Blogging for Basis Points

Some of the greatest resources I have as a financial professional are my fellow investment bloggers.  Don’t get me wrong, a good book or whitepaper can be worth its weight in gold in terms of developing a knowledge base, becoming technically proficient and formulating an investment philosophy.  But from a practitioner standpoint, I can’t even begin to describe the value I have gotten over the years from people like Larry Swedroe, Josh Brown over at The Reformed Broker, Tadas Viskanta at Abnormal Returns, Ben Carlson from A Wealth of Common Sense, Morgan Housel at The Motley Fool and countless others.  Reading their posts and interacting with them on social media has opened me up to a wonderful community of like-minded individuals all sharing a common purpose of helping people make wise investing decisions.

There is not much undiscovered territory left in markets.  Sure, there is still plenty of innovation but most of what takes place today is largely refinement or fine-tuning of what’s already proven to be successful.  You could build dozens of “Mount Rushmore’s” with the faces of the pioneers responsible for much of what we know today about how financial markets work and what drives risk and return.  We owe them a debt of gratitude as today we are in a position to stand on the shoulders of these giants that did much of the heavy lifting that at times we take for granted.  The challenge for most of us today is not to reinvent the wheel, teach people how to get rich quick or figure out how to side-step the next bear market.  Rather, it is to take simple – but not easy – principles that can help deliver a successful investment experience and communicate them over and over again until they resonate with our audience in a way that adds incremental value over time.  Jason Zweig, perhaps the greatest journalist our industry has ever seen, said it best:

“I was once asked, at a journalism conference, how I defined my job. I said: My job is to write the exact same thing between 50 and 100 times a year in such a way that neither my editors nor my readers will ever think I am repeating myself.

That’s because good advice rarely changes, while markets change constantly. The temptation to pander is almost irresistible. And while people need good advice, what they want is advice that sounds good.”

After observing from the sidelines for years, I decided it was time to throw my name in the hat.  Since I first launched the “bps & pieces” blog over a month ago, the most common question I have received (from folks outside the finance industry at least) has been:

“What does bps mean?”

I’ll admit, when I first came up with the name I liked it mainly because it rolled of the tongue easily and sounded kind of catchy.  But the more I thought about it, the more I realized how important the concept of bps – or basis points – really are to finance and investing, despite the term being a little inside baseball. For those unfamiliar with the term, here’s Investopedia’s definition:

What are ‘Basis Point (BPS)’

Basis point (BPS) refer to a common unit of measure for interest rates and other percentages in finance. One basis point is equal to 1/100th of 1%, or 0.01% (0.0001), and is used to denote the percentage change in a financial instrument. The relationship between percentage changes and basis points can be summarized as follows: 1% change = 100 basis points, and 0.01% = 1 basis point.

By using basis points in conversation, finance folks can eliminate some of the ambiguity that can arise when discussing things in percentage terms.  We use it in many iterations, from fund  performance and expense ratios to inflation and interest rates.

So why is such a small unit of measurement so important? It’s simple: because over time they can add up and make a HUGE difference.  The chart below provides an illustration of this point.  Below is the growth of $10,000 over the last 30 years – a reasonable investing lifetime for most people – had you invested in seven different “versions” of the S&P 500.  I started with the total return of the index “as is” and then added or subtracted 25 to 75 basis points each year to determine the terminal growth of wealth at the end of the period.

Source: DFA Returns 2.0

As you can see above, what amount to relatively small differences early on have a profound effect over long stretches of time.  Had you just owned just the S&P 500 without any adjustment, your initial $10,000 investment would have turned into $165,769.  If you then gained or lost an additional 75 basis each year, your resulting values would have been $207,425 and $132,259, respectively.  That’s a pretty significant gap and can be even more staggering over longer periods and higher basis point differentials.

A few “bps” here and there may not seem like much, but compounded over an investing lifetime they can make a difference an order of magnitude higher than most people can fathom.  For investors, “bps” can come in many shapes and forms:

• Returns: there is very little “low hanging fruit” out there in the form of risk-free returns – markets do a pretty good job.  That said, there are a number of styles or factors that have added value over time (like value and momentum strategies).  Just remember that nothing works all of the time and that patience is a prerequisite for out-performance.
• Risk Management: Effective diversification results in a portfolio where the risk of the whole is less than the sum of its parts.  Think of it as teamwork.  The best basketball teams excel on both ends of the floor – offense AND defense.  Having star players is great, but if they all have the same strengths and weaknesses, the team as a whole may suffer.  The same goes for you investments
• Expenses: all else equal, lower is better.  At the risk of sounding obvious, you get what you don’t pay for.
• Taxes: be smart about asset location, tax loss harvesting and the preferential treatment of long-term gains over short-term gains.  The less Uncle Sam gets, the more you keep.  Just be careful not to let the tax tail wag the investment dog.
• Behavior: automate good decisions, set reasonable expectations and filter out the noise (easier said than done, I know).

Many people assume successful investing requires hitting home runs, finding needles in haystacks and calling tops and bottoms.  It doesn’t.  For most people, successful investing is about doing a few little things – the “bps” – right and doing them consistently.  When it comes to investing, there are no “bps” too small.  Pick them up when you can find them, hold them close and let the magic of compounding do the work for you.