The Nifty Personal Finance Index Card That Gets One Important Thing Wrong

The household net worth of Americans is currently north of $70 trillion. So it seems to make sense that we would hire financial professionals to help us manage this large pot of money wisely.

In reality, however, it might not necessarily be wise to pay up for financial advice. Harold Pollack, a contributor to the Washington Post's Wonkblog, believes that all the investment advice you really need fits on a 3x5 index card. He actually demonstrated that fact by grabbing a pen and writing it all down (see photo above). A strategy of following the advice on this index card is obviously a lot cheaper than paying several thousand dollars to a financial advisor or wealth manager. Let's see how the card holds up after taking a closer look.

Here's the list of recommendations along with some very brief commentary:

1. Max your 401(K) or equivalent employee contribution. Yep, this is a no-brainer. Everyone should do this.

2. Buy inexpensive, well-diversified mutual funds such as Vanguard Target 20XX funds. If he's recommending that everyone should own some index funds, then yes, I agree with that. I'm somewhat ambivalent about target funds, however.

3. Never buy or sell an individual security. The person on the other side of the table knows more than you do about this stuff. I believe he's wrong here. We'll consider this one in more detail later in the article.

4. Save 20% of your money. Sure, if you can, great. Sadly, I'm not saving this much myself at the moment.

5. Pay your credit card balance in full every month. This is wise advice. I'm able to do this now for the first time in my career.

6. Maximize savings vehicles like Roth, SEP, and 529 accounts. This seems reasonable to me, though I don't follow this advice personally.

7. Pay attention to fees. Avoid actively managed funds. Yes, and yes. Fees are killers when it comes to investing returns. And most ordinary investors will not be able to select winning, actively managed mutual funds.

8. Make financial advisor commit to a fiduciary standard. This is crucial. If your advisor isn't putting your best interests first, then you need to find a new one.

9. Promote social insurance programs to help people when things go wrong. I agree with this one too, though I recognize not everyone feels that way. We'll leave the debate surrounding this particular topic for another time.

Hedge fund managers ain't nothing
All in all, I really like the list, and feel that most people would do quite well by following most of its recommendations.

My biggest criticism relates to No. 3, however, which is bad advice in my opinion. The first part of the statement -- Never buy or sell an individual security -- implies that individual investors can't succeed by picking individual stocks. But that's just not true, as Warren Buffett argued in his classic "The Superinvestors of Graham-and-Doddsville" [link opens in PDF].

When Pollack says that ordinary investors shouldn't buy stocks, I feel he should really say something like, "many investors should stick with index funds." Clarity in language is important. As Einstein famously said, "Everything should be made as simple as possible, but not simpler."

The second part of the advice -- The person on the other side of the table knows more than you do about this stuff -- is equally flawed in my opinion. If the person on the other side is a hedge fund manager, does he or she really know more than an intelligent, ordinary investor? Remember, the U.S. stock market, according to the Financial Times, has returned eight times as much as the average hedge fund since 2009.

Or how about the average mutual fund manager -- 57% of whom have underperformed the S&P 500 (SNPINDEX: ^GSPC  ) over the past 10 years, according to Goldman Sachs? Do they know more than you do about this stuff? Maybe. Maybe not.

The truth is that big institutions are playing a different game than we are. Buffett, of course, knows this, and that's why he believes "a business approach to security selection, gives some opportunity for long-term results slightly above average without corresponding increase in investment risk." Saying that ordinary investors can't compete with the "smart money" sounds like well-meaning advice. But it's not accurate.

Maybe a better way of phrasing No. 3 would be: Most people will do fine with just index funds. But those long-term investors who are willing to do some research will prosper by investing in individual stocks.

It ain't bragging if you can do it
We're obviously biased when it comes to the merits of picking individual stocks. At The Motley Fool, our entire business is built on the premise that ordinary investors will do well by investing in great companies over the long term.

So far, the record shows that we are correct in that belief. The Hulbert Financial Digest recently ranked the performance of 200-plus investment advisory services over the last five years, and three Fool services were ranked 1, 2, and 3. According to Hulbert's numbers, the three services have delivered average annual returns of 18%, 16%, and 15%, compared with the 7.2% for the Wilshire 5000 index during the time frame. Hulbert also notes, "of the six Motley Fool services I currently monitor, five have beaten the Wilshire 5000 over the entire periods I have been tracking them."

We're proud of that record, but we also know that investors can achieve solid returns by picking stocks without our advice. A normal person with the mentality of a business owner and a long-term time horizon is more than a match for the hedge fund manager (who I'll concede is well-versed in all the likely moves of the Fed) across that table.

In fact, we look forward to that transaction. As Buffett says in the conclusion to his "Graham-and-Doddsville" essay, "there will continue to be wide discrepancies between price and value in the marketplace, and those who read Graham & Dodd will continue to prosper."


Read/Post Comments (15) | Recommend This Article (39)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On September 25, 2013, at 11:18 PM, HalMBundrick wrote:

    You compare mutual fund performance over ten years, but Fool portfolios over only five. Shouldn't performance be measured over the long term -- at least ten years? To be totally honest with readers, how about revealing performance to date of the original Fool investment strategy (the Dow Dividend approach) as laid out in The Motley Fool Investment Guide in 1996? That would provide at least a 17 year performance history.

  • Report this Comment On September 25, 2013, at 11:26 PM, malclave wrote:

    "Avoid actively managed funds. Yes"

    So I should sell the FOOLX I bought shortly after joining this site?

  • Report this Comment On September 26, 2013, at 9:01 AM, TMFBane wrote:

    @HalMBundrick,

    Yes, I agree that performance is best measured over the long term. I quoted Hulbert's five-year returns because he's an objective, independent source. I really was just trying to illustrate that it's possible for individual investors to outperform the market.

    You'll note that I also quote Hulbert as saying 5 of 6 of our services have outperformed the market since he's been tracking them. I'm assuming that's a longer horizon than the five-year numbers I also refer to.

    Stock Advisor is our longest-continuing newsletter, and its performance over the past 11 years holds up very well. Our internal numbers show that Stock Advisor has delivered annualized, time-weighted returns of 16.5% since inception (in March 2002). That's outperforming the S&P 500 by 11.5 percentage points on an annualized basis. I think our long-term performance supports the view put forward in the article.

    @malclave,

    Fool.com and Motley Fool Asset Management are separate entities.So under the regulations, I'm not allowed to comment on our funds.

    I would like to clarify my point about actively-managed funds in general, however. I believe that some funds can definitely beat the market. The ones with high fees and high turnover will face challenges, though. I think it's hard for many investors to choose between the good ones and the bad ones. But perhaps -- for clarity's sake -- I should have said, "avoid actively managed funds unless you are confident in your fund-selection process."

    Thanks for the comments! Foolishly,

    John Reeves

  • Report this Comment On September 26, 2013, at 8:44 PM, malclave wrote:

    John,

    Thaks for the response. It was mostly a rhetorical (and satricial) remark, I just thought it was amusing that fool.com would say to avoid actively managed funds when a sister organization manages funds.

    I understood the intent of the "rule" though... it's not so much a rule to avoid, but to be extra cautious about them. It's just space on that index card is pretty tight, and writing "avoid" takes up less space.

  • Report this Comment On September 27, 2013, at 9:23 AM, dsalhany73 wrote:

    When I pulled up the article, I first read the 3x5 card image. I actually read point #3 subtlely different from how you interpreted it:

    "Never buy or sell an individual security the person on the other side of the table knows more than you do about this stuff."

    If you do not use the '.' in the middle, you get a different meaning. In fact, I would agree. You really shouldn't make a decision of buy/sell if someone who knows more than you about a particular stock (ie. insider) is pounding the table with advice.

    Example: Would you sell a stock if an insider is urging you to do so? Probably not, he just wants to buy it back cheaper. There is usually a reason.

  • Report this Comment On September 27, 2013, at 9:38 AM, TMFBane wrote:

    @dsalhany73,

    Yeah, I completely agree that the punctuation is important in that sentence (it reminds me of that book, "Eats, Shoots & Leaves).

    I definitely tried to underline the point that the "intelligent investor" can do quite well picking stocks. But for the guy who has know interest in following companies, then the index fund route is probably better.

  • Report this Comment On September 27, 2013, at 9:39 AM, mikecart1 wrote:

    Saving 20% or more isn't that hard and no this has nothing to do with whether you make $40K/year or $100K+/year. It has to do with the ability to see the world for what it is - to see the economy for what it is. You are designed from birth to be part of this 'economy'. You are programmed to go to school, work hard, and after working hard to spend as much money as possible for the greater good of the 'economy'. I say no to this.

    When you start looking at what you need to live, what you need to enjoy life, and then everything else, you realize that the 'everything else' category is full of worthless items. Do you really need 300 cable channels and spend $100+/month on TV? Do you really need to eat out every day and waste $100's/week on junk food? Do you really need 10 pairs of shoes and 50 pairs of clothes? Do you really need the latest and greatest cell phone?

    Could you remove 80% of your possessions and still be nearly as happy as you are now?

    Bigger question - would you be even happier because you will have a lot more in the bank? :)

  • Report this Comment On September 27, 2013, at 10:03 AM, JessicaMcMillen wrote:

    Harold Pollack collected terrific advice (in principle, not arguing about a specific bullet) and I think that this 3x5 index card is the core of our todo list. The challenge is to apply these general guidelines to my specific situation & financial and life conditions.

    Since the financial planners do ask for thousands of dollars to analyze and develop a personalized plan (which is beyond what I can afford) I searched for alternative solutions. The two best ones I found are LearnVest (www.learnvest.com) and Plan&Act (www.planandact.com). The companies follow different business models and have different advice approaches but both are good. LearnVest charges $300 for a financial plan and Plan&Act $200.

    Enjoy :)

  • Report this Comment On September 27, 2013, at 10:23 AM, Nairb1971 wrote:

    Missing one important aspect that makes the %savings discussion more realisitic.

    1. LIVE ON LESS THAN YOU MAKE.

    Also regarding 401k/Retirement: Max out 401K may be unrealistic/inappropriate. Maxs. may exceed income a reasonable % of income. Should go with 15%.

    The Saving 20% if including the 15% for retirement should be easy to get the other 5% saving for kids college, saving for large purchases (ie, Cash for car), home repair or vacation.

    The key is live on less than you make.

  • Report this Comment On September 27, 2013, at 10:58 AM, nasis wrote:

    @TMFBane - I agree, but focusing on individual stocks vs index funds sounds like nitpicking from someone who admittedly has been comfortable carrying credit card debt.

    Assuming an average 15% credit card interest rate, choosing between that risk- and tax-free return vs virtually any stock investment should be, as you say, a no-brainer.

  • Report this Comment On September 27, 2013, at 12:01 PM, knighttof3 wrote:

    "Save 20% of your income." Yeah, ummm, OK.... because it's just that easy.

  • Report this Comment On September 27, 2013, at 3:00 PM, mack441 wrote:

    Point #1. "Max out your 401K" isn't all that obvious. Now it depends on your program. If your employer is giving you a 6% match and your salary is $100K then you get $6000. If they charge you more than 1% for management and your account balance is greater than $600K then you've become a revenue source for them.

  • Report this Comment On September 27, 2013, at 4:28 PM, Mathman6577 wrote:

    I've had good luck maxing (meaning the most that the IRS allows) out my 401k, paying off debt every month and using a taxable account with an emphasis on dividend growers for that needed retirement income at a lower tax rate (i.e. Dividends are taxed lower than capital gains). However, the "long-term" should be defined as 20 years (not 5 or 10).

  • Report this Comment On September 29, 2013, at 12:45 AM, Thror wrote:

    Agreed with Nairb up there.

    1. LIVE ON LESS THAN YOU MAKE.

    My wife and I have bought much less house than we were qualified for (on our dual incomes), and it put us quite a bit ahead of the game when it comes to saving. Now, although we're living a bit modestly for a few years, I know we'll have a good nest egg for retirement and perhaps even building that dream house someday.

    Anand's Article on Monday was a good treatise on home ownership... but never bite off more than you can chew. Your home should never be your only investment vehicle.

  • Report this Comment On October 07, 2013, at 4:56 AM, valuecliff wrote:

    I have to take issue with point 3, to buy a target date fund. I can't believe he hasn't come under increased criticism for this. There are many problems with target date funds but to include a few:

    1) Has a build in asset allocation so unless all your asset are in a single fund (unlikely) you're effectively buying a portfolio within your portfolio with it's own allocation and glide path which can be very difficult to manage within your portfolio.

    2) Asset location is undermined because the target date fund holds all asset classes in the same account type (e.g. in your 401k). You'd definitely want to hold some asset classes in your taxable account or tax free (if you have one). The impact of asset location should never been understated over a long time horizon.

    3) One size doesn't fit all - just because I'm planning to retire in the same year as someone else doesn't mean we should have the same asset allocation. Our needs and resources are probably very, very different.

    I know the author wants to keep things simple but I don't agree at all with TDFs. I agree with most of the other points (except for 3) however some are impossible/very difficult for some people to attain (20% savings) but they should aspire to them.

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