Most of you might have read this joke before. Personally, I think it is easy to give a “good advice” like “stop smoking, invest the money and you will get a Ferrari in 15 years”. Realistically, is that true? I discovered that most people do not take context or circumstances into account before giving “good advice”. This “good advice” might serve as no practical value at all if it is not applicable to the person.
In the financial world, we have many “good advice” around. In this article, I hope to debunk one “good advice”: “Buy Term And Invest The Rest”.
Speaking about advice: I’m a financial planner and here are 3 pieces of money advice no one ever wants to hear.
What is ‘Buy Term And Invest The Rest”?
John (imaginary figure) wants to plan for his financial journey. He read a few articles online and discovered that there are many people recommending “Buy Term And Invest The Rest”.
Buy Term: He can consider buying a Term policies for his insurance needs. A Term policy’s regular premium are generally cheaper than Whole Life Policies or an Investment Linked Policies (ILP) that serves his insurance needs (broadly speaking).
Invest The Rest: Because his regular premiums are generally cheaper, he now has more budget to invest in the stock market. He wants to invest in low cost ETFs (exchange traded funds) to reduce any fees. With low charges, this will take care of his wealth accumulation needs.
This sounds great. Personally, I think this is a great advice and a possible strategy for John to consider in his investment journey.
Then Why Do I Think It is “Bad Advice”?
This very simplistic advice often do more harm than good. One example that I would like to draw reference is giving advice to someone to lose weight. The secret to losing weight is very “simple”. All you need to do is just “Eat Healthy Food, Eat Less, Exercise More”. Yet, adult obesity rates in the USA (2017) is a shocking 42.4%. If people already knows this secret, then why are there still so many people who are obese?
This is because everyone’s circumstances and context is different! Duh.
Do you know that price of healthier food is around 2X of unhealthy food? For a person who is living from paycheck from paycheck, how would he/she be able to afford this new diet?
Do you know 95% of diets fail? For a person who has been on a donut diet for most of his/her life, would it be easy to follow this diet?
The conversation today is not about diet. By using the example of weight lost, I hope to be emphasize that everyone is different. This same advice could work for someone with a certain set of mindset and circumstances (maybe he is rich, having a 6 hours work week and a can-do mindset). But not for everyone.
So Why Is Buy Term and Invest the Rest “bad advice”?
Frankly, this advice works. But it only works with a given set of circumstances and context. You can consider this advice if you resonate with the following.
Balanced/Adventurous Risk Profile
I have the privilege of speaking to many people in my career. I have came across some partners and clients who are risk adverse in nature. They do not enjoy fluctuations in their asset prices nor do they like to see losses in their assets. Their favorite asset classes are typically fixed deposits, endowment or bonds. A stock portfolio may not be very suitable for this person’s character. Imagine if you force this individual to buy the ARK K ETF, I willing to bet that he/she will not be able to sleep well at night.
Long Holding Period
In theory, we should all be like Warren Buffett who has an “infinite” holding period. Buy term, invest the rest works ONLY if the person invest the rest and continues to invest the rest. However, this is something we don’t see practically.
A simple question to ask yourself or your friends would be this: when was the last time you sold a stock?
The average holding period of US stocks is 5.5 months. The average holding period for SGX stocks is 10 months. ETFs are slightly better. The average holding period for ETF is 6 years. If statistics shows that an average someone is only willing to hold for that short a period, then wouldn’t you be “investing the rest” temporarily? Will this help you achieve your financial goals?
I do acknowledge that there is a combination of factors that contribute to the short holding period. One example is cheap transactional cost. This seemingly good benefit actually destroyed wealth all around the world. In the past, transaction costs to trade was relatively higher that people are more willing to do it only when necessary. Because of the cheap transactional cost now, people are entering and exiting the market as if they are buying groceries in the market. Where did the long term investing go?
But my favourite is the “fear of market crash”. From 2008 until 2020, there have been thousands if not millions of articles/youtubers/gurus world wide calling for market crashes every single year. This keeps people from “investing the rest” into the stock market because they are afraid the market will crash every other month (read this again). Missing the five best days when you’re otherwise fully invested drops your overall return by 35%! Missing the best 10 days will more than halve your long-term returns. Research has again shown that not fully invested will have disastrous effects in the long run. Are you really investing in the long run?
Strong Emotional Stability (in the market)
Investing in the market is not easy. It does not matter if it is a passive strategy or an active one. Imagine if you open your brokerage account one day to see your robo-investing strategy lost 20% of your capital, will you feel afraid and fear that it will continue to drop?
I know there are some who will feel excited. However, I doubt this will apply to the general population.
Investment/Financial Planning Knowledge
When you buy term and invest the rest, there is a strong assumption that you know very specifically the kind of coverage you want and the structure for your insurance needs. At the same time, it also suggests that you know enough about stocks or ETFs to invest appropriately for the long run.
I do acknowledge that there are indeed talented individuals out there that really can do it. They don’t spend hours, they spend decades of their lives to master their financial planning.
Are you spending enough time to acquire these knowledge?
So What Is A Better Advice?
An advice is only good when an individual is able to act upon it in his unique circumstances and context. The best advice are often discovered through brainstorming, asking and answering good questions and also working with someone who is good at doing that.
Just like the best companies in the world hire the best minds in their strategy department, you should also “hire” the best minds to help you in your financial journey.
“Buy term and invest the rest” is a great strategy. However, it only works for a very specific group of individuals. You may or may not be suitable for this strategy. Remember, everyone is different.
I believe it is more important to focus on your priorities and your financial needs instead. It would be wise to rethink if these heavily blogged strategies (buy term and invest the rest) can serve you in your financial needs in your unique circumstances and context.
Chengkok is a licensed Financial Advisor since 2012. He is an Investment and Critical Illness Specialist. Wealthdojo was created in 2019 to educate and debunk “free financial advice” that was given without context.
He will be happy to provide professional advice to you personally.