445 | Fundamental Truths of Investing | Brian Feroldi

0:00Hello and welcome to ChooseFI. I'm your host Brad Barrett and today on the show we have Brian Feraldi on to talk about many of the lessons he's picked up over his nearly two decades as an investor. And it's fascinating how there's a common thread of understanding history and understanding psychology and thinking long-term. And I think you're really going to enjoy this episode where we go through the tactical and then zoom out to talk really broad-based lessons on how to succeed as an investor over an investing lifetime. With that, welcome to ChooseFI.

0:41Brian, my friend, welcome back to Choose a Vi. It's always great to have you here. Brad, it is always a pleasure to be here. Thank you for having me. Yeah, this should be fun. So, okay, you obviously are prolific on Twitter, and you are extraordinary on Twitter, frankly. So I think at last count, you have nearly half a million followers on Twitter, which is absolutely unbelievable. But honestly, it's not unbelievable when you see the amount of content and the quality of content you're putting out. And you put out a bunch of Twitter threads recently that I wish we could spend an entire episode talking about each of them, frankly, because I think there's a lot there.

1:15But the one that piqued my interest the most and I thought would be great for a wide ranging conversation. I think what's so great about you is you can get down to the minute tactical, but then zoom out and look at, okay, what's the psychology? What are the things that I need to know to succeed over a long period of time? And I think that's, it's a really interesting skill to be able to do both, frankly. So kudos to you, obviously, but I wanna dive into these. This post is, I've been investing for 18 years. Here are 38 short investing truths I've learned the hard way. Now, obviously, Brian, we're not gonna do all 38, but let's try to bomb through as many of these as we can and just talk about it with our own backgrounds because I think that gives some flavor on these truths.

1:59And really, people can see how it's applicable to their own lives. Yeah. If you are an investor for any period of time, you're going to learn a lot of lessons along the way. And it is going to be painful to learn those lessons. And that applies, by the way, if you're doing the thing that ChooseFI suggests, and I suggest 99 % of people, which is just dollar cost average into index funds. if you follow that path that is dead simple, you are still going to learn a lot of lessons along the way because markets are volatile and volatility wreaks havoc on human emotions. So I think many of these lessons will apply to you even if you don't buy individual stocks like I do.

2:37Yeah, wholeheartedly agree. And I think just as recently as March of 2020 exposed a lot of us, myself very much included, to the potential cognitive issues that we have that we didn't, we weren't aware that we did have, frankly. I thought that I had my investor policy statement. I thought I was bulletproof in terms of the behavioral side of this. And I learned very quickly that when the sky is falling, my brain went to some pretty dark places and I didn't make dramatically negative decisions, but, but man, Brian, my brain went there. And I think that's what's so important about having a conversation like this, about understanding that even people who think they know what they're doing.

3:19We're susceptible to this just as much as anybody else. Yeah, that just goes to show that you are indeed a human, Brad. And like you just teed up, you have an investor policy statement. I know that your finances are rock solid. You've been following the fire lifestyle for a couple of decades now. So if there's anybody that is well positioned to handle mentally the volatility that's going to be thrown your way by investing in the stock market, it's you. And even by your own accord, you struggled with it. So you can imagine how hard it is to deal with the volatility of the markets if you didn't have those things taken care of ahead of time, if you had debt to your name, if you weren't so on top of your personal finances.

4:02So yeah, let's just get that out of the way up front. Investing is hard. Yeah, it is hard. And we try to talk about, okay, this is a long-term thing. Think in terms of decades or many decades, not in terms of months or quarters or even years, but it still is hard. And I think that's what's so important about this. So let's get into it. Where do you want to start with the important truths that you've come across? Well, I think the most important one to start with, or at least a very important one to start with is the first one in the tweet storm, which is just, you're going to be wrong a lot, period, full stop, end of story.

4:39Now that That lesson mostly applies to people like myself who make individual investments into either stocks or real estate or into cryptocurrencies. If you're buying individual assets, you have to go in knowing ahead of time that you are going to be wrong a lot. One reason that index investing works so well is that all of those mistakes that you make by investing in the stock market are actually completely hidden from your view. If you buy the total stock market index, what most people don't know is that about two thirds of the thousands of the stocks that they buy when they make that investment underperform the index overall.

5:22And actually, 40 % of those have a negative real return. So even if you're buying the index and you're buying every stock that exists out there, by definition, the vast majority of the companies that you're buying are going to lose you money. The reason that index investing works so well is that you're guaranteed to get all of the mega winners in your portfolio as well. And crucially, all of that chaos is hidden from your view. So the chaos of companies losing money, you don't see, you just see one number on a screen that shows you the value of the total market index. But just know, if you're making individual stock selection or individual investments, know ahead of time, plan for it.

6:07You're going to be wrong a lot. Right. And that's just part and parcel of, okay, this is a strategy. I have to understand that. Even doing a ton of research, right? I know you've talked about on previous episodes, the spreadsheets you have and the different categories and how you're constantly, you're going back and updating that. I mean, like you said, 40 % of stocks in an index are going down every year. I obviously don't know specifically what percent of yours are winners and losers, but undoubtedly, even amongst these highly curated stocks that you personally have bought, it's littered with losers.

6:43But yet, the few mega winners a la Tesla are far outweighing the potential loss of these potentially small losses that just essentially rounded down to zero in your case. And because you understand the strategy, it's amounted to this big net win. At least that's how I conceptualize it. I'd love to hear, does that ring true with you? Not only does that ring true with me, that rings true with the greatest investors of all time. Everybody knows that Warren Buffett is a master investor. He's been doing it for 60 years. Even Buffett himself has admitted, if you take away our 10 best investments that we've ever made, our track record would be perfectly average.

7:28And people think that if Warren Buffett likes a stock, it's going to be a guaranteed winner. Warren Buffett has bought plenty, plenty of stocks that have lost him billions of dollars over time. But that doesn't matter because he also bought Coca-Cola. He also bought See's Candy. He also bought Geico. And the returns from those few mega winners have literally made him the greatest investor of all time. But make no mistake, Warren Buffett has been wrong a lot on investments. Yeah. And he's a perfect case study for this, right? Because you're going to be wrong a lot. But that means you have to be open-minded and you have to be willing to change your mind.

8:11I mean, his purchase of Apple after many, many years and decades of being overtly anti-technology Apple is now, at least to my understanding, or my recollection, the biggest holding they have. And it's been a remarkable winner. And that's a 80-something-year-old man changing his mind. And I think that's a remarkable skill for all of us is, okay, look, the world changes and you have to keep up with, hey, I can't just get my head stuck in the sand and stick to one opinion for the rest of my life. I need to constantly look at the facts and be willing to update my own thought process. And I think that's really important.

8:51Yeah. Buffett was famous for decades of ignoring technology stocks. He just said, I don't understand it. I don't see the competitive advantage. It's not for me. And funny enough, one of the first times he broke that rule, he didn't do well. Buffett made headlines about 10 years ago when he took a huge position in IBM and he held that position for a period of about five years. and he ended up actually losing money on that position. And rather than being deterred, he sold off of IBM and then plowed a huge amount of Berkshire's capital into Apple. And I'm pretty sure that they have made more money on their investment in Apple than they have on every other investment that they've made combined.

9:32I'm not 100 % sure on that, but I know that the gains from their Apple purchase have been enormous, tens of billions of dollars. Right. And yeah, even if it's not exact, it's certainly directionally accurate. It's a remarkable, remarkable thing. All right, Brian, what's the next truth you want to talk about? Well, how about this one? And I think if you invested at all, you know this truth all too well. Losing money hurts about three times more than making money feels good. What that means is that if you made an investment, a$1 ,000 investment that went to zero, that would be as emotionally painful as seeing that same$1 ,000 investment going to$4 ,000 would feel good.

10:11Humans have dozens of innate biases built into them. One is called loss aversion bias, and we are just programmed to feel the pain of loss far more than we are programmed to feel the pain of gains as people. Yeah, I certainly have heard of and I'm aware of loss aversion, but I wonder what's the takeaway in terms of, okay, these behavioral biases, it's important to be aware of them. But is there something that you've done that that might potentially change behavior? Or is it just the awareness alone is critical to you? Yeah, I think that awareness just speaks volumes about it. Just somebody saying those things out loud has really helped me to be like, Oh, other people experience this too.

10:57I'm pre programmed to feel like that. That makes me feel so much better as an investor. But it's funny, if you talk to an investor, many of them might not be able to off the top of their head tell you the biggest winners that they've had or some great investments, but every single one of them can tell you the stock that they bought and went down 90 % and were just so hardwired to focus on the losses as opposed to the gains. Yeah. What you said in there, quote, other people feel that too. I think that might be the most universal truth about humanity is it does feel better when you understand that it's not just you.

11:34I think a lot of us, and this is certainly not just limited to investing, I think a lot of us think the issues that we're dealing with or our problems are maybe just us in a silo and we suffer in silence. And I think this is a perfect example of, hey, there are other people out there like me. And I think clearly with these innate biases, just becoming aware of them and just doing a simple Google search for most common cognitive biases, just being aware of that, like, oh, wow, that that does happen to me all the time. And it's not just me. It's literally eight billion people. So, yeah, that's a great one, Brian.

12:09I love it. Yeah. A side note. Charlie Munger has a wonderful talk that he's given called the psychology of human misjudgment and essentially lists through a couple of dozen innate human biases that they've had. If you've never listened to it before, just go and find that talk and listen to it and listen to him rattle off the ways that humans make bad decisions. And if you're like me, you'll be nodding your head like, yep, I've done that. Yep, I've done that. Yep, I've done that. It's just amazing. That's brilliant. Yep. We'll definitely try to find that and put that in the show notes. And I think he is something similar in the poor Charlie's Almanac book as well, which is just a masterpiece.

12:46If anybody's looking for a 20 pound,$80 book to pick up, that's just filled with Mr. Munger's wisdom. All right, Brian, what's up next? How about this? Humans are pre-programmed to be bad at investing. Those biases that we talk about, they make us naturally bad investors. And a huge amount of learning to invest well is coming up with systems or educating yourself to overcome your innate biases that make it so hard to make money in the markets. A real simple example is when are people, and I've seen this firsthand over the last couple of years, when are people most interested in investing? The answer is at market tops.

13:33Why? Because they know people in their real life that are bragging about how much money they have made in the market. And they look back at the recent returns and they look fantastic. And it seems it's the most perfect time to get in because we take our cues from other people. We want to mimic what other people are doing. So the time that it feels best, that feels riskless to invest is when the market is nearing its peak. The inverse, of course, is also a true. The time that we are most disgusted with investing, the least willing to put our capital at risk is when markets have gone down dramatically recently.

14:13That's because other people have lost money in the markets. You see just a sea of red everywhere. There's just mass negativity. And we want to naturally fit in with the herd, do exactly like we see our peers doing. So knowing that it's very common for investors to want to get in at the top and sell out at the bottom. That's just how we're programmed. So know ahead of time, if you have those urges, it's because you're human and you're pre-programmed to be a bad investor. Yeah, two things immediately spring to mind. First, Mr. Buffett's quote, be fearful when others are greedy and be greedy when others are fearful.

14:52And just not to pick on Cathie Wood by any means, but Cathie Wood and her ARC investing funds. I think the inflows to their funds when it was at the absolute peak of the returns were extraordinary after it had already gone up. And I think many of them, and I don't have the exact numbers in front of me, but many of them are down 40, 50, 60 % since those highs. And it's just, it is very, very interesting. We're herd animals. We're talking about base human instincts. And yeah, when you see other people making money, when you hear other people talking about things, you get interested. It's just the way we are.

15:31Yep. It's just really important to acknowledge that upfront. So many things, so many times doing the right thing from an investing perspective literally feels, it feels in your gut like you're doing the exact wrong thing. Nobody wants to sell at the high. Nobody wants to buy at the bottom. This is why taking your emotions out of the equation by just dollar cost averaging, committing the same amount of money on a fixed schedule works so well because you remove those emotions from the equation and just keep things automatic. So that's again why dollar cost averaging works is because you overcome your innate biases through automation.

16:09Yeah. All right, Brian, that was a great one. Let's keep rocking and rolling here. What's next on your list? Yeah, this one is borrowed heavily from a Morgan Housel and that is successful investing requires an uncomfortable mix of both pessimism and optimism, which is damn hard for our brains to handle. I think Morgan Housel said it best when he said, save like a pessimist, invest like an optimist. What that essentially means is be really conservative with your personal finances, right? Have a high savings rate, have multiple sources of income, have an emergency fund built in and save like the near term is going to be brutal, like some bad stuff is going to happen.

16:50But investing by its very nature is a bet on optimism. It's a bet on the continued success of the human race. It's a bet that life is going to get better, companies are going to come along, technologies are going to come along, and we're all going to prosper as a species. So it's important to keep both emotions in mind, short-term pessimism and long-term optimism. And actually, if you get too one-sided, if you become a perma-pessimist and you position your portfolio as if the world's going to get worse, you might be right in the short term, but in the long term, you're almost guaranteed to fail.

17:25And the opposite is also true. If you take on a lot of leverage, you invest, you put all of your money into investments, assuming that everything is going to be sunshine and roses forever. Well, you're going to get burned as soon as there's an inevitable downturn. So keeping both emotions in mind and balanced, short term pessimism, long term optimism is the key to success. Yeah, yet another hard thing for our brains to handle. You're absolutely right. And I think the short-term pessimism to me, I don't necessarily view it in my own mind as pessimism necessarily, as much as though I guess upon reflection, that is what it is in that things are never rosy forever.

18:04We talk about a rainy day for a reason because things outside of your control often happen. You might lose a job. And if you are literally spending 100 % of your income. I mean, this is the fundamental of financial independence is if you are spending 100 % of your income, then you are at that edge at every given moment. And during the good times, it might feel wonderful, right? We're spending, we're making a lot of money, we're freewheeling, we're enjoying life. But man, that underlying stress that has to always be there when you lie down at night and you realize if anything happens, anything, we're on a knife's And that's just, that is not a way to live.

18:44So I think clearly understanding that, all right, life is sometimes going to be lumpy and throw things at us. We need to save some money, but yet, right. The ingenuity of humanity as a whole leads you to believe that investing for the longterm is the best possible way to grow your wealth. So it's important to, to do both of these things. And that is, that's a hard thing. But like you said, the perma bears, I mean, there are so many of these people and they just like, they get off on it. They really do. It's astonishing, right? I think people think they're smart when they talk doom and gloom and there's something there that's hard to even discern, but I think there's just something alluring about doom and gloom, but it runs counter to what we see in actuality, which is you look at, and I know many of your tweet threads are, hey, what does the stock market look like over a hundred year period?

19:40I'm picturing a graph that I've seen on one of your recent tweet threads, maybe from the day we're recording this, actually. It just is up and to the right. And amongst that hundred years, there were world wars, there were terrorist issues, there were everything you could imagine. And it's up and to the right. So there's good cause to be optimistic long-term. And I think it's just, it's really important. And like you said, if you're a perma bear and you're a perma pessimist, you're not going to invest. You're going to sit on the sideline and think of how brilliant you are. And you're going to miss out on all of that wealth accumulation and growth over decades.

20:12Yeah, it's been said that perma bears get on TV and perma bears get clicks. But it's really the optimists that really make the long term money. Wholeheartedly agree. All right, Brian, what's up next? How about this one? I know you're going to love it. 99 % of investors should dollar cost average into index funds and call it a day. And I think people in the ChooseFI community know me as someone that loves individual stock selection. I love everything about the stock picking process. I like researching companies. I like the mental challenge that goes along with it. I like following companies. But I know that 99 % of people are not cut out for that because mostly they're just not interested in managing their money.

20:55that closely, which is why I firmly believe 99 % of people that want to invest in the market should just dollar cost average into index funds and call it a day. Boom. Nothing really to follow up on that. I totally agree, obviously. And I think it's so counterintuitive in the sense that most people have this feeling that the more effort you put into something and the more intelligence you apply to something, the better the results. and it is one of the most fascinating things that in investing, like you're saying, 95 to 99 % of people are going to have the best long-term outcome by just dollar-cost averaging into index funds.

21:32And it's a remarkable thing. Where else? I can't think of any other aspect of life where essentially the brain-dead version is going to get me the best results. And I love that. I hate to be so crass about it, but that's just the way it is and it's really important. Yeah, that is the ultimate formula for automatic wealth building that I've ever seen. Dollar cost averaging plus index funds plus time equals automatic wealth creation, or at least the closest thing that we have to it. And I know that the vast majority of people that are in the FIRE movement do exactly that, myself included, with my retirement funds.

22:03Right. Of course. And you've said that many, many times. So yeah, totally clear that a significant amount of your net worth is in index funds, even though you were the one who opened our eyes to individual stock investing. And I think there's room for both. and like you're saying, it's you need to have an interest in it. You need to put in the time. There's a lot that goes beyond it. But again, 99 % of you just low cost index fund. And you're going to you're going to do absolutely wonderfully over 30 to 50 years. Totally agree. All right, Brian, let's keep on moving. How about this? History and psychology are the most important subjects for investors to study.

22:40I think a lot of people that get into investing, they immediately go to the math side of the equation. They want to study formulas that are out there. They want to analyze financial statements and they want to read SEC filings. They think that that is the key to investing success. And I think that you'll have more of an edge by studying history, specifically market and financial history and psychology than you will anywhere else. I mean, most of Warren Buffett's most famous quotes and his reasons for doing the best over a long period of time is they say that they have an edge in psychology more than they have an edge in analysis.

23:19And that's doubly true if you're an individual investor. You're not going to have faster computers than the best hedge funds. You can't out trade them. You can't get information faster than they can. But you do have one massive advantage that they don't. You have permanent capital and you can truly invest with a long term mindset. That is something that professional investors can't do by their very nature. So the edge that you get as an investor will come from psychology, not from analysis. Brian, do you have sources that you go to if for even just the most rudimentary of backgrounds for psychology specifically, but history and psychology?

24:00If somebody was coming in and say, hey, look, I have no background in this, but I'd love to get up to speed. Of course, I can Google it. But any two or three things jump to mind? One thing that comes to mind is exactly the Charlie Munger talk that I talked about before, the psychology of human misjudgment. Of course, Morgan Housel recently wrote a fantastic book called The Psychology of Money. Those are two great starting points to really see how people behave with money. And then there's another book out there by Michael Mobison. It's a little bit more analytical, but it's called Expectations in Investing.

24:35And that gets into the expectations that are built into stock prices and kind of the psychology around that. So there's a couple of resources that come to mind. Nice. Yeah, that's really helpful. Thank you. All right. What do we have next on the list? How about this? Consistently avoiding ruin is the most underrated financial skill. When you first start investing, I think a lot of people, myself included, they really want to go after the highest returns possible, right? And one way that you can cheat and get even higher returns is buying assets with leverage. So they look for, they get really into stock options.

25:11They get into using leverage to grow. They're interested in buying two, three, or four X leveraged ETFs in an order to turbocharge their return. What they're overlooking is that age old math problem. And I'm going to paraphrase a Warren quote here. And it was a string of impressive numbers multiplied by a single zero equals zero, which is something that so many people overlook. And in your financial life, it's the exact same thing is true. It doesn't matter how good your returns are. If you multiply that by a single zero, or if you single-handedly get wiped out, all the financial progress you've made goes to zero.

25:52So setting up your financial life not to maximize returns, but instead to maximize longevity is the thing that investors should focus on. Yeah, that reminds me of a Munger quote. And he talked about the very few ways where smart people can go broke and leverage is the number one in that list. And yeah, just essentially putting all your eggs in one basket. It's just it opens you up to like you're saying this ruin. And that is just such a powerful word. It's a visceral word, Brian, when you said it before, when you think of ruin, there's no need to do that. Because again, like we talked about 99 % of people can do just fine.