Dr. Robinhood or How to Stop Worrying and Love the Plan
Updated: Sep 1, 2020
As a recent finance grad, and 20-something finance professional, I have plenty of interesting conversations with my peers on “investing”. Many of my conversations include talking about trading stocks, asking for the latest tip, and of course, Robinhood. This short excerpt may be more of a mass PSA for my friends, but hopefully there may be a bit of nuance for the savvy investor as well.
First off, I will admit, in college I did have a Robinhood account. Checking the history, I made a whopping $30. Not bad for someone still learning the basics of an income statement. It was fun, and an interesting learning opportunity, but that is all it was. My $30 profit was not from my “investment”, but rather a random act of luck and curiosity. Dear friends, you are not an almighty stock picker, just like I am not Patrick Mahomes because I completed a 20-yard pass to my roommate. I am not utterly against picking stocks as a learning or exhilarating experience; just understand that is all it is, nothing more.
First Tip: So, young investors, what can we do? If you want to become an investor what is that first step? First, change your timeline. Your first investment priority should be towards retirement – and that is 30 to 40 years away. What if I want to save for an engagement ring, down payment on a house, or car? These are exciting stages in life, but stocks are often not the instrument for short-term savings. There are other methods, alternatives, and products that will better suit those time-horizons and risk tolerances. I want to specifically address stock investing. Your investment mindset should be set for the long-term, not something that may go up or down depending on today’s tabloid news.
Second Tip: taxes. There are only two certainties: death and taxes. Open a “tax-deferred” account. Many young people I speak to do not have a 401(k) offered employment plan yet, so the other options include a traditional IRA, or Roth. I find that my peers understand Roth as a financial buzz word and nod their head when I mention its mythical tax-deferring powers. Without going into the nuances of the different types of qualified tax accounts, they all will be more optimal towards long-term investing than a taxable brokerage account (you know, like Robinhood accounts) as they grow tax deferred.
Third Tip: Once you get those two things down, the third thing is a bit more complicated. What is the right way to invest? Many different financial professionals, I am learning, disagree on this. Like many professionals there is much conflict, but usually a framework of understanding. That framework is diversification. Diversification is the only free lunch in investing. Diversification simply means to spread your investment across a broad swath of companies, rather than 5, or even 100. Here at my place of employment, Burkholder Wealth Management, we believe in diversifying across different factors, and creating exposure to different parts of markets to match risk profiles. This approach is called factor investing. Factor investing is driven by CFA (Finance gold standard qualifications) experience, academic-based research, and industry-wide support. I understand this may seem way over a beginning investors head, but I will circle back to that later.
From my limited time explaining these three principles to some of my best friends, I still often run into lots of rebuttals. Frequently, my friends can accept my time-horizon and tax-deferral advice, but not the last segment on diversification. “I have seen growth from my account from buying all Tesla and Apple”. “Ok I understand diversification, but I am riding the wave of this new stock I saw on Twitter and its absolutely ripping”. Again, this is behavior is suited for exhilaration and learning, not necessarily long-term investing. We, I will include myself in this, fall into the pitfalls of thinking we are so much more knowledgeable or better at predicting, and thus can outperform the market. The overwhelming monster wave of data, and research would explain to you otherwise.
Stock picking is not a sustainable feat for nearly anyone. Especially those promising getting rich quick, as they are most likely over exposed to risk and will eventually crash and burn. “Well, what about that guy from the Big Short movie I saw once, or Warren Buffet, or all the hedge funds that create wild returns”. Notice I said nearly anyone. Let me discuss just a glimmer of who you are up against. If you are picking individual stocks you are now entering a zero-sum game (meaning that you are either winning or losing). So, who is the opposing side? Well, when you open your laptop to pick a stock you are up against some of the world’s fastest computers. The hedge funds who pick stocks have probably enough computing power to defeat Thanos with one click of a mouse. Some firms analyze data from satellites to monitor the average daily traffic in a fast-food restaurant in the outskirts of New Mexico to predict the earnings for that quarter. Most of these businesses have the world’s top mathematical scientists, and graduates from prestigious universities. Not to mention that many of these firms are still unsuccessful and die out anyway. I love a David and Goliath story, but ultimately you will be the one with a stone cast at your portfolio if you enter in this battle. And if you do somehow consistently beat these businesses, I would encourage you to quit your day job and focus full-time on executing these strategies. Yet, for 99.9% of investors out there this will not be the case.
Is there no hope? Of course, there is. But first, my fellow peers, we must give in to the idea of long-term investing, utilizing our tax efficient methods, and diversify when we can. By diversifying through smart factor investing we are trying to capture the most efficient market returns. I said I would circle back to my third point. Factor investing, if done correctly, is still very complicated. My advice to my peers is to do research and develop a plan. Love the plan. Stick to the plan. Make sure that plan includes diversification, likely accomplished through ETF’s and mutual funds, and invest internationally. Get off Robinhood!
To my wealthier people, I strongly advise working with an advisor. I know my bias is screaming, but the benefit of an independent fiduciary advisor is the route to go. I have seen some “do it yourself” strategies for large portfolios, and sometimes stay up at night tossing and turning, because of the horror and mishandling of their investments. I personally am fascinated with kinesiology, and how muscles work, but I will refer to my chiropractor if my back is out of alignment. You, too, would be mortified if one of your friends attempted to do surgery on themselves. Handling smart factor investing is simply too tricky with larger sums of money, it is worth it for my younger and broke friends (like myself). But, at a larger scale, it is easier, and more peaceful to work with a professional.
The firms I mentioned above are trying to beat the market. The average investor should not be concerned with playing that game; we will all lose. I simply want to help you ride that monster wave of data, instead of getting pummeled by it. Anyway, the market will return much sweeter fruit if we invest the right way. Over the course of 30 to 40 years, the market return’s compounded will give back to us what we need and more. By investing properly, being financially aware, employing sound reason us young people can be well on our way to financial freedom and retirement. Of course, it is still fun to pick a stock or two, but just do not do it at the expense of your long-term goals.