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The Little Book of Safe Money by Jason Zweig

The Little Book of Safe Money
by Jason Zweig

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The author and Wall Street Journal personal finance columnist, Jason Zweig, explains why there's truth in the old adage that investors get the returns they deserve, and recommends books that might help you avoid being taken for a ride.

Interview by Sophie Roell, Editor

The Little Book of Safe Money by Jason Zweig

The Little Book of Safe Money
by Jason Zweig

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Bill Gross of PIMCO, the world’s largest bond fund, has written articles saying the US treasuries market is a Ponzi scheme. The stock market has been through a terrifying plunge. Traditionally we learned that our own home, at least, was a safe place to invest our money – but a lot of us have lost on that as well. What’s to be done right now in terms of personal investing? What should our approach be?

It certainly is a frightening time. People had come to regard the entire world around them as an ATM. The bond market was making double digits every year. The stock market provided a double-digit return. Your house would go up at a double-digit rate. You didn’t even have to be smart; no matter what you did, no matter what happened, you would just keep compounding your wealth at 10% or better every year. Because 10% is a round number, it had a strong effect on people’s perceptions and they came to regard it as a right, as a given. Anything you put your money into would go up at least 10% a year for the rest of human history. That never was true, of course. It just took a while to be proven false. Now that it has been proven false, people feel they have lost their moorings. They’re adrift. They don’t trust their brokers, they don’t trust exchanges, they don’t trust regulators, they don’t trust anybody. And, frankly, they probably shouldn’t.

So what do we do? Do these books you’ve chosen offer a clue?

There are a few basic principles that people should keep in mind. There’s an old expression on Wall Street that I’m very fond of, which is: “You get the returns you deserve.” People who had gotten to the point of believing that high returns were a given didn’t deserve to earn them, because the markets don’t exist for our convenience. They don’t exist to make people rich. They exist to transfer capital from people who have an excess of it to people who have a more immediate need for it. Sometimes those are great growing companies that will take that capital and put it to very productive use. At other times, it might be somebody selling bundles of crappy mortgages, and you’re going to lose 95% of what you put in. The reason you get the returns you deserve is because if you put the time and effort into proper research – and into forming realistic expectations – then you’re a lot less likely to get wiped out or be caught by surprise. The real lesson for people from what happened over the past 10 years should be that investing done properly requires either a considerable amount of homework and research, or an enormous amount of emotional equanimity. Ideally it takes both. You have to be prepared for anything and you have to be very humble about the abilities of the experts and yourself to predict what’s about to happen.

Your first book is John Bogle’s Common Sense on Mutual Funds. Is this basically advocating that index fund investing is the only way to go?

Yes. It’s a wonderful book. Of course, as people say on Wall Street, Mr Bogle is talking his own book, i.e. he’s pitching his own speciality. But as long as you bear that in mind, you can get an enormous education from this book. It’s a wonderful, comprehensive introduction to how the financial markets work. It shows who has your interests at heart, and what the various self-interests are, of all the people you are likely to encounter when you invest. Every step of the way, somebody is going to be dipping into your wallet and pulling money out – often without fully informing you. When you read this book, you’ll have a much better sense of who is taking the money, where it goes, and whether you should be willing to permit it.

“Every step of the way, somebody is going to be dipping into your wallet and pulling money out – often without fully informing you.”

My own view is a little different from Mr Bogle’s. I wouldn’t go so far as to say that you should never buy a fund that isn’t an index fund. But if you do, you need to have compelling reasons why you are departing from that strategy, because indexing really works. That’s not because professional money managers are stupid or dishonest. It works because indexing is very, very, very cheap. It’s an incredibly low cost way to manage money. And it’s very hard for any other strategy to overcome that disadvantage.

Because any smartness that the fund manager has to get ahead of the market – that gain is lost in the fees that you have to pay him?

Exactly. And it happens at several levels. The first level is because he or she has all this brainpower, you have to pay for that. It’s expensive to research individual stocks, and to have a team of analysts doing it. All of that costs substantial amounts of money – often, for a large fund, well into the millions of dollars a year. The second cost is that someone who is attempting to buy the best stocks, and avoid the worst ones, has to do a fair amount of trading. That fund manager will be buying and selling pretty frequently. Each time he or she trades, that triggers trading costs.

An index fund, on the other hand, is pretty much a pure buy-and-hold vehicle. It buys all the stocks in a market index and just holds them, until, for some reason, they’re no longer in the index – and that can be many, many, years. Typically, the average fund that is run by an active portfolio manager will hold a stock for about 11 months at a time. For an index fund, it’s often more like 10-20 years at a time. That’s at least a 10-fold difference in the frequency with which the stocks are traded. Each time, brokerage charges are incurred, which come out of your pocket and add up over time. For many funds, the costs of trading can equal or exceed the costs of management. But at index funds, trading costs are tiny. The third factor is taxes. Index funds tend to generate lower tax bills for people who hold them over time, which can be a very valuable advantage.

There are also two philosophical questions that investors might want to ask themselves. One problem is, if I’m buying into this fund because I believe the people running it are extremely smart, then presumably I want to own it as long as they run it. You wouldn’t want to buy a fund run by somebody who is likely to leave before you’re ready to sell, because you don’t know who is going to take over to replace that person. But life is very unpredictable, and at any given moment the genius who is the reason you bought the fund may decide to leave, may get fired, may get hit by a bus, and you suddenly find yourself owning a fund run by someone you’ve never heard of. At which point, you may say, “Wait a minute! I don’t want to own this fund anymore.” Then, if you decide you want to sell it, you may have to pay a tax bill to get out of a fund you don’t even want to own anymore.

The second problem is this remarkable paradox: Investors are charged very substantial fees for all this research on stocks that the average fund manager doesn’t even bother hanging on to for more than 11 months. It’s as if the manager spends months and months on research, learns everything there is to know about the company, puts the company into the portfolio, and then as soon as it goes in, it’s time to take it out. That should lead people to question the value of this research process. If, after all that work, the fund manager changes his mind 11 months later, how much could he have learned in the first place? Why was it worth paying him all that money? Those are questions that aren’t easy to answer, even for people who do it for a living. I’ve never actually heard a good answer to that from a fund manager.

In terms of Bogle talking his own book, does his company, Vanguard, still completely dominate the index fund world?

In the US, at the retail level, yes, Vanguard is the largest provider of index funds to individual investors, and anyone reading the book should bear Mr Bogle’s perspective in mind. Chances are that if he had run a fund company that specialised in something other than index funds, he wouldn’t have written the same book. We all have our biases. But some biases are good for people. Mr Bogle’s is obvious, he doesn’t try to disguise it or excuse it away, and it so happens that his advice is so beneficial for people that I think the bias is entirely appropriate.

Tell me about the next book, the Belsky and Gilovich, Why Smart People Make Big Money Mistakes.

This is a wonderful book. The authors have a wonderful collective voice, and then each of them separately has a distinctive and informed voice. Tom Gilovich is one of the leading cognitive psychologists in the world. Gary Belsky is a sports journalist, although earlier he worked at Money magazine, where I once worked. You might think that being a sports journalist has nothing to do with financial decisions, but you’d be wrong. Anyone who is an informed sports fan knows perfectly well that there are a lot of analogies between sport and money management. That’s not just because it all seems to be about who is ahead and who is behind. It’s also about understanding the proper use of statistics, being aware of the strategy behind the scenes, and keeping in mind that who is on top is not necessarily who wins the championship in the end. This book seeks to explain a central puzzle in personal finance, which is, “Why don’t smarter people consistently have better financial lives?” On average, you would expect they would, and in many cases they do, but it’s far from universal. There is even some evidence that intelligence and investment performance may be inversely linked.

Eek. There’s a few friends I might not mention that to.

There’s certainly not much good evidence that there’s a strong, consistent, positive correlation that smarter people are predictably better investors. And the reasons are clear. They come out of the fact that the limitations of the human mind aren’t correlated with intelligence. The same behavioural pitfalls trip everyone up, regardless of education, IQ or levels of experience. It’s only at extraordinarily high levels of expertise that some people can avoid these common pitfalls. This book does a wonderful job of explaining the basic principles of behavioural finance and the ways that some predictable limitations of the human mind have very clear financial implications.

Do you want to give an example?

A lot of the book is based on the research of Daniel Kahneman and Amos Tversky, two Israeli psychologists who did their best-known research in the 1970s. They explored a number of persistent problems in human thinking, including the “law of small numbers”, which is a tendency of people to extract sweeping conclusions from very small samples of data. You can see why somebody who is interested in sport might pick up on this – because if a team in baseball or basketball wins three games in a row, it’s very hard for anyone to ignore the urge to conclude that the team is hot or on a roll, when, of course, it’s not actually that big a deal statistically, to win three games in a row. Even the worst team in the entire sport is capable of doing that on any three days. The same thing happens in financial markets. From a short streak, people will conclude the future is more knowable, and that it’s representative of how the investment is going to continue to perform. In fact, all it really is is a little burst of randomness and, all else being equal, there’s no reason to assume that it will persist. This is the kind of idea they explore over and over again, very beautifully in the book. Anybody can come away from reading it better equipped to spot these kinds of pitfalls in himself or herself.

Because once you know about a pitfall, you’ll be looking out for it?

Yes, though it’s easier said than done. I wouldn’t want to give people the impression that all you have to do is read about it, and you’ll no longer be prone to it. Even psychologists who have studied these problems for a lifetime still go out and commit those errors of thinking themselves. But you can at least see it in yourself after the fact, and with luck, in certain situations you may be able to say to yourself, “Am I about to commit this kind of cognitive error that I just learned about?”

There was quite a nice review on Amazon.com saying, “You’ll never spend money the same way after reading this book”.

Yes, and as someone who has written books like this myself, that is what you hope for as an author. That’s the ideal. But these biases of the human mind are very deep rooted. You don’t stand much chance of being able to avoid them unless you understand them – and one of the best ways to get to understand them is by reading a really good book about them like this one. It’s still no guarantee, but it certainly improves your odds.

Your next book is about the history of risk, Against the Gods, which I believe looks at the concept of risk all the way from ancient Greek times to the present. Tell me about it and how it ties in to investing.

Peter Bernstein was one of the most remarkable people I’ve ever known. He had an extraordinary mind, he was a wonderful person and a profound, broad renaissance thinker. What he does in this book is bring risk to life as an idea in a much richer way than anyone had ever thought to do before. For anyone who has read a book like Longitude, by Dava Sobel or some of the Mark Kurlansky books like Cod or Salt, Peter’s book is very much in the key of those wonderful explorations of a single idea. It’s telling you everything you could possibly want to know about a topic which turns out to be even more important to you than you realised.

Risk is central to investing and personal finance. Without risk, there is no return. What investors have often failed to understand is that it goes both ways. Investments can’t provide returns unless they carry risk, and risk can be extraordinarily dangerous if you don’t understand it. Of course that was one of the lessons of the financial crisis, and it was something Peter warned about throughout his long life [Bernstein died in 2009 aged 90].

In the book, he explores risk at every conceivable level – what it is mathematically and what it is psychologically, how it has played out historically, how people have thought to measure it and also to control it. It’s probably the best and most interesting high-level book on investing I can think of. It’s a very serious, very elegant, beautifully written book that people should take the time to relish and understand. It’s not for casual readers, it does take some work. You have to be literate, and you have to care enough about the subject to stick with it. But it’s one of my favourite books of all time.

Does it help your mindset in terms of investing?

Yes, because one of the great things that Peter does in the book, by providing an intellectual history of risk, is to show where people have gone wrong in the past – by not fully appreciating how risky investments can be, or not fully understanding what risk means. The historical and psychological perspectives that he gives are just so valuable to anyone trying to be more mindful and more thoughtful as an investor. It’s a great intellectual voyage and a terrific book.

So he’s focused on financial events or risk generally?

The book is centred on the history of financial risk, but it also talks a lot about probability and the mathematics of taking risk. So even if you’re not someone who cares enormously about investing and personal finance, you could get a great deal out of it, because it helps you think probabilistically, which is a very important skill.

Yes, as humans we’re very bad at assessing risks that way. Like many people I sometimes get nervous on airplanes, which my husband likes to point out is really not worth it – the chance of crashing is one in 11 million.

That’s right, and Peter explores that beautifully. As does the Belsky and Gilovich book. There are any number of people who, knowing they’re about to take an airplane, get a little nervous. They’ll have a few cigarettes, they’ll have a beer or a glass of wine to calm their nerves, then they’ll get in their car and drive to the airport. Of course statistically speaking, they’re in vastly more danger on that drive to the airport than they will be on the airplane, but on the plane they’ll sweat and grab the armrest in terror as the plane takes off and lands, while they never gave a second thought to the cigarettes or the alcohol or the fact that by driving they were taking their life into their hands.

Your next book is Where are the Customers’ Yachts?, which is based on the author’s experiences on Wall Street in the 1920s.

This is such a fun book. The author, Fred Schwed, was, for many years, a broker, but it’s very clear, when you read the book, that his real love was for writing. He wrote beautifully. Even now, some 70 years after it was written, I believe this is still the funniest book ever written about Wall Street.

And his observations remain true?

Parts of it read as if he wrote it in 2008 or 2009. It’s remarkable how well the book has held up. There are a lot of old books about which people say, “Oh it reads as if it were written yesterday” – when if you actually read the book it doesn’t. This book is different. It’s about process rather than events. It’s about what happens when stockbrokers approach their clients with a wonderful opportunity, what happens when money managers tell customers, “We have the right plan for your money,” what happens when investors decide that a particular financial asset is attractive or unattractive. He doesn’t name a lot of names, he doesn’t talk in specifics about the Pennsylvania Railroad or Radio Corporation of America. He mentions some of them in passing, but he’s talking about process more than events. And because processes are generated by human beings, and human nature never changes, the book has this phenomenal freshness. It really does read as if it were written based on today’s headlines. And the best thing of all about the book is that it is laugh-out-loud funny. It’s a very sophisticated kind of humour, and the more times you read it, the funnier it gets.

Even the title, Where are the Customers’ Yachts?, is pretty hilarious. Can you explain what it means?

This is a moment where I should say that I wrote the introduction to the latest edition of this book (though I don’t receive royalties or hold any other financial stake in its success). In my footnotes, I make an ever so slight correction to a bit of folklore that is the source of the title, a wonderful story that Fred Schwed ever so slightly garbled. The title comes from an anecdote that originated from a man named William Travers, who was one of the great speculators on Wall Street in the 19th century. He was one of the sharpest minds on Wall Street, very cynical, almost bitterly so. He was in Newport, Rhode Island one day with some of his friends. They were giving him a tour of the harbour and pointing out the magnificent yachts that were moored there, saying, “This one belongs to this broker,” “This one belongs to that banker” et cetera. At which point Travers asks “Where are the customers’ yachts?” It’s a wonderful quip, which of course still holds. The point he is making is that the brokers got rich and owned big boats and it didn’t seem as if any of their customers had big boats. It’s one of the most wonderful anecdotes in Wall Street folklore. The entire book is just an elaboration of the various ways the financial system has of picking people’s pocket, at every step along the way. What makes the book so much fun to read is that it isn’t angry. It’s full of this mordant, biting humour and it’s an absolute pleasure, that would probably take the typical person three to four hours to read, if that. It also has these delightful illustrations by Peter Arno, who was a cartoonist for the New Yorker.

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I don’t know of any book that is this funny and I know of very few books that are this informative about Wall Street. I know of no books that are both this funny and this informative. So if you want to know how the system works, and you don’t have the patience for a more serious, sober look, pick this one up, because it’ll tell you just as much, but it’ll make you laugh.

Do hedge fund managers count as Wall Street customers? Because these days they are extremely rich as well.

Hedge funds are customers in one sense, because they consume a lot of products that Wall Street generates – investment research, trading services and a variety of lending and other sorts of products. But hedge funds are also middlemen, because they themselves have customers.

And it’s those hedge fund customers that are the ones without the yachts?

Put it this way: the hedge fund managers will tend to have bigger yachts than most of their customers. They may both have yachts, but there’s not much doubt about whose, on average, will be bigger.

Your last book is How to Lie with Statistics by Darrell Huff.

This is another terrific book. It’s light-hearted and a lot of fun to read. It’s a wonderful introduction to critical thinking about statistics, for people who have never taken a class in statistics, don’t like statistics, and may even think that statistics aren’t relevant to their decision-making. What he does – in a very entertaining and easily understandable way – is walk you through the techniques that people who have something to sell will use to blind you with science and use statistics as a weapon against you. The book is called How to Lie with Statistics for a reason, because numbers are used all the time to mislead consumers, particularly consumers of financial information. For someone who cares about investing or personal finance, it’s important to be an intelligent consumer of statistical information.

The book weight five ounces and is less than 150 pages long – you could read it on a long commuter train ride. But it’s absolutely delightful, and the last chapter in particular is terrific. It’s called “How to Talk Back to a Statistic” – which I just love. In it, he gives you five rules on how, as a consumer of information, you can push back against what you’ve been told and use your own scepticism as a shield against people who may be trying to mislead you. This is the one book that I universally recommend to people that always surprises them. Very often, a few weeks later, I get emails from people saying, “Thank you so much for recommending that book. Now I understand how I’ve been taken advantage of.” It’s just a wonderful little tool people can use to make themselves smarter.

One of the things I’ve really noticed living in the US is that figures really are used to mislead. You have the U-Haul trucks, advertising a daily rate of $19.95 – when I know, from personal experience, that the real bill is likely to be triple that, even for a short distance. In my bank yesterday, they were encouraging me to get a “Freedom” credit card, telling me how low the APR is – when everyone knows a credit card is an outrageously expensive way to borrow money. It’s so misleading and I don’t understand why these things are even allowed.

Once you become sensitised to it, you see this kind of thing going on all the time. Anyone can get tripped up in the way pricing is used against us. I filled up our car with gas yesterday, I was in Connecticut and I paid $3.84 and 9/10 cents a gallon. When I got home, my wife asked if I got gas and how much I paid. I said $3.84. Then, a few minutes later, I said to myself, “I didn’t pay $3.84, I paid $3.85” – but the gas station wants me to believe I paid $3.84, because those are the big numbers, the 9/10 of a cent doesn’t count. But it really adds up when you fill up your entire gas tank. You’re essentially paying a penny more on every gallon, and believing that you’re paying a penny less. You see it everywhere. There have been studies done showing you get an entirely different response from shoppers if you say 50% off, compared to “buy one get one free”. People are much more likely to buy if you say “buy one get one free”. If you read the Darrell Huff book and the Belsky-Gilovich book together, you will be a lot more aware of the ways the market plays and manipulates you. You won’t be completely immunised from ever being the victim, but you would be a lot more sensitised.

But with credit cards or with getting a mortgage, there are presumably numerous pitfalls along the way – but with anything involving interest rates, even if you are sensitised, but not great at maths, it’s often quite hard to calculate.

One thing both the credit card companies and mortgage lenders have taken enormous advantage of over the last few years is that people are not very good at making financial judgments about time. The very essence of a credit card transaction is that you get pleasure now, and pain later. You get the pleasure of having the consumer good that you want – the iPad, the Manolo Blahniks, the video game or clothing product you happen to want – you consume it now and have that immediate pleasure – and the pain of paying for it doesn’t come till much later. In your mind, you say, “Pleasure now? Or pain later? Well. OK. I’ll go for pleasure now, and I’ll deal with the pain later”. The problem is that for many people, later lasts forever. The temptation of pleasure now encourages you to buy something you can’t afford now or later and you have to spend the rest of your life paying for it, in many cases. There are hundreds of thousands of people declaring bankruptcy right now because they incurred debts they could never pay back. You should be able to anticipate the pain, but the immediate pleasure kick is more powerful in the brain, and just overwhelms it. Something similar happens with teaser rates for mortgages. People are given an upfront rate. They’re told it won’t last, but the disclosure of that tends to be pretty minimal, at least historically. The thrill of getting a cheap rate upfront makes people’s minds up for them, and a few years down the road they find they’ve made a commitment they can’t keep.

 

Interview by Sophie Roell, Editor

September 21, 2017

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Jason Zweig

Jason Zweig

Jason Zweig is an investing and personal finance columnist for the Wall Street Journal. He is the author of The Little Book of Safe Money: How to Conquer Killer Markets, Con Artists and Yourself.

Jason Zweig

Jason Zweig

Jason Zweig is an investing and personal finance columnist for the Wall Street Journal. He is the author of The Little Book of Safe Money: How to Conquer Killer Markets, Con Artists and Yourself.