How to Become an Investing Adult

DECEMBER 18, 2013
James M. Dahle, MD, FACEP
William Bernstein, MD, recently came out with a series of short booklets he calls Investing for Adults. While it might sound pretentious, the truth is that the vast majority of investors never actually reach “adulthood” as defined by Bernstein. The analogy is easily explained.
 
My children worry and complain about many things that don’t bother me in the least. They have a short-term perspective caused by their lack of experience in life. They lack patience and their behavior is often motivated by their emotions, such as fear and greed. Their ability to use logic is limited, and, at times, apparently non-existent. They have little knowledge, understanding, or appreciation for history.
 
As an adult, I have learned patience, sometimes in the school of hard knocks, and am better able to guide my decisions using logic and the guideposts of history.
 
Children go to school for a reason
There is a certain amount of financial knowledge that must be mastered in order to grow from an “investing child” into an “investing adult.” This includes basic mathematical concepts such as compound interest and the future value of money.
 
It also includes understanding the basics of the tax code, retirement accounts and financial products such as stocks, bonds, mutual funds and insurance products. It also includes understanding the importance of minimizing investment expenses, avoiding active management risks and diversifying a portfolio broadly.
 
Investing “children” worry about the wrong risks
The biggest problem with being a child when it comes to investing is that you spend all your time worrying about the wrong risks.
 
In order to more easily study financial history and investing in the pre-computing age, academics were forced to use simplified models that generally equated investment risk with volatility. The problem with doing this is that, in the words of Bernstein, volatility is a “shallow” risk. It is not a risk that investing adults worry about.
 
Just like adults don’t care what the other people on the bus think about their shoes, they also don’t care that their long-term investments can be very volatile in the short term.
 
Personal risks
There are essentially three categories of risk that investing adults deal with. The first is best described as personal risks. This includes dying, becoming disabled, acquiring an illness or injury that is expensive to treat, or becoming legally liable for physical or financial damage to another person.
 
Investing adults don’t spend a lot of time worrying about these risks because they are easily dealt with by purchasing appropriate life, disability, health, malpractice and personal liability insurance policies.

How to deal with shallow risks, on the next page.
 


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