The problem of N=1

I am big on evidence, big on reason. Probably at times bordering on psychopathic in how much I try to rely on reason over emotion. I think it makes me a pretty decent giver of advice. It’s certainly easier to be reasonable about someone else’s situation over your own, at least.

And so I like to rely on the evidence whenever we can. What does the evidence say about a reasonable long-term investment strategy? What does the evidence say about how you should plan to spend from a retirement nest egg? What does the evidence say about your need for life or disability insurance? What does the evidence say about the size of your health care deductible vs. premiums? What does the evidence say about how to save for college, where your child will likely go to college and how much tuition support will be needed? What does the evidence suggest about your future earnings, or your child’s future earnings? What does the evidence suggest about that Roth IRA conversion strategy? What does the evidence tell us about your Social Security claiming strategy?

The trouble with all of this evidence is that it gives us only probabilities. We have to make decisions based on the odds. We can tip the scales in our favor by doing so. Odds are that global stock markets will give us better long-term returns than cash, so we defer our consumption to play those odds. Odds are that deferring taxes now will help us grow our nest egg over time, so we play those odds. Odds are that a low-cost, tax-efficient index fund strategy will outperform most actively managed funds you could otherwise invest in, so we play those odds.

The problem with the big decisions in life is that we only get to throw the dice once. We get one shot at all of this. One shot at saving, one shot at investing for 30 years, one shot at spending money in retirement. One shot at deciding when to retire, one shot at claiming Social Security, one shot at hiring a financial advisor for any past period. One shot at deciding to jump in or out of the markets. No do-overs, no re-deals. Sometimes if you take a bad beat at the table, that’s it. Sorry. If you push all in, you can’t just buy back the next night. We only get this one life.

And that makes people nervous. It makes people risk-averse. It makes people work just one more year, bail out of the market to try to avoid “the big one,” it makes us chase past performance. How many people got into cryptocurrency in late 2017 because they were afraid of missing an alleged once-in-a-lifetime opportunity, only to get wiped out in 2018? Fear of only getting one throw of the dice once contributes to manias, panics and crashes. But that’s where we are, that’s how we see the world. Sure, I can watch hundreds of clients save, invest, retire and spend during my career. But each one of those clients only does that one time.

The best example of the negative consequences of this one-shot mentality is how people claim Social Security. On average, people should wait until their full retirement age. Most married couples should have the higher-earning spouse defer beyond their full retirement age, as joint life expectancy is higher than single life – that’s just math. If you have financial means and access to medical care the odds are even more in your favor that you should defer benefits. In the absence of major personal health issues or a serious lack of family longevity, most people reading this should defer benefits.

But what do most people do? Most people are afraid that “something might happen” to them and instead of playing the odds, they claim early in a misguided attempt to “get what’s mine.” And then the average person lives the average life expectancy and fails to “get theirs” precisely because of this mindset.

I don’t have great answers to this problem. Sure, some risks we can hedge. What if US stocks underperform for a long time? We make sure we’re diversified internationally. What if we experience an unfavorable sequence of returns? Well we’re hedged with bonds and we don’t have to make the portfolio more conservative automatically in bad markets. What if we become disabled, die suddenly, our house burns down or Tommy wrecks the car? We can insure all of those things. If you were inclined you could even insure against your own longevity with a lifetime income annuity (or just defer your Social Security benefits, ahem).

But ultimately we still have to make tough, one time choices. When do you fully retire from your career? How do you pick an investment strategy to stick with through thick and thin? How do you keep spending from an investment portfolio that has fallen 20% in value? At some point, you have to make the tough call, and that requires us to play the odds. Whether we want to or not, we have to make some firm decisions. We can’t hedge everything. So we are forced to either:

  1. Act rationally and decide based on the evidence; or
  2. Let our emotions drive us to (likely) sub-optimal decisions.

I know which path I’ll keep advocating. Can you commit to 1. over 2.?

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