By Dr. Jim Dahle, WCI FounderThe majority of investing discussions you will see and hear involve the question, “What?” However, the most important investing decisions you will ever make usually involve “How Much?” Get the “How Much?” decisions right, and the “What?” decisions won’t matter nearly as much.
Successful Investing
Consider what it takes to be successful in reaching your financial goals:
- Adequate funding (a “How Much” issue)
- A reasonable investing plan (a “What” issue)
- Staying the course with that plan
Which matters the most? Far and away, it’s Step 1. In fact, if you save enough money, it really doesn’t matter what you invest in at all. But no investment will provide returns adequate to overcome a minimal investment amount.
What vs. How Much Questions
We’re always asking questions like, “Should I invest in actively managed or passively managed mutual funds?” Yes, getting the “What” right does have an effect (the answer is passive, by the way). But really the question is a “How Much” question. How much of my money should I put into passive vs. active funds? If you put 90% into passive funds, you’re going to be fine. If you put 10% into passive funds, you’re likely to underperform. The “How Much” matters more than the “What.”
Nearly 100% of financial news, financial blogs, and financial advice are concentrated on “What” to buy and sell—crypto, real estate, commodities, options, stocks, bonds, CDs, or MYGAs. We shouldn’t be surprised when investors think those are the most important questions. But don’t these “How Much” questions matter a whole lot more?
- How much of a good investment should you buy?
- How much leverage should you use to buy it?
- How much should you spend to insure against low probability events?
- How much should you spend (vs. save) today?
- How much should you spend over time?
Consider people who have become financially ruined due to a bad investment or fraud. What was the problem? Was the problem that they chose a bad investment? Or was the problem that they put too much money into it or borrowed too much money to buy it?
Sizing matters. Remember the debacle that was Long Term Capital Management. The bets they made would have paid off over the next few years, but the short term comes before the long term. Too much leverage and too much was placed on those bets; they couldn’t ride out the short term to get to the long term.
The same issue happens with real estate investors. How do you turn a cash flow negative property into a cash flow positive property? You put more money down. What is cash flow negative with a 20% down payment is often cash flow positive with a 33% down payment. The problem isn’t the investment, a “what” question. The problem is the leverage, a “how much” question. Cash flow positive investors can ride out long real estate downturns. Cash flow negative investors declare bankruptcy, or they end up fire-saleing assets.
I’m invested in a fund that focused on buying single-family homes. Prices fluctuate, but there wasn’t a major downturn or anything. The investment thesis about single-family homes being a good investment was fundamentally sound, especially in the long term. The problem for this fund was that it tried to grow too quickly, and to do so, it took on debt at terms that turned out to be unfavorable as interest rates (unexpectedly) rose. The result was a significant loss of capital for all of the investors. The problem wasn’t the single-family homes. It was that the fund bought too many of them. What saved my portfolio from this disaster? The fact that I didn’t invest very much into the fund. I was still “trying it out” with something like 0.2% of my portfolio when it imploded.
The size of your bets matters more than what the bets are. When risky bets are small and leverage is low, the portfolio may take a hit. But it survives. Large, leveraged bets are a pathway to eventual financial ruin. Good bets with bad sizing can be catastrophic.
More information here:
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Where Are All the Billionaires?
The authors of The Missing Billionaires make this point well. Their premise is that there should be a lot more billionaires than there are today, even with estate taxes and the dilution of fortunes among multiple heirs. As they write:
“When Vanderbilt died in 1877, he was the wealthiest man in the world. His eldest son, Billy, received an inheritance of $100 million—95% of Cornelius’ fortune. Unfortunately, it came without even the most basic of instructions on how to invest and spend this wealth over time.
Within 70 years of the Commodore’s death, the family wealth was largely dissipated. Today, not one Vanderbilt descendant can trace his or her wealth to the vast fortune Cornelius bequeathed. The Vanderbilt clan grew at a higher rate than the average American family, but even so this outcome was far from guaranteed. If the Vanderbilt heirs had invested their wealth in a boring but diversified portfolio of US companies, spent 2% of their wealth each year, and paid their taxes, each one living today would still have a fortune of more than $5 billion.”
Considering $100 million in 1877 is the equivalent of $2.9 billion today, what happened to all these people? They had “how much” problems.
“In our book, we explore in detail the most common ways in which these missing billionaire families discarded their enormous head start: taking too much or too little risk, spending more than their wealth could support, and not adjusting their spending as their wealth fluctuated. Above all, they did not have a unified decision-making framework, which left them susceptible to chasing whatever was hot and dumping it as soon as it was not, anchoring spending decisions on hoped-for portfolio returns, and paying exorbitant fees for poor advice.
Notice that among the primary errors we listed, we did not include choosing bad investments. That’s because one thing that did not cause these billionaires to go missing was a poor investment environment. Indeed, it’s hard to imagine a better one. The US stock market delivered a 10% pretax annual return over the period, turning $1 million in 1900 into roughly $100 billion dollars at the end of 2022, a 100,000x return.”
More information here:
Should You Aim for Generational Wealth?
How Much vs. What in Insurance
Consider another personal story. As a medical student, a “friend” sold me two Northwestern Mutual insurance policies. The first was a $20,000 whole life policy. The second was a $280,000 Term 80 policy with increasing premiums every five years. The “What” issue here was a complete miss. Neither policy was appropriate. I should have been sold a 30-year level premium term policy. But that really didn’t matter all that much. The premiums on such a tiny whole life insurance policy were never going to bankrupt us.
The real problem here is that the “How Much” issue was also a complete miss. What was $300,000 going to do for my family if I died? I don’t want to say “nothing,” because $300,000 sure beats $0. But that $300,000 wouldn’t have bought my heirs a house, sent them to college, and provided for my wife for the rest of her life. Katie wouldn’t have made it to 30 years old before that money was long gone.
My insurance needs at that point were in the millions. Maybe we couldn’t have afforded a $5 million policy back then. But $1 million was probably doable. Once we figured out what was going on as I became an attending, we quickly had over $2 million in coverage. Too bad we didn’t buy some portion of that a few years earlier when it would have been cheaper.
As you make your financial plan and work through your financial life, put at least as much focus on the “How Much” decisions as on the “What” decisions.
What do you think? What mistakes have you made from focusing on “What” instead of “How Much?” Know somebody who could use this information? Make sure to share it with them.
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