Highlights
- False proxies are misleading indicators that don’t align with the desired outcome you thought they did. For example, engine sound is a false proxy for vehicle speed. While a sports car is both loud and fast, a junky car might be incredibly loud, yet still slow.
- Personal finance is full of false proxies, mainly because money is a strange mix of objective numbers and subjective feelings. Something can feel one way but, in truth, be the opposite.
- Some common false proxies in personal finance include “salary = wealth” and “confidence = knowledge”
False Proxies
As Seth Godin writes:
We need proxies. You’re not allowed to read the book before you buy it or taste the ketchup before you leave the store. We rely on labels and cultural cues to give us a hint about what to expect. We do judge a book (and a condiment) by its cover, all the time.
Seth Godin
Proxies are shortcuts. When accurate, proxies are not only useful but vital. Proxies save us time, effort, and brain space, attaining desired results with a fraction of the exertion.
False proxies, though, can lead us down dangerous paths. A false proxy is a misleading or inaccurate indicator of achievement or progress. It could be a metric, benchmark, or societal standard that may not align with the true purpose or desired outcome.
Billy Beane and Paul DePodesta had an epiphany in the late 1990s. Traditional baseball talent analysis was rife with false proxies, relying too heavily on subjective judgments and outdated statistics. They realized a few simple, logical truths:
- Baseball games are won by scoring more runs than the opponent.
- The most important individual on-field metrics, therefore, are those most likely to add runs for your team or reduce runs for the other team.
- Some “traditional” baseball metrics were highly valued (in terms of dollar amounts in players’ contracts) despite having little impact on scoring runs. These are false proxies! They incorrectly indicated the ability to win games.
- Other overlooked statistics were barely valued, despite being highly correlated to scoring runs and winning games.
Batting average, for example, has some correlation to scoring runs. But as baseball fans know, a walk is equally as good as a single. Yet walks are ignored by batting average! Batting average, therefore, is a false proxy for offensive talent when compared to the superior on-base percentage.
Beane and DePodesta built a baseball team (the Oakland A’s) by identifying and ignoring baseball’s false proxies. Michael Lewis famously told their story in Moneyball and, quite literally, changed sports (and business, to some extent) forever. Leaders in all arenas are opening their eyes to prior false proxies, correcting them, and ultimately finding more efficient solutions to their problems.
Personal finance and investing are one such arena. Here are some of the most common false proxies I see, and the “true proxy” needed to correct the old misconceptions.
Salary = Wealth
There is certainly a correlation between salary and wealth. After all, earning more salary can only help your journey to improved wealth.
But one of the most common false proxies I see is drawing an equivalency between salary and wealth.
Show me two families. One earns $300,000 and spends $300,000. The other earns $150,000 and spends $100,000. The first family will never be wealthy. For the second, wealth is inevitable – despite only half the salary!
Wealth is not solely determined by how much money you earn but also by how much you spend. Regardless of a high salary, if someone consistently spends beyond their means, they won’t be able to accumulate significant wealth. As friend-of-the-blog Morgan Housel writes:
Morgan Housel
“What’s Your Retirement Number?”
How much money do you need to retire at 55?
$1 million? $2 million? Who knows?
Or how about this question…if you’re age 40, how much retirement money should you have saved? $200K? $500K? Even more?
I can almost guarantee you’ve seen proxies for retirement numbers. They look something like this:
Or like this:
But I submit these numbers are misleading false proxies. They are like batting average in baseball: not a terrible proxy, but ignoring vital information.
After all, how can we lump all 60-year-olds into the same bucket and suggest that “8x their starting salary” is the correct savings amount to have? That’s far too one-size-fits-all.
Similarly, how can we suggest that the 4% rule, 3.5% rule, or 5.0% rule is the proper withdrawal rate for all people? The 4% rule is, largely, a false proxy for proper financial planning. Why?
- Most people misunderstand and misuse the 4% rule. It is far more nuanced than most people understand.
- The 4% rule is just as likely to 4x your retirement nest egg as it is to lose a single dollar. It’s far too conservative in most cases…yet still fails in some scenarios. Flexibility, in other words, is vital to ensuring the 4% rule’s success. You need to be willing to break the rule.
Take a typical public school teacher. I’m helping a bunch of them at work. In New York, a teacher approaching retirement likely earns $70,000 – $90,000 in salary. If a particular teacher’s total monthly bills are $5000 per month or $60,000 per year, then the 4% rule dictates this teacher needs $1.5 million saved to safely retire.
$1.5M is a lot of saving on an $80,000 salary! But are we missing something important?
What about Social Security? A teacher working a full career will likely retire with $2000 – $2500 in monthly Social Security Payments.
And don’t forget pensions! New York state teachers (at full retirement) earn 60% of their salary as a pension. In our scenario, that’s $3500 – $4500 per month.
Combined, our teacher’s fixed income (SS + Pension) is in the range of $5500 – $7000 per month, easily covering their monthly retirement spending needs of $5000 per month. Conceivably, they could retire with zero dollars saved and simply live off their fixed income! I’d conservatively nudge them toward some retirement savings, but the original $1.5 million goal is ridiculous.
And we haven’t even touched on important questions like:
- How much will healthcare cost during retirement?
- What if there is a market crash right after you retire?
- What assumptions are you using for market returns?
- Will you have any dependents relying on you to support them?
- How will your spending change as you age?
- How flexible will you be with your as market performance changes?
The 4% rule is a false proxy. Detailed cashflow planning is needed for true retirement analysis.
Short-Term Results –> Long-Term Results
One of the oldest tropes in the investing world is that short-term success is an indicator of long-term success. But short-term success a null proxy at best and a false proxy at worst.
For short-term success to lead to long-term success, we need repeatability. We need many consecutive “short-terms” to create a “long-term.” Such repeatability is a hallmark of skill.
But in study after study, the results of active investment choices are shown to express more luck than skill. Short-term investing results are, in other words, a false proxy for long-term results.
We dive into this topic in Episode 56 of The Best Interest Podcast:
Confidence = Knowledge
On a recent episode of The Trusted Partner Podcast, John Jennings told us:
I have a section of the book where experts – not just from investing but a number of different areas – show a person’s ability to forecast or predict the future is inversely related to their confidence in their forecast. So it’s this paradox where the people you want to hear from with a forecast are the ones that won’t give you one because they’re not confident.
John Jennings, author of The Uncertainty Solution
Confidence is routinely used as a proxy for knowledge, for correctness. But in terms of investing predictions, confidence is inversely correlated to correctness! It’s a false proxy.
The smartest people in the room instead say, “I’m not sure. I’m not confident. That’s why I’m diversifying and hedging my bets.”
Being smart enough to say “I don’t know,” is infinitely better than overconfidently losing millions of dollars. That’s a hard pill for many to swallow.
Complexity = Superiority
Similarly, I see too many people thinking that complexity in finance must be a signal of superiority. The more complicated an idea, the better.
That’s simply false. Complexity is a false proxy for superiority. In fact, if you’re looking for a proxy for superiority, I’d argue that simplicity is a better proxy. There is no secret sauce in finance. Simpler usually means cheaper, and cheaper is better.
Take “EBITDA,” which as every kindergartner knows stands for earnings before interest, tax, depreciation and amortization. EBITDA is a hot financial metric used by stock analysts all over the world. But what do Buffett and Munger, the kings of simple thinking, think of EBITDA?
I think you would understand any presentation using the word “EBITDA,” if every time you saw that word you just substituted the phrase ‘bullshit earnings’“
Charlie Munger
Most of the time, complexity is just bullshit.
Don’t let false proxies stunt your personal finance growth. Invest in knowledge instead.
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-Jesse
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