark F. Toledo, CFA is a Partner at Chicago Partners Wealth Advisors. Founder of TPM and current member of the CFA Society of Chicago, Mark helps clients build and maintain their long-term wealth management strategies for financial success.
1. Morgan Housel. The Psychology of Money. Harriman House. 2020.
2. Scott D. Sagan. The limitation of Safety. Princeton University Press. 1993.
Important Disclosure Information
Past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Chicago Partners Investment Group LLC (“CP”), or any non-investment related content, made reference to directly or indirectly in this commentary will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this commentary serves as the receipt of, or as a substitute for, personalized investment advice from CP. Please remember to contact CP, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services, or if you would like to impose, add, or to modify any reasonable restrictions to our investment advisory services. CP is neither a law firm nor a certified public accounting firm and no portion of the commentary content should be construed as legal or accounting advice. A copy of the CP’s current written disclosure Brochure discussing our advisory services and fees continues to remain available upon request.
September 29, 2020
Estimated Reading Time: 4 minutes
Nothing’s Free
A friend recently recommended the book The Psychology of Money by Morgan Housel. Housel examines personal finance through the lens of human behavior1. In chapter 15 he presents an effective way to think about the price of higher returns.
He notes that investors too often view a decline in the immediate liquidation price of securities as a fine for doing something wrong versus a fee to earn higher expected returns. People generally accept paying fees, but avoid fines- traffic tickets, IRS penalties, etc. The natural response for anyone who watches their wealth decline and views the drop as a fine is to avoid future fines.
Investors who view market volatility as a fee, rather than a fine, have a higher probability of investing in equities long enough to be rewarded. The adage that “time in the market” beats “market timing” has worked for investors. People do not enjoy the feelings that result from a 20% decline in the value of their portfolio. If they view these feelings as a fee for higher returns, rather than a fine for a mistake, they have a higher likelihood of long-term success.
Housel states that “market returns are never free and never will be. They demand you pay a price, like any other product.” Volatility and uncertainty represent the price that equity investors pay to earn higher returns than available from cash and bonds.
This concept also applies when looking at the returns for a portfolio relative to a benchmark. To earn a higher return than the benchmark, the portfolio must be invested differently than the benchmark. The discomfort felt during periods of time when the performance lags behind the benchmark represents the cost of expected higher long-term returns.
Unfortunately, we do not know what the price for higher returns will be in advance. Uncertainty about the unknown future cannot be accurately quantified. Scott Sagan in his book The Limitation of Safety notes that “things that have never happened before happen all the time”2. Paying the price for higher expected returns requires living through first. Accepting firsts as part of the price helps to maintain commitment to a plan.
The challenge is to estimate a reasonable price that you are willing to pay, and then accepting that the price may be higher or lower than your estimate. Over time, you can make adjustments to your plan based on new information. However, you never want to forget the adage that “time in the market” beats “market timing.”
Mark F. Toledo, CFA is a Partner at Chicago Partners Wealth Advisors. Founder of TPM and current member of the CFA Society of Chicago, Mark helps clients build and maintain their long-term wealth management strategies for financial success.
1. Morgan Housel. The Psychology of Money. Harriman House. 2020.
2. Scott D. Sagan. The limitation of Safety. Princeton University Press. 1993.
Important Disclosure Information
Past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Chicago Partners Investment Group LLC (“CP”), or any non-investment related content, made reference to directly or indirectly in this commentary will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this commentary serves as the receipt of, or as a substitute for, personalized investment advice from CP. Please remember to contact CP, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services, or if you would like to impose, add, or to modify any reasonable restrictions to our investment advisory services. CP is neither a law firm nor a certified public accounting firm and no portion of the commentary content should be construed as legal or accounting advice. A copy of the CP’s current written disclosure Brochure discussing our advisory services and fees continues to remain available upon request.