Investors are often told that success comes from optimisation: lower fees, better tax outcomes, and the highest possible expected returns. In this episode we explore why the most efficient financial decision isn’t always the one that leads to the best life.

The idea behind the ‘inefficient path’ is simple: investments are just tools to achieve broader life goals. Financial independence and wealth are important, but they often sit alongside other priorities like stability, family, peace of mind, and lifestyle choices. When investors focus exclusively on maximising returns, they can lose sight of what those investments are actually meant to support.

We discuss how many investors fall into what can be called the efficiency trap - asking only one question: What will deliver the highest expected return? Professional portfolio management often focuses on this type of optimisation, but individual investors live far more complex financial lives. Personal circumstances, risk tolerance, and emotional comfort with money all influence whether a strategy will work in practice.

You can find the full article here.

Some more tips on finding your financial goals:

Do you know why you are investing? Research from our Behavioural Insights team suggests that many investors should clarify what drives their investment decisions.

Why I’ve chosen to rent for life. Is owning your home the only way to build wealth? Mark runs through why he has foregone the Australian dream of owning a home.

Estimate the savings you need to retire. Use the Morningstar retirement model to come up with a retirement plan that estimates the amount you need to retire and the variables that will impact future outcomes.

Dual income, no wealth, how do you build for the future? Many dual income households are treading water. Here’s how to supercharge your financial security and wealth creation.

Podcast: Buying a home out of reach? Try this framework to find your financial goals instead.

Future Focus: Are you making the right decision saving for a home? How to weigh up whether the biggest financial commitment you will likely make is right for you.

You can find the transcript below:

Shani Jayamanne: We’re going to talk about something that’s missed a lot from financial content. What we see is that a lot of content focuses purely on optimization, tax efficiency, and portfolio construction. And we tend to obsess over a basis point here and there.

Mark LaMonica: And we do want to say, of course, before we go into this, small differences in returns do matter over time, but an investor that’s too focused on this level of efficiency can lose sight of what they’re actually trying to achieve.

Jayamanne: So today, what we want to talk about is an uncomfortable truth with investing, and that is that the most efficient path is not always the right path. And it’s really just reflecting the simple truth that we try to bring to every podcast that we produce and every article that we produce, and that is that each investor is different and they must invest in the way that suits them and their financial goals.

LaMonica: All right. We’re going to draw a clear distinction between investment decisions and life and financial goals. And so that’s the starting point. So, investment is a tool to get you the outcome you want. A financial goal represents that end outcome, and that is a really important distinction.

Jayamanne: Financial goals can be multi-dimensional. My financial goals include financial security and independence, but my goals also include lifestyle goals, stability, and peace of mind. So, some of my goals can be measured in dollars and cents and some can’t. So, we start to see efficiency and other measures of success start to blur. So, let’s talk about something called the efficiency trap, Mark. So, do you want to give an explainer?

LaMonica: Okay, I will. And I think to start out, we both think that investors do tend to fall into this efficiency trap, and that’s when your entire focus is on one question, one question only. What’s going to give me the highest net expected return? And we need a lot more context than that. But only asking this question ignores the realities of life and, of course, personal circumstances.

Jayamanne: And many people turn to professional investors for guidance. Professional investors manage large funds, and they don’t need to think about the individual circumstances of the investors in their funds. They don’t know what these investors are trying to achieve. And I think a great embodiment of this singular focus without consideration for other factors is a FIRE movement or financial independence, retire early. And what we see that’s central to this movement is sacrificing severely in the pursuit of the highest return. You’re forgoing all other goals to maximize your wealth, hoping that that pursuit will lead to a higher return and the life of financial independence as soon as possible. But in this pursuit, you may not actually get there in time.

LaMonica: I wrote an article on the FIRE movement. I think you’ve got it linked in the show notes on our website, morningstar.com.au. And all of this sacrifice for an end goal may not actually end up being what you want. So, there’s plenty of financial news media and marketing that’s willing to give you the answer on the most efficient way to build wealth, but they don’t recognize that this might not be the pathway for you.

Jayamanne: So, we’ve talked about this at a high level. I think it’s time to go into a few examples to explain this. And there are countless examples, but we can speak about a few common ones that always come up when we talk to listeners and readers. The first is children, which we are both completely unqualified to talk about. But children are financially inefficient, but they are completely rational. If you took the efficiency standpoint and focused on wealth maximization, having kids is one of the least efficient financial decisions a person can make.

LaMonica: I mean, Shani, you have a dog.

Jayamanne: I do.

LaMonica: And Priscilla…

Jayamanne: is expensive.

LaMonica: …is expensive. You seem to take him to the vet a lot because he eats stuff in your yard. So that’s very expensive. But anyway, we may not have kids, but we know that raising a child in Australia is expensive. It’s estimated that it costs between $300,000 and $500,000, including housing, food, education, childcare, and the opportunity costs of reduced work hours. And of course, there’s no financial return on that decision. So, if your only goal is maximizing your net worth, the rational decision is obvious and just doing what we’ve done.

Jayamanne: I have a story. So, a colleague told me that she sat down with her husband and crunched the numbers on children and they estimated the extra expenses and how this would impact their cash flow. And this exercise made my colleague anxious. She worried that a child would put them on a financial precipice in an expensive city like Sydney. And this conversation happened when she was visibly showing at six months and not far off her maternity leave.

LaMonica: Seems like a conversation for…

Jayamanne: eight months ago. I don’t know.

LaMonica: We don’t want to make any assumptions.

Jayamanne: Anyway.

LaMonica: The important thing is, and I think that this example shows, is that wealth is not the only goal in life. And the example of kids makes this really obvious. But the issue is that a lot of us struggle with applying this same concept to less obvious tradeoffs between financial and non-financial goals. So, most people don’t really consider happiness when making these less consequential trade-offs.

Jayamanne: So, let’s move on to Australia’s favorite topic and that’s housing. It’s a classic example. Property can be an investment, but a home is more than a financial goal. I’ve spoken before about how much it cost me to buy my first home. So, I went through all of the expenses that I had, which with a few that were quite unexpected. And you can find a link in the original article to that. But I bought in an area with low rental yields and a house with capital works that would not be recouped to free-souled immediately. And at the time, my house was tenanted with an old rental agreement from early 2020, where the tenants had a really good deal. The gross yields was 2.04% on a two-bedroom terrace, one-and-a-half kilometers from Sydney CBD. So, from a purely financial perspective, this was a really bad investment and I would have gotten a higher return in the savings account.

LaMonica: And now I’m going to say things that will anger most of Australia. So, there are studies and models out there showing that particularly with housing prices, where they are today, that renting and investing the rest could mean a better financial outcome. So, you basically can get better long-term returns than buying a home, living in that home, especially because of all the costs, the transaction costs, the maintenance costs, the insurance costs, and that concentration risk of putting most of your net worth into one asset.

Jayamanne: So, on paper, the efficient move may be clear, but people don’t live on paper. A home provides stability and control. It provides a place to raise a family. It provides an environment that you can customize and make your own without fear of repercussions. And none of these factors are included when you look at the total return of an asset. The human element matters when making a decision and calling a home purchase a bad investment really just misses that point. It may be a perfectly good financial goal even if it’s not the most efficient capital outlay.

LaMonica: I’d like to pause and point out that I am two for two now making what you described in your article as the efficient choice.

Jayamanne: You are.

LaMonica: I have no children and I don’t own a home.

Jayamanne: And are you wildly unhappy?

LaMonica: Yes, but I don’t really want to talk about it during the podcast. But the next topic that we’re moving on to also does not apply to me. That is HECS or HELP debt, so student loans because I did not go to uni in Australia.

Jayamanne: So, I’ve written before on when you should pay off your student loans. There are a few choice circumstances where it is better to pay it off. But in Australia, the loan is indexed instead of having an interest rate applied to it. So, some of these circumstances include having children where you might need that extra cash flow or buying a house and having your borrowing capacity reduced due to the loans.

LaMonica: And it is important to remember that our money and our finances, they’re all shaped and influenced by our personal experiences. There’s some people that face genuine anxiety from holding any type of debt. One of those people is on the podcast with me today. So, Shani, I know obviously you can emphasize with people who feel this way.

Jayamanne: Anxiety is obviously not a rational feeling. You can’t argue away anxiety with bulletproof rationale, logical workings or just the telling yourself to forget about it and embrace the best loan that you’ll ever get. So, if you truly can’t put the loan into the back of your mind, just pay it off and move on with your life. And at the end of the day, a debt paid off is not the worst thing that you can do for yourself.

LaMonica: So, in summary, the efficient choice, if it’s giving you anxiety, just choose another approach. So, money and being good with money and saving money and investing money is all about choice. And choice allows you to pursue the life you want to live. And that means taking all aspects of a certain decision into account.

Jayamanne: All right. So, let’s talk a little bit about behavioral return and the premium that you could get from the inefficient path. We talk a lot about investor behavior on this podcast and that’s because it has a meaningful impact on the outcome that you will get. The best portfolio isn’t the most efficient one. It’s the one that you can stick with over the long term.

LaMonica: And how this plays out will look different for each investor. It might mean that you’re holding more cash in your emergency fund. It gives you peace of mind. It might mean paying down debt early to reduce anxiety. It may mean owning your own home to provide stability. So, it could be as simple as choosing a simpler portfolio that you understand so you know how it will behave, which will then increase your confidence.

Jayamanne: And always being in the most efficient investment may make sense from a pure return perspective, but it may mean that you will incur transaction costs and taxes, which means less money in the end. And the investment industry is always coming out with new shiny investments with lower fees, platforms with no transaction costs and more efficient operations. And in theory, this would result in better outcomes. Your job as an investor is juggling these advantages with the frictional costs of making changes. So, you need to consider the total efficiency over time and not just the most efficient path at a certain point in time.

LaMonica: And there are so many more examples that we can use of this than the ones that we just ran through. So mental accounting, for example. So mental accounting means you’re separating each of your assets and investments by financial goals. So, it’s generally frowned on by economists. It may be inefficient from a tax perspective and from a cost perspective, if you have all these different accounts. But this structure does help a lot of investors to connect their investments to their financial goals. It shows progress towards those goals and it can really help with behavior. And that’s important.

Jayamanne: And then there’s divorce. It’s rarely the most financially sound decision, but it can make a meaningful difference to how happy you are and your ability to live the life that you want to live. And there are plenty of examples of where the inefficient path is the most balanced in terms of wealth outcomes and happiness.

LaMonica: Well, there you go. Divorce, children, student loans. We’re really covering every part of life today, right? All right. So how do you strike the right balance? The inefficient path doesn’t mean indulging in every want and whim and throwing away your financial plan. Like most investment and financial decisions, it’s really about balance and the trade-offs that you’re making.

Jayamanne: So, to help frame the trade-offs, it helps to go through a comprehensive goal setting process to understand what you actually want from life. So, our behavioral research team developed a process to help improve the way that financial advisors help clients with their goals. So, you can find more information in that original article as well. But the beauty of this process is that it helps you to clearly segregate between a financial goal and an investment.

LaMonica: And ultimately having a goal is what’s going to guide you. And if you can’t define a goal and what enough means for your life, optimization becomes an endless crusade and you are constantly going to be searching for the most efficient path and the best ways to maximize your wealth.

Jayamanne: So, here’s a framework that might help. Go through these questions to help add some context to your goals. So, with investment decisions, am I in the best structure or investment product? Have I minimized costs and taxes? Am I diversified enough to protect myself? And am I going to reach my required rate of return in my portfolio by investing in this asset?

LaMonica: And then for life goals, is this what I want from life? Is this going to fill an emotional or physical need? Is this moving me towards the life I want within the capacity and constraints I have? So, asking yourself these questions will help you understand whether you’re making an investment decision or you are forming a life goal.

Jayamanne: And just to end this, avoiding the most efficient path can lead to guilt. People feel guilty for choices that reduce future wealth even when those choices increase happiness, stability or meaning. And I definitely struggle with guilt with my own spending. My natural inclination is to seek stability and safety. And for me, that means more money in the bank. Over time, I’ve learned to balance my savings with my non-financial goals in life, like getting furniture I actually like. And I try to make choices that make my life better. And I would encourage you to do the same. Put the guilt aside and pursue the non-financial goals you have in life. Start a family, pay off good debt that causes anxiety. Put the deposit on a house if that makes you happy.

LaMonica: And none of this makes you a bad investor. Live your life with intentionality. Make trade-offs consciously and decide how you can use your financial resources to make your life better.

Invest Your Way

A message from Mark and Shani

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