Embracing the Beauty of Being Average

by Kevin on September 24, 2008

I mentioned last Friday during the CGM Focus discussion that I would be telling you about the beauty of being average. Today’s the day. Grab your average coffee, sit at your average desk, and read this (probably) average article.

Average is Easy

When it comes down to it being average is easy. It doesn’t require a lot of effort to be average. A ltitle bit of effort and you’ll maintain the status quo. In some cases you don’t even have to have the effort part.

Think back to your days in school. Elementary, high school, college. Were you a below average student? I doubt it. There were very few of those in my experience. The ones that did fall into the category either didn’t show up at all, or put absolutely no effort in. Average is not equal to no effort.

Being above average required lots of work. Studying and working hard to achieve better results. Those that did work hard were usually rewarded.

But it’s that average piece in the middle. There’s nothing wrong with being average. You’re not that group that has to overachieve and be perfect at everything, but you’re willing to at least participate. You’ll take your low B or C and say thanks on the way out the door.

You Want to Be Average in Investing

The beauty of investing is that average should be your goal. You don’t even need to really worry about that extra effort stuff. Average is the place to be.

Why Embrace Average

Here’s how it works: if you chase fund returns, you will earn a return lower than the average of a major index like the S&P 500. If you see an advertisement for a fund in a financial magazine and it is showing off top-tier returns over the last five years, you’re hopping in at the wrong time. That is counter-intuitive. Your gut tells you to jump on the bandwagon at the top.

Unfortunately, over a long period of time (10, 20, or 30 years) those hot funds today will end up being average. Returns will fall, you won’t be able to find their advertisement in the financial magazine (it will be replaced with the next ‘hot’ fund from the fund company), and you’ll wonder what happened.

Going Against Your Investment Gut

Your gut is also telling you that the funds with the bottom-tier returns over the past five years aren’t likely to go up. Again, if you look over a long period of time, those funds are likely to outperform for a bit to get them back to being average. Then again, they could continue to falter and you’re still missing out on the average returns.

Index Funds Guarantee You Average Returns

If your goal is to be average look no further than an S&P 500 index fund like Vanguard’s S&P 500 index (VFINX). I am privy to Vanguard, but with any index fund you are guaranteed to be average. Guaranteed. The fund won’t outperform the S&P 500, and it won’t lag it either. You are locked in on average returns.

You’re Not as Good as You Think You Are

You will again have to fight against your gut. Your brain thinks you are smarter than you really are. You attribute the gains you earn by yourself as skill, and the losses you incur as bad luck. You also do the opposite for other people — if someone earns high returns you will consider them lucky, if they earn poor returns you attribute it to their poor skills. This is called fundamental attribution error.

So if you have a great year by picking individual stocks or individual actively managed funds, your brain tells you it is because you are just so darn great. If your strategy fails, you tell yourself it was just plain bad luck and we’ll do better next year.

With average index returns, all of the guesswork is removed. You earn the return of the index, that’s it. Case closed.

Your Only Concern: Cost

This leaves one decision to the average investor looking to invest in index funds: cost. If Vanguard is offering it’s index fund for 0.15% fund expenses and T Rowe Price is offering their fund (PREIX) at 0.35% fund expenses… why would you ever choose T Rowe Price?

The choice becomes amazingly simple — you pick the fund with the lowest cost. End of decision. Get back to enjoying life. You don’t have to worry how much your fund outperformed it’s benchmark in order to cover for the higher expenses. You earn the average return and don’t worry about it.

Don’t Be Average in Everything

Just a quick reminder that this average thing applies to investing only. There are a bunch of things you don’t want to be average in:

  • work or school performance – you don’t want to be fired, do you?
  • savings percentage – Americans on average spend more than they earn. You definitely want to avoid this average.
  • the effort you put into your marriage
  • how happy you make your spouse
  • etc.

So, who is embracing average with me? Leave your comments on how you’ve learned to be average.

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