"Irony is just honesty with the volume cranked up," George Saunders once said. Here are my favorite financial ironies.
1. Lower trading costs make it more tempting to trade, which increases costs.
The average stock transaction cost in 1970 was 1.2%. Want to buy $10,000 of stock? It'll cost you $120. Thanks.
Fees have fallen through the floor over the years, and now round to free at most online brokerages.
But I doubt lower trading fees have helped investors. Just the opposite: They've removed all barriers to stupid.
The evidence is overwhelming that the more you trade, the worse you'll do. That's because most trades are expressions of your own delusions and biases.
Just as gasoline taxes promote efficient cars, trading fees promote efficient behavior by putting a financial burden in between you and bad decisions. They make you think before acting. Over time, that might save you far more than the incremental gain of lower trading fees. If you think a $120 trading commission was expensive, calculate the cost of day trading your 401(k). There's no comparison.
2. Your prime investing years are in your teens and 20s, but your prime earning years are in your 40s and 50s.
Compound interest grows exponentially, but market returns are random and unforgiving in the short run.
So here's what happens: Time is on your side when you're young, but you have no money to invest. When you're old and have money to invest, the most powerful years of compounding are long gone and you're left fighting the psychotic whims of short-term market returns as retirement approaches.
This is why so many people think the market is a casino. Since they don't invest in earnest until they're nearing retirement, they don't have enough time to let the market work, and they truly are left gambling on short-term returns.
The solution is to teach younger generations how powerful saving even a few dollars can be. We've made progress here. Thanks to auto-enrolment into 401(k)s, younger workers are saving for retirement at rates their parents couldn't fathom.
But the fact remains: The market is made for people with 30-50 years in front of them, and that's always going to be the segment of the population with the least amount of money to invest.
3. Investing gets more expensive the richer you become.
A rich person pays the same price for a pair of shoes as a poor person. But the rich person will pay way more for investment advice than someone with less money, even if they're receiving the same product.
Nearly all financial fees are processed as a percentage of assets. Say a mutual fund charges 1% a year. Someone who invests $10,000 will pay $100 a year. Someone who invests $100,000 will pay $1,000 a year. But both are receiving the same service: The same set of stock picks from the same money manager who puts in the same amount of effort regardless of how much money you have.
The money manager has his own set of expenses that scale with assets -- custodial fees and transaction fees -- which is why this fee system is as ingrained as it is. Everyone in the business has signed onto scaling fees with assets, which makes it hard for anyone to break away. But the result is that the richer you become, the more expensive investing becomes. It's one of the few industries with negative economies of scale.
Success attracts money, but attracting money ensures less success.
If a money manager clobbers the market for a few years, investors will reward them with billions of dollars to invest.
But opportunity is a scarce resource. It's not something even the smartest investor finds day after day. So new money often heads into the only thing left on the manager's list: Overpriced assets or sub-par ideas. Disappointment isn't far behind.
Money doesn't chase opportunity, it chases past performance. The irony is that in a cyclical world, high past performance is often a harbinger of a future slump. But this is so counterintuitive to everything our brain wants to believe that we keep repeating the same chasing-the-shiny-things mistake over and over again.
Some money managers close down their funds to new investors to keep a balance between money and opportunity. But they're rare. Bill Gross, Bill Miller, Ken Heebner, and John Hussman have all been hit by the curse of success, with a career cycle that will look something like this:
- Manager has a winning streak.
- Investors pile in, hoping winning streak will continue.
- Manager puts new investor money into sub-par ideas. Returns drop.
- Investors pull money out.
- Manager finds new opportunity.
- Few investors are left to enjoy it.
- Manager has a winning streak.
Many investors repeat this process until broke. The smarter ones realize that everything is cyclical and chasing past performance is the fastest road to misery.