What investors can learn about how external forces — expected and unexpected — can impact ecosystems.
And how to manage your own investment landscape to pay less fees and taxes.
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In the early 1980's — drug lord and narco-terrorist Pablo Escobar bought four hippopotamuses, and had them shipped to his estate outside Medellin, Colombia.
Magdalena River in Doradal, Colombia. Juancho Torres / Anadolu Agency via Getty Images
I imagine people in that line of work are more concerned about personal, near-term risks, rather than forecasting long-term, environmental consequences. But alas, four hippos doesn't stay four hippos for long.
This month, Colombia announced they started sterilizing some of the estimated 170 wild hippos that live today in Colombia, whose existence is thanks to fruitfulness, multiplying, and Pablo. The executive decision was made given the ecological havoc of an invasive species (albeit innocent!) living amongst no natural predators, breeding mostly uninhibited for decades.
Of course the bigger issue, and why Colombia is being proactive, isn't that four hippos turned into 170 hippos after 40 years. It's that the next 170 hippos will come much quicker. And the 170 after that, and again after that, etc...
We envision compounding as exponential growth: a lot more hippos in future years compared to earlier years.
But there's a parallel description: growth of the same number of hippos in increasingly less time.
Ecosystems are interconnected, and so the tradeoff of these hippo's existence must be managed. There will be less manatees and capybaras if there are more hippos.
All parts impact all other parts — even if small at first, doesn't mean not large eventually.
Colombia's sterilization efforts will now unexpectedly disrupt the compounding, and the hippos can't do anything about it.
But your investments are different.
There is no necessary outside ecological dependency. No external forces required to stop you from getting the returns you deserve, for as long as you can stay invested.
There are only factors that can inhibit your portfolio growth: fees, taxes, and distractions.
Don't sterilize your own portfolio. Fight the inhibitors.
Once you have designed an appropriate asset allocation, here's how to combat the forces trying to slow you're compounding:
Advisor fees: if you use an advisor, know what you pay them! If you don't know, you are likely paying too much. Using an advisor can be a fantastic way to improve your outcomes, but there needs to be demonstrated, comprehensive expertise that is worth the fee. Both sides — advisor and client — should find immense value in the partnership.
Fund fees: keep them really stinking low! Using passive funds that try to deliver the market return itself (rather than picking and choosing parts of the market)...should accomplish this.
Income taxes: start by reducing your taxable income, now and in the future, through the right account architecture.
Accounts like 401Ks will allow you to immediately shelter income from the government and not pay income tax on it today, as well as defer taxes on future portfolio growth. Other accounts (like Roth IRAs) will allow you to pay necessary taxes now, but never again. Understanding how these accounts work, and integrate with each other into a comprehensive plan, allows you to pay less taxes over time while managing your own goals and liquidity needs.
Next, limit receiving unwanted, taxable income from your portfolio itself by prioritizing keeping assets that distribute high levels of income (e.g. high yield bonds, high-dividend stocks, REITs) in accounts where you don't owe taxes on the income (e.g. IRAs or 401Ks).
Then prioritize keeping assets that don't typically kick off high income distributions in accounts where you would owe taxes on portfolio income.
Capital gains taxes: when you need to rebalance, which you should be doing, be thoughtful about which accounts you trade. Don't just fire-sell positions with capital gains in accounts where those gains are taxed (e.g. Individual/Brokerage Account, or Trust) simply to get back to your target portfolio weights.
Unless you can simultaneously capture tax-losses, typically best to perform rebalancing in qualified accounts that don't have tax friction when you trade (e.g. IRAs or 401Ks).
Distractions: shiny toys are the most pernicious force. They can make an investor her own worst enemy. There is a reason you see endless commercials about new financial products: marketing FOMO to tiny human brains is a heckuva business model. In the words of Charlie Munger, the investing legend who passed away this week — the world is not driven by greed. It'd driven by envy. That's why shilling shiny toys is so successful.
But you are on the receiving end of a marketing campaign, so ignore it. Once your portfolio is properly designed, hold a very high bar for ever introducing new line items. Avoid becoming a hobby collector of investment products.
Tackle these basics, and create an ecosystem for your money to compound.
Easier said than done, but the bounty is great.
End.