Mental accounting: why we sometimes like lower returns

Richard Thaler’s Paper on Mental Accounting Matters, looks at “the set of cognitive operations used by individuals and households to organize, evaluate, and keep track of financial activities”, in the Journal of Behavioral Decision Making.

In his work, Richard finds that the framing of gains and losses isn’t often rational.  According to mainstream academic theory, we are all selfish, rational being.  Therefore, we should all be looking to maximize our holdings, presumably?

The evidence suggests otherwise. Firstly “losing $100 hurts more than gaining $100 yields pleasure: v(x)< -v(-x). The influence of loss aversion on mental accounting is enormous”.  

Perhaps we shouldn’t be surprised why, despite the evidence, very few people want to have a portfolio which is 100% in the markets, or even 90% in markets.   Many people prefer a 60% stocks-40% bond portfolio, even though it will usually perform worse over time.  The stability will reassure people, over the better performing, but fluctuating 100% stocks account.

What was also interesting about his research, is that people don’t get used to `losses`. I put losses in inverted commas here, because in investing, a loss doesn’t occur until you sell.

He found that adding one loss to another should diminish its marginal impact. By wishing to spread out losses, subjects seem to be suggesting that they think that a prior loss makes them more sensitive towards subsequent losses, rather than the other way around. In other words, subjects are telling us that they are unable to simply add one loss to another (inside the value function parentheses). Instead, they feel that losses must be felt one by one, and that bearing one loss makes one more sensitive to the next”.

Perhaps we should not be surprised that few consumers wanted to invest in 2009 when the Dow Jones was at just 7,000+ at one stage, after 9 years of falls.  The `losses` had compounded. If they were just a bit more patient, they would have seen the Dow hit 26,600 this year.  But the human mind isn’t a rational one.  That is just one reason why DIY investors fail.

Adam Fayed – International AMG – [email protected]

Account openings and online investment sites

Updated August 29, 2019

This article will review some of the best investment platforms in 2019, and get into the whole DIY vs advsior debate.

 Best investment platforms UK in 2019

  • Hargreaves Lansdown – A FTSE100 company, Hargreaves Lansdown charges a 0.45% fee for the first £250,000 invested, 0.25% for investments between £250,000 and £1 million and 0.1% charge for investment in excess of £1 million. They have access to numerous fund, ETFs and other options.  
  • Vanguard Online – charges 0.15% fee, capped at £375 a year.  They focus on passive investments, whereas Hargreaves Lansdown has both active and passive investments.
  • Charles Stanley Direct – similar to Hargreaves Lansdown.    Charges 0.35% on smaller accounts per year.

Best expat investment platforms in 2019 

  • Interactive Brokers – A cheap option, however, they are based in the US, so US estate taxes may apply.
  • Saxo Bank – Cheaper than Internaxx on smaller accounts, but more expensive on larger accounts.
  • Internaxx (formerly TD Direct) – The flat fees are `a killer` on smaller accounts, but a steal on larger accounts.

Best investment platforms USA in 2019

  • Vanguard Online – Just like the UK, Vanguard has a platform for US residents. 
  • Fidelity and TD Ameritrade- two other low-cost investment platforms.
  • Living in mainland Europe 
  • Degiro fees are low, often less than $1 to trade.


Are there other options out there?

Yes. It isn’t an extensive list. There are hundreds out there which could also be put on the list, but you won’t go wrong with the above.

I was reading on best investing platforms on Reddit – should I get advice on there?

A lot of readers have asked me about answers they have read on Reddit, Quora and Medium, and ask if they should trust those answers.

It depends on the author, of course. There are some great answers online, but some awful answers as well!

Do the fees matter?

They do, but the fund selection also matters. Bare in mind flat fees vs percentage fees.  Internaxx is more competitive on fees than Saxo Bank on larger accounts, but less competitive on smaller amounts and maybe up to $60,000, as the fees are flat.  If you have a small amount to start with, check out what the flat fees are.

Does DIY investing for beginners work?

DIY investing can be brilliant for those who have the self-control to manage their own finances. But a surprising few people seem to be able to steer away from fear, greed and egoism and end up speculating. Perhaps good old human nature is too powerful to stop.

Academic research has shown the average DIY investor only gets 4% when markets have averaged 10% per year, and countless investors panicked during 2008-2009 and other crashes. 

How can I know if I can be a good DIY investor?

By asking yourself questions such as these

  • Do I always invest when I have money, or try to market time`?
  • Have I ever tried to get rich?
  • Did I panic during the last financial crisis, Trump’s election or Brexit?
  • Have I ever stock picked?
  • Have I read investment books on subjects like index funds? 
  • Do I always read the financial media and panic?
  • Do I know that nobody can predict markets, stock price direction and so on?

DIY investing vs advisor – what are the positives and negatives?

Do it yourself investing is cheaper IF you do two things; a).  Buy index funds – avoid all stock picking and the time and money that takes.  b). Buy and hold for 40-50 years.

Using an advisor will be more expensive, but a good advisor can act as a `coach` as well as an advisor.

Or put it another way, would you have panic sold in 2008-2009 if you had an advisor breathing down your neck, showing you academic evidence about why market timing doesn’t work?

Often in investing, knowledge isn’t enough. We all know how to get a 6 pack at the gym, but how many of us have one?

The same with investing. Having knowledge is only one part of the process.  Implementing the knowledge is 10x more important.

Can American expats invest in expat platforms?

It depends.  Some accept Americans and some don’t. 

Can American overseas invest in Vanguard?

Typically not, but rules are always changing.

Does Vanguard accept expats?

It depends where you live.  They do in some locations, but not in others. 

Does It Matter Which Index Fund You Use?

Typically not.  iShares, Vanguard, BlackRock , HSBC and many other providers have virtually identical index funds, tracking the same indexes. 

Vanguard was just the first provider of index funds, so they had first mover status. 

Investment portfolios in UK, America or Singapore – should they be different?

How you should invest shouldn’t differ radically. Everybody should have some allocation to global markets, whereas you live. Avoid only investing in your home country – called `home country bias`. 

Does past performance matter in investment manager selection?

No, at least not the past 5-10 years. Over 50 years, however, lower cost funds outperform higher cost funds.

Do you offer investment help?

Yes, I can help people step up an online account.  Minimums are $75,000 on the lump sum side, and $600 on the regular savings side.

 will try to keep the minimum as low as possible for as long as possible, because I do want to help people who aren’t super wealthy, but I may have to incrementally raise the minimum depending on the demand.

The accounts are:

•Low cost, access to global markets from 0.02% or similar low flat fees on the platform

•Well-regulated funds from developed countries like US and UK Territory, which means strong investor protections.

•All accounts are linked to the academic evidence in the book I wrote in 2018.

•Available to all except people living in America.  Americans living overseas are a possibility but it is a little more complicated than other nationalities due to regulations.

Which assets perform well in inflationary conditions?

As previous blogs have pointed out, equity markets have consistently beat inflation, producing an average return of 6.5% after inflation in the US.  This is a simple average, however, so let’s look at whether there is a correlation between inflation and the rate of return for different asset classes.

Bennyhoff, and Donald G, wrote a paper in 2009 called  “Preserving a Portfolio’s Real Value: Is There an Optimal Strategy?”.

They looked at the average inflation rate from 1926 until 2008 , and then the real terms returns of different asset groups. They came up with the following results:

Annual inflation: Year-over-year basis point change Stocks total average return  Long-term Treasury bonds average return  Intermediate term treasury bond total return  T-Bills total average returns 
▲ 150 bps  –2.33  –4.81 -2.50 –1.99
▼ 150 bps and ▲ 20 bps 5.83 2.31 1.86 0.85
▼20 bps and ▲-40 bps  10.94 6.41 3.71 1.46
▼ –40 bps and ▲ –200 bps 20.37 3.01 3.03 1.55
▼ –200 bps 7.07 8.55 6.03 2.43

As the figures above show, there has been many years where average stock market returns have been much high than 6.5% after inflation, and other years where they have been much lower. Moreover, from 2008 until today, the price of stocks has certainly performed excellently, in a low-inflation environment. 

This backs up the researchers claim that “stock returns are not entirely independent of the inflationary environment, but, as can be seen in the table, some of their best and worst annual real returns have occurred whether inflation was rising or falling”.

For the other assets, because of the relationship between inflation and interest rates, sudden shifts in inflation expectations affect the total return of bonds much more than that of stocks. In fact, for bonds (particularly Treasury bonds), inflation shocks are the primary factor affecting performance; for stocks, inflation is just one influence among many.  

For bonds, on the other hand, the best real returns tended to occur when inflation was falling rapidly, and the worst when it was speeding upward. Changes in inflation expectations tend to result in changes in interest rates, which affect prices of longer-duration bonds more than those of shorter- duration investments like T-bills.

If we look at real rates of return by the decade, a similar pattern emerges 

CPI Inflation annualized  Stocks real    returns  Long-Term Treasury real returns  Intermediate-Term Treasury real returns  3-month T-Bill 
1930s  –2.04% 2.08% 7.06% 6.76% 2.70%
1940s 5.36 3.52  –2.01  -3.35%              –4.64%
1950s 2.22 16.66  –2.25  –0.86%             –0.17%
1960s 2.52 5.16 – 1.04 0.94% 1.47%
1970s 7.36 –0.32  –1.37 -0.11% 0.88%
1980s 5.10 10.98 7.34 6.33% 3.93%
1990s 2.93 14.24 5.48 4.05% 2.06%
Average (1926-2008)  3.01 6.44 2.60 2.25% 0.8%

I am sure one thing that surprises people is that in the 1930s during the Great Depression, US stock markets actually produced more than during the 1970s.  This is because prices started to recover after 1933, deflation affected the real rate of return, and by January 1  930, the Dow Jones price was already lower than it was during the height of 1929.   The figures also show it is common for stocks to under and outperform their historical averages of 6.5% after-inflation.  

What do these figures show for people’s portfolios then?  I would summarize the findings as:

  1. Once again shows why you shouldn’t panic if markets are down for a considerable amount of years.  The last 18 years are a great example of this.  Between 2000 and 2009, markets performed very badly by historical standards, whilst they have performed very well from 2009 until today.  
  2. Having a diversified portfolio with some government bonds will lower your long-term portfolios growth slightly, but will smooth out the ride, as they perform well during periods when stocks perform badly
  3. It is completely rational to be 100% in stocks when you are young, from age 21 until 40, but then go for 25% or more in bonds.  However, you need to be physiologically prepared for the falls as well as the rises.  
  4. If you start investing in the markets today and the markets have a bad 5-10 years, you should actually be happy, as that will further increase your long-term returns, if you are patient, as you are buying at lower prices.
  5. The markets always go up in the US, but the ride wasn’t been smooth.  So don’t try to find the best time to come into the market.
  6. For a well-diversified, strategically managed portfolio— such as most policy portfolios today—research has shown that asset allocation is the primary determinant of risk and return. For these reasons, the asset allocation decision should be the highest priority.
  7. For people in retirement, if the goal is to maintain long-term purchasing power and the liability stream is expected to grow at a rate similar to CPI-U, then investing the portfolio entirely TIPS or T-bills may be appropriate.
  8. However, if the goal is to increase the real value of the portfolio or if the liability stream is less certain, assets with potentially higher real returns probably should be included in the asset allocation.  
  9. Especially if you want to live for more than 30 years after retirement, it makes sense to have at least 50% in equities for a simple reason.  A 0.8% or even a 2.6% return after inflation isn’t much if you are withdrawing money from it every year.  In comparison, if you are getting a 5%-6.5% return after inflation, you can withdraw 4% from the portfolio every year and not run out. 

Adam Fayed – International AMG – [email protected]

6 Steps to Financial Freedom and Passive Income Investments

During all my years overseas, I have been amazed at how few people are truly financial independent.  Perhaps I shouldn’t be surprised, after all 98%+ of industries want to convince you to spend money on impressing people you don’t even like.

Instagram and L’oreal, with their famous slogan, are probably two extreme examples of this culture.  This culture leads to overconsumption and unhappy people working in jobs they don’t like.  Even for those who love their jobs, nobody would want to work if their health goes tomorrow.

In the book, just is free on Kindle Unlimited, I detail the steps needed to achieve financial freedom, and speak about the following topics:

  • How the average person can easily become a millionaire or even a multi-millionaire and retire by age 35-55.
  • Equity markets vs gold and property
  • Spending habits and how you can spend less
  • The general academic evidence on finance, spending habits and retirement
  • How you can retire early
  • How much you need for retirement
  • How much you can withdraw every year in retirement
  • Pension transfers
  • Wealth protection.  How much insurance, if any, do you need?
  • Pension transfers for expats living overseas
  • Why the average DIY investor underperforms and what you can do about it.

If implemented properly, this book can save the average person hundreds of thousands in fees, and also build up their wealth over a number of decades.

There is one thing I can’t promise.  It isn’t the most slick book out there, with the best cover.  But that is partly intentional as such sales-orinetated books often disappoint.  It is simple a book that gives fantastic value by looking at the academic evidence in an easy to understand way, and some real life examples, to turn your financial life around.

It also won’t be overly useful for the 2%-3% of the population who have already read the evidence.  I don’t aim to help people who already know the evidence and the answers.  I aim to help the vast majority of people who find personal finance complex and difficult to understand. I make the complex as simple as possible.

Please note I am no longer sending PDFs of the book, unless people can pay  by bank transfer or Western Union (for people in cash based societies, this option isn’t preferred).

The book is already inside the top 30  bestsellers for knowledge capital after just 3-4 weeks (as of June 29) and selling fast!

Below are some consumer reviews:

“Well written. Concise. With lots of informed guidance. You will learn a lot” – Amazon

“I really enjoyed this book. It is great for a beginner or even somebody who knows a reasonable amount about finance, and shows the importance of spending habits, investment strategies and many other things. The author seems to have travelled a lot and met many different people from many countries, which can help me see and explore ways to make money beyond my narrow comfort zone. It also includes some specific useful portfolios you can invest in and make money from. I didn’t notice any substantial grammar errors so I guess the author has updated his book since the first review was made” – Amazon 

“Adam, thanks a lot for writing book, I will be implementing some of the model portfolios in particular” – personal email.

As a aside, longer-term, I aim to start a community and help people beyond the book, especially for people who don’t have the minimum $30,000 to become a client.

So if you found the book useful please write a review online, and tell me about it, as I would love to have a personal relationship with some of you, and I do plan to start seminars and other giveaways (some free seminars and other things) to loyal readers

As the book makes clear, it isn’t just reading the evidence, it is implementing the evidence. If you want to share that journey with me, I am happy to help.


Some extra reading

1. How to become rich investing 

CNBC vs Bloomberg? Switch them both off

Most people who have read the evidence know that it is time in the markets, and not timing the markets, that matters.  Many don’t realize just how important that is, however, and just how profitable that can be. 

Consider a startling statistic.  Professor H. Nejat Seyhun found that between 1963 and 1993 the stock market was open during 7,802 days.  During that period 95 percent of the stock market’s gains came from just 90 of those 7,802 days.  If you tried to time the market, it is unlikely you would have gotten that benefit which turned $100,000 into $650,475!

Nobel Laureate William Sharpe wrote a paper in 1975 called “Likely Gains from Market Timing”.  He found that a market timers must be accurate 74% of the time in order to outperform a passive portfolio.

This may surprise viewers of CNBC and Bloomberg. The advisory group CXO looked at forecasts from well known market gurus who appear on the show.  They looked at their forecasts.  Marc Faber was only right 44% of the time.  The most successful was Ken Fisher, who was right 66% of the time. 

However, none were right at the 74% threshold which makes market timing profitable.  Remember, being right 66% of the time isn’t going to be as profitable as staying invested for three reasons.  One, you will need to hold money in cash when you think a crash is coming.  Two, when you are sometimes wrong (the 33%+ of the time) you are missing out on good gains from those days when markets soar.  Three, you will be accumulating costs, including trading costs and tax from selling.

In The Big Investment Lie, Michael Edesess has a very good quote, “The stock market can turn on a dime and always does. Prices are constantly twisting and turning without trend or predictable pattern. Their recent movement gives you nothing to go on.”

Just invest now, and stay invested.

Adam Fayed – International AMG – [email protected]

Lump Sum Investing – is it easier to gradual invest?

This is a question I get asked a lot.  It is often asked by people who have just gotten a lump sum, either due to a lay off or inheritance.  Should I put the money in in one go as a lump sum, or gradually?  Maybe investing it in 2-3 installments to make it `safer` or monthly. 

Investing monthly to reduce volatility is called `dollar cost averaging` (DCA).  Really just a fancy way of saying it is good to invest every month to reduce volatility and risk.  But what does the evidence suggest is the best strategy?

Vanguard produced an excellent study.  They looked at the US, UK and Australia, assuming 1,000,000 (1M pounds, 1M dollars and 1M AUD) is immediately invested into a stock/ bond portfolio and then held for 10 years.  They then compare the ending portfolio values from each strategy to determine how each performed during the 10-year period. 

They repeated the comparison over rolling periods.  For example they looked at the U.S. markets from January 1926 through December 1935, the second covers February 1926 through January 1936, and so on until 2011.

They repeated the analysis for various stock/bond allocations ranging from 100% equities to 100% bonds, and for various holding periods ranging from 1 to 30 years. Finally they calculated the probability and size of greater wealth accumulation in one strategy versus the other, as well as the risk-adjusted returns for each strategy.  

The results are below:

Asset allocation  United States (1926 –2011) United Kingdom (1976 –2011) Australia (1984 –2011) 
100% equity 66% of the time lump sum `won` 68% of the time lump sum `won` 62% of the time lump sum `won`
60% equity – 40% bonds 67% of the time lump sum `won 67% of the time lump sum `won` 66% of the time lump sum `won`
100% bonds 65% of the time lump sum `won 61% of the time lump sum `won` 58% of the time lump sum `won`

So there you have it. Don’t be worried about volatility. Just invest whenever you have a lump sum and don’t try to time markets.

Adam Fayed – International AMG – [email protected]