Source: "The Diary Of A CEO" Podcast

Compiled by: Felix, PANews

Ben Felix, Portfolio Manager and Chief Investment Officer at PWL Capital, is an evidence-based investment expert who translates academic financial research into practical decisions that the average person can understand. Recently, Ben Felix was a guest on "The Diary Of A CEO" podcast, revealing why most people make poor financial decisions. PANews has summarized the highlights of the conversation.

Host: There are many experts discussing personal finance and investment around the world. How does your approach differ from other financial experts on YouTube?

Ben: What I have always tried to do is draw wisdom from academic literature. I look at what the smart people who spend a lot of time thinking about these issues have concluded, and then apply that to the financial decisions of ordinary people. Whether it's renting or buying a house, or asset allocation, the principles of investing are the same whether you have $10,000 or $10 million.

Host: How much of making money through investing is caused by psychological factors?

Ben: The issue of investing has actually been "solved"; you just need to buy low-cost index funds. The real difficulty lies in our psychology. The brain is designed for survival, and it doesn’t handle long-term, abstract concepts very well, such as putting your money into the stock market today, ignoring everything that happens during that time, and having some money left for retirement in the future. People often talk about strategies and tactics, but I believe that whether one can execute any strategy or tactic depends on their psychological state. One of the best methods, although a bit counterintuitive, is to avoid looking at your investments. Academic studies show that the more often you check your investment accounts, the lower your risk tolerance becomes and the worse your returns are. Watching the stock market's fluctuations every day can cause extreme stress, leading one to believe that the stock market is highly risky; however, for investors who buy and hold for the long term, the stock market is much safer than they think.

Host: What advice would you give to young people in their twenties who are thinking about financial strategies?

Ben: This is a tricky topic; young people often face immense pressure from parents and society to save money. However, academic research shows that over-saving during low-income periods may not be optimal; the general principle is to save more when income is higher and less when income is lower. However, the premise is that one should not develop the bad habit of spending all their money and being unwilling to save when income increases in the future.

Host: Let's discuss one by one the 10 financial mistakes you mentioned that people often make.

Ben: Alright, Mistake 1 is not earning enough. Many people feel that a low income is unavoidable, but in fact, you can invest in your human capital, such as formal education, learning new skills, or starting a business, to become a more valuable asset. Academic data confirms a mechanical causal relationship between education and skills and lifetime income.

Host: I have always believed that one should optimize "knowledge" and "skills" as much as possible while young. The key is to acquire a combination of market-valued, scarce, and complementary skills. For example, if you study engineering and finance, and now also have the skills to create content for YouTube, that greatly enhances your earning potential. When I used to do marketing for a biotech company, I found a writer with no medical background, who only knew a little about biotech writing, was earning $250,000, which is five times the salary of an ordinary writer. Selling skills to the market can result in exponential income growth.

Ben: Yes, Mistake 2 is not saving enough. Wealth grows through the power of compounding over time. If you don't save enough money early on, it becomes extremely difficult to catch up later. It's like health; if you have a poor diet and never exercise, getting heart disease at 55 is hard to reverse.

Host: This is similar to the analogy about brushing teeth in "The Slight Edge": Not brushing today is fine, not brushing this week is also fine, but if you don’t brush for five years, you’re done and will have to sit in the dentist's chair to have teeth pulled. Finances are the same.

Ben: Mistake 3 is not setting financial goals. People often blindly pursue making money or buying a house without thinking about what a good life means to them. We developed a three-step method: first, list your goals; then, double the number of goals to stimulate deeper thinking; finally, use the "PERMA model" (Positive Emotion, Engagement/Flow, Relationships, Meaning, Achievement) to test these goals.

Host: What if my goal is to buy a Ferrari?

Ben: A Ferrari may not meet the PERMA model; the positive emotions it generates might only last a few days. But if you drive it to the track to enjoy racing (engagement), or if it helps you integrate into the sports car community (relationships), then it is meaningful.

Mistake 4 is overspending on the wrong things. For example, spending $12 every day on iced coffee just to hurriedly drink it on the way to work does not increase your positive emotions; instead, it occupies funds that could be saved for a better life.

Mistake 5 is not taking investment risks. The opportunity cost of not investing in the stock market is enormous. If cash yields 2% and the long-term expected return of the stock market is 7%, this 5% difference in compounded returns is staggering. Investing $10,000 now at a 7% annual return will grow to $150,000 in 40 years. In other words, when you spend $10 on a cup of coffee now, you are giving up $150 in 40 years.

Mistake 6 is taking the wrong investment risks. Many people avoid index funds and instead speculate on stocks, options, or cryptocurrencies, which have negative expected returns and high transaction costs.

Host: What about buying a house? This is one of the biggest decisions most people make in their lives.

Ben: I don't think buying a house to live in is an investment; you are actually buying an asset that provides you housing consumption. The down payment on a house carries a huge opportunity cost, as it could have been invested in the stock market. There are also many irrecoverable costs, such as mortgage interest, approximately 0.5%-1% property tax, and severely underestimated maintenance costs, which are reasonably estimated to far exceed the 2% value of the property.

Host: That's right. After I bought a house abroad, the garden, pump, flooring, and heating system are always breaking down. If I were renting, it wouldn't be my problem, not to mention the massive time cost spent contacting repairs.

Ben: Yes, there are also emergency repair and renovation costs. I proposed a "5% rule" to measure the costs of buying versus renting a house. For example, for a $300,000 house, the calculation would be $1,500. If the monthly rent is equal to or lower than $1,500, renting is financially the better decision. In addition, buying a house severely limits the mobility of young people. For instance, if the apartment prices in Toronto plummet and you bought a house there but received a high-paying offer abroad, you'd be stuck.

As for the common example of "someone bought a house for $70,000 30 years ago that is now worth $1 million," we can't use the returns from a time of collapsing interest rates and population surges to predict the future. In Canada, if you bought at the peak in 2021, adjusting for inflation, you are currently experiencing severe asset shrinkage. If you care about liquidity, investing in index funds is a better choice. Only those who are extremely risk-averse and want long-term stability in one place should consider buying a house.

Mistake 7 is missing tax planning opportunities. Average people should fully optimize the tax-free or tax-deferred accounts offered by the government, such as Canada's RRSP/TFSA, the U.S.'s 401k/IRA, and the UK's ISA. Rich people take advantage of loopholes, such as using stocks as collateral for tax-free loans without selling the stocks to avoid capital gains tax, but if ordinary people borrow against volatile assets, they face significant risks of margin calls.

Mistake 8 is ignoring estate planning. Not having a will can lead to your assets being distributed according to the government's default scheme, incurring high taxes, and giving money to the wrong people. If there are dependents, having a will is crucial.

Mistake 9 is the choice of marriage partner. Academic research categorizes people into "savers" and "spenders." These two types are extremely likely to be attracted to each other and marry, but this often leads to decreased marriage satisfaction and financial conflicts.

Host: I have a successful friend who spent 6 or 7 years in divorce court, where lawyers fueled conflict to collect high legal fees, which not only destroyed their originally good relationship but also led to significant asset loss. If there had been a prenuptial agreement from the beginning, everything would have been much faster.

Ben: Yes, a prenuptial agreement may not be romantic, but it can prevent future financial disasters if both parties can accept it.

Mistake 10 is inadequate insurance against catastrophic risks. If you are the primary earner in the household, you must purchase sufficient life insurance (low-cost term life insurance) and disability insurance to prevent your family's life from collapsing if you lose your ability to work.

Host: What about asset allocation? You once mentioned the "most controversial financial paper"?

Ben: Traditional wisdom suggests buying more stocks when young and switching to bonds when older. However, that paper, which tested data from 39 countries since 1890, found that the optimal long-term strategy is to hold 100% stocks for life, with one-third in domestic stocks and two-thirds in international stocks to diversify risk. The paper argues that in long-term high-inflation periods, so-called "safe" bonds can be severely stung, while stocks can be relatively safer.

Host: Are there any financial products that people should absolutely avoid?

Ben: First are "covered call option" funds. They give up the enormous upside potential of stocks for a small current option fee, resulting in high hidden costs. Second are "theme ETFs" (funds specifically investing in AI, cannabis, clean energy). These funds are often launched at the peak of some theme, when asset prices are at their highest bubble. Subsequently, asset prices fall, and these funds typically perform poorly. Finally, hiding cash under the mattress. At a 3% inflation rate, your money will lose half its purchasing power in 20 years. Holding cash effectively carries negative expected returns as a risk. The best method is to invest in low-cost index funds.

Host: We are currently in a surge of AI; people are worried about losing their jobs, and many fear that the large influx of funds into AI will lead to a market crash. What are your thoughts?

Ben: Historically, technological revolutions always bring disruption. For instance, when ATMs were first introduced, people thought bank tellers would lose their jobs; however, due to lower operational costs, banks opened more branches, and teller jobs actually increased. There is also the "Jevons Paradox"; as coal engines become more efficient, transportation costs decrease, resulting in more people traveling by train, leading to a thriving coal industry instead. As for a market crash, looking back to an article from 1847, the world was similarly filled with panic and uncertainty then, but history has proven that humanity always gets through it, and stock markets long-term continue to rise. Of course, the massive influx of capital in the early stages of a technological revolution can indeed lead to inflated asset prices, followed by a correction, which is also a normal cycle.

Host: So how should we think when buying stocks? A friend once told me that when I spent $10 on Facebook stock, the world's expectations and positive outlook for that company were already factored into that price, unless I knew a secret that others didn’t.

Ben: Your friend is describing the Efficient Market Hypothesis. When you buy stocks like Tesla, all public information is already included in the price. Buying stocks essentially means purchasing the expected future cash flows of a company at a discount rate. Therefore, trying to beat the market by picking individual stocks or timing the market is futile. The vast majority of professional fund managers underperform the market in the long run. The best practice is to buy index funds, accept market returns, and then forget the password and stop checking it. Focus on what you can control: saving money, asset allocation, and tax planning.

Host: Research from Fidelity and Berkeley shows that women tend to have higher investment returns than men because men trade more frequently. Do you agree?

Ben: I completely believe these data. Men tend to be overconfident, and they attempt to pick stocks and trade frequently, which is also related to their greater susceptibility to gambling addiction, inevitably leading to worse investment outcomes. Not meddling is key to successful investing.

Related Reading: Dialogue with Bitwise Advisor: From K-shaped economy to AI taking jobs, how can Bitcoin save young people?

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