The 50/40/10 Rule and Investing

 

You can’t teach height in basketball. When investing, you need to know how tall you are.

Right now, some should not be investing in the stock market. Not that these folks are crazy (or weird); they are just not wired to invest at all-time highs in a choppy stock market. Blowing yourself up, shooting yourself in the foot, or just being anxious or ADHD about day-to-day market moves indicates that you are taking too much risk.

You can’t teach height in basketball. Yes, people can and do change. But if you understand yourself, you can invest better. Tall people play basketball, but you can’t teach someone how to be tall.

If you are short, try to avoid playing basketball. If you panic or have ever sold when the market tanked, you may want to consider how involved you are in the stock market.

Do it now, when times are good.

Let’s talk about the 50/40/10 rule and investing. Can people change if they are short and want to play basketball or panic and want to own the stock market?

 

Are People Able to Change?

In investing, your personality is set, just like your height.

Some people are aggressive and like to take risks. They may buy individual stocks, options, or leveraged ETFs. Some people are also likely to sell when the market tanks (even though it does regularly and will continue to do so).

Is your investing personality set, or can you get taller to play basketball?

If you know yourself, you might be better able to invest correctly based on your investment personality. After all, if you are prone to selling low, investing in 100% equities is a terrible idea. How much control do you have over your investing personality? You can grow. Let’s introduce the 50/40/10 rule.

 

50/40/10 in Happiness and Investing

The 50/40/10 rule applies to happiness and investing. Some parts are fixed, and some parts are malleable.

 

Above, you can see the basics of this 50/40/10 model.

You can control 50% of your happiness, and 50% is set in stone, derived from your genetic make-up. The half you can control is 10% circumstances and 40% internal state of mind.

In other words, 40% of our happiness is due to our internal state of mind, and only 10% of circumstances play a role in our happiness.

We can only affect 50% of our happiness and marginally change how well we invest and how tall we are.

Some people are generally happy regardless of their lot in life, whereas others will never be happy. Sure, you can change your circumstances for the most part, but you still have 50% fixed and 40% you can attempt to change.

This concept is from Sonja Lyubomirsky’s “The How of Happiness.” Yes, it is essentially made up. The point is that we do have the power to change, at least a little. We should understand the fixed 50% of our personality.

So, to review:

• 50% of happiness is determined by genetics
• 10% of happiness is determined by the circumstances in which you live
• 40% of happiness is determined by your actions, your attitude or optimism, and the way you handle situations

 

The 50/40/10 rule of investing states that you can’t change 50% of your poor investing hygiene (it is genetic), 10% of your success will be determined by luck (or by the market results during your investing life), and 40% of your success is determined by your actions, your attitude, or your optimism and the way you handle times of stress.

 

You Can’t Teach Height in Basketball

So, 10% of your happiness is determined by what happens to you, and 40% is how you respond. The other 50% is just who you are. Like, you can’t teach height in basketball.

You are likelier to be a good basketball player if you are tall. How does this apply to investing?

 

You Can’t Teach Height in Investing

About 50% of your chance to shoot yourself in the foot as an investor is set by genetics or other inelastic forces. How well do you understand that 50% are wired to behave poorly during volatility?

When the market tanks, do you panic sell or find coins in your car and couches to buy stocks? They are on sale!

We are at the top of a long cycle of stocks doing well. If you invested in US growth, your circumstances are like shooting fish in a barrel. You cannot lose stock picking right now or trading options. You are AWESOME! And full of recency bias.

Yet, we all know how this is going to end. Many people will lose money, and those taking more risk than they should will find the dance over when the music stops.

People sell low when the market goes down. It happens every single time. I’m not predicting that a correction will come, but I understand that corrections and bear markets are a regular and expected part of the market cycle. We just haven’t seen one in a while, so some forget.

Moreover, some should not be invested in the stock market because they will commit the cardinal sin of investing and sell low. Is that part of your 50%?

If you are going to sell low, you are better off in structured products or annuities with principal protection. As much as I dislike these products (because they are expensive and limit the upside) if they prevent you from selling low, then they are better than cash.

 

The 50/40/10 Rule and Investing

The immutable 50% of your investing personality is the risk you take in investing. The difference you need to understand is risk tolerance.

Risk tolerance is a key factor in creating your asset allocation. It allows you to avoid selling when the market takes a normal downturn.

But we know risk tolerance changes during the market cycle. Your “set” risk tolerance is 50%. However, things are going so well right now that the 10% circumstantial is all green lights and rocket ships to the moon. This leads to the 40% wanting to go big, too.

So, you might be 100% risk on right now. “Game On, Garth!” When the tide turns, don’t be naked or too far in front of your skis.

 

Summary: 50/40/10 in Investing

While 50/40/10 is not based on scientific facts, it may be a useful model for happiness and investing.

Remember, 50% of you is essentially set in stone, and you’d best understand it. If you have panicked in the past, you will do so again. If you buy more when the sky falls, understand that, too.

Because right now, 10% (the situation around us) is all green lights, and the 40% we can control is ripe for FOMO.

You can’t teach the ability to tolerate risk more than you can teach someone to be tall.

If you are tall, you are more likely to play basketball. Find another game if you are short (or have a 2-inch vertical like me). The same goes for investing.

People are taking risks because the stock market is “Game On” right now. They are over-invested, over-leveraged, over-everything, and not sticking to the game plan.

Set your asset allocation for the worst possible scenario, and be rewarded when you don’t sell low.

Here are a couple of lessons to leave you with:

1. The harder you practice basketball, the better you are. This is not true when investing. Your efforts are not only not rewarded but usually come at a cost. Investments are like a bar of soap: the more you touch them, the less you have.
2. When we see bad behavior in other people, we think it is their disposition or personality. Conversely, when we demonstrate poor behaviors, we believe it is due to the situation rather than our personality.

Understand your 50%. It is game-on risk-on right now. How you will act in the future depends on your daily decisions. Understand yourself and set yourself up for the real risk you face in your investments.

Get the best anxiety-adjusted returns over your lifetime.