When asked what is the perfect portfolio for an average investor Nobel Laureates in economics have a highly consistent answer. No one advises amateur investors to buy stocks at a low price and sell at a high price. No one advises allocating resources in funds that try to outperform the market. No one advises investing the majority of your portfolio in real estate. No one advises leaving large amounts of money parked in your checking account. No one advises investing in cryptocurrencies. On the other hand, all of them advise to diversify internationally and to buy low-cost total market index funds or ETFs.
These uniform tips are no mere coincidence. They say so because the best data and models overwhelmingly suggest that this is the best way to invest. On average, for most investors, if you follow these guides you would have higher returns and lower risks compared to your current investments. These tips were supposed to be no-brainers. However, most people still hold a huge amount of their portfolio in real estate (e.g. Wolff, 2017), leave money parked in checking accounts, cherry-pick stocks, and/or invest in actively managed funds. Almost no one invest internationally and relatively few invest in low-cost total market index funds or ETFs (like S&P 500 and MSCI EAFE ETFs).
Therefore, why people invest so badly? Why basically no one follows what the Nobel winners and the data say? Part of the answer is very simple, people just do not know the data and the most develop financial models. Virtually no one reads the work from Nobel laureates or follows up with the most recent developments in the field of finance. Therefore, they invest in what they think is best for them given the information that they have, i.e. bounded-rationality (Simon, 1955; 1979). For example, the academic field already knows for decades that funds that try to outperform the market give fewer returns than the market average after accounting for their fees (Jensen, 1968). Therefore, investors are better off investing in index funds or ETF that simply follow the stock market (e.g. S&P 500) than parking their money with professional investors that choose which stocks will go up. However, when Robert Shiller (the 2013 Nobel Laureate) asked investors the following question he found out that less than 1/3 of the respondents said that cherry-picking the best actively managed funds is a bad idea:
"Trying to pick mutual funds, trying to figure out which funds have experts who can themselves pick stocks that will go up, is:
1. A smart thing to try to do; I can reasonably expect to be a success at it. 50%
2. Not a smart thing to try to do; I can’t reasonably expect to be a success at it. 27%
3. No opinion. 23%"
More than not knowing the data, a myriad of factors influence individuals to make poor investment decisions. Even when investors have all the information they often behave irrationally. That is, they do not make the investment that will give them better returns and lower risks than the ones they currently have. One of the reasons this happens is because many investors are not very influenced by historical data, statistical analysis, and financial models as they see them as vague. Investors tend to put much more weight on the experiences they lived (Shiller, 2000). This lack of confidence in numbers can lead to spurious allocation of investment even if the investor knows all the information. The subfield that studies this "irrationality" in economics is called behavioral finance. In this section, we will explore three other factors backed up by the best studies that help to explain why many individuals tend to embrace investment portfolios with low returns and high risks:
1. People Are Influenced by Society (Herd Behavior)
2. People Are Overconfident
3. Loss Aversion
"Never underestimate the difficulty of changing false beliefs by facts" - Henry Rosovsky, Dean Emeritus at Harvard University.
"I am right there with Henry Rosovsky [...]. We are raising whole generations who regard facts are more or less optional. [...] [People] are not being taught that it is important to know what you are talking about. It is important to hear the opposite viewpoint and more important to learn how to distinguish whether why viewpoint A and viewpoint B are different and which has the most evidence or logic behind it. [People] disregard that. They hear something and they run with it." - Thomas Sowell, senior fellow at Hoover Institution at Stanford University. He is also regarded as one of the leading names of the Chicago School of Economics.
- Jensen, Michael C. (1968). "The Performance Of Mutual Funds In The Period 1945–1964," Journal of Finance, American Finance Association, vol. 23(2), pages 389-416, May.
- Shiller, Robert (2000). Irrational Exuberance. Princeton, N.J. :Princeton University Press.
- Simon, Herbert. A. (1955). A behavioral model of rational choice. Quarterly Journal of Economics, 69, 99–118.
- Simon, Herbert. A. (1979). Rational decision-making in business organizations. American Economic Review, 69, 493–513.
- Wolff, Edward N (2017). “Household Wealth Trends in the United States, 1962 to 2016: Has Middle Class Wealth Recovered?” NBER Working Paper No. 24085.
IMPORTANT: THERE IS NO ONE BEST TAX OR INVESTMENT STRATEGY. IT ALL DEPENDS ON YOUR GOALS, RESOURCES, AND CITIZENSHIP.
For example, are you willing to move abroad? If so, where? How long do want to stay in each place? What is your annual income? How much money are you willing to invest? Do you want short term gains or long-term investments? What is (are) the source(s) of your income? How much taxes do you pay annually? Do you want to decrease your tax duties or completely remove them? Do you feel like you want to pay some taxes even if you do not need to? What is your citizenship? Do you have multiple citizenships? Depending on each of these answers the best investment/tax strategy for you will differ. In order to see what option is best for you and to help with the implementation of the strategy feel free to reach out to us. You do not need to be rich to create a global investment portfolio. Most of the bank and brokerage accounts we open do not have minimum initial deposit or maintenance fee. Thus, you can invest as much as you want or even leave the accounts empty until you have enough capital or interest to invest abroad.