by Ben Carlson, A Wealth of Common Sense
Investors have to take some personal responsibility for their own actions, but one of the reasons so many people struggle with their investments is because many in the field of finance tend to perpetuate myths, rules of thumb and assumptions that just arenât true.
Here are some that come to mind that can be harmful to those outside of the financial arena who are just trying to understand how things really work:
Investing is about finding new opportunities and security selection. In reality, new ideas and security selection are overrated. Portfolio management is really about risk management and portfolio construction. If you canât get these things right it wonât matter how many new opportunities or stock picks you come across. Those are just tactics, not a portfolio.
200 page quarterly reports are a good idea. Charlie Munger once said, âAny time anybody offers you anything with a big commission and a 200 page prospectus, donât buy it.â The same could be said about advisors, consultants or money managers who supply endless pages of performance or portfolio reviews. Iâve seen countless quarterly performance reports in excess of 100 pages. Who reads these things? Theyâre basically a way for a firm to say, âLook, weâre doing something on your behalf, even if itâs worthless busy work youâll never bother reading anyways.â
Clients want to be impressed. Finance people have a nasty habit of using jargon to talk over peopleâs heads under the assumption that clients are looking to be impressed. Some probably are, but most people really just need a better understanding of the complexities involved with the markets and their own investments. Itâs more impressive when you can communicate your message in a way that anyone can understand.
People care about risk-adjusted returns. The relationship between risk and reward is one of the most important ones to understand in all of finance, but like all good things, it can be taken too far. Investment people place a high premium on risk measurement, but not enough on actual risk management. Just because something looks good in a formula does not mean it will help someone achieve their financial goals. Yes, volatility matters but you canât become a slave to some meaningless risk-adjusted return formula because it looks good in a textbook.
Intelligence is all that matters. One of the finance industryâs biggest failings is many blindly assume absolute brilliance is all they need when itâs really a relative game. There are plenty of smart people who are terrible investors because they canât admit their own limitations. Intelligence is never in short supply on Wall Street, but the correct temperament is.
You have to have an opinion about everything. Some money managers just canât help themselves and have to predict whatâs going to happen with the Fed, the election, interest rates, the price of gold, who the winner on the next season of the Bachelor will be, etc. Itâs OK to have a âtoo hardâ pile or simply admit you donât know whatâs going to happen at all times.
People need certainty. While people may crave certainty, what they really need is an honest assessment of the current situation and the prospects for the future. Thereâs no room in the financial markets for always or never, 0% or 100%. It doesnât work that way. The best you can do is perform an assessment on future probabilities and scenarios, but nothing is ever set in stone.
Complex markets require complex solutions. To me, this is one of the most damaging myths out there for most investors. The simpler, the better (with the understanding that simpler does not mean easier). There are no extra points for degree of difficulty.
Past performance is all that matters. Past performance always requires context â investment style, market & economic environment, assets under management (then & now), the current situation, how returns were calculated, the amount of risk involved to get said performance, fees, luck, skill, future prospects, the process employed, etc. While the markets can be something of a running scoreboard of your investment decisions, you always need to provide context around historical returns.
Clients need more choices, more ideas, more products, more portfolio changes, more everything. Nope. Less is more. The best in this business know how to pay attention to fewer and fewer things â and only the ones that matter.
You need a repeatable process. I hear this one all the time. And while I agree that a repeatable process can be helpful, itâs an incomplete solution. What really matters is your discipline to follow a process. Iâve seen many a ârepeatable processâ that gets changed because something doesnât go as planned. A process only works if youâre able to follow-through with it and have repeatable actions yourself.
Not everyone in finance works on Wall Street. Iâll call myself out on this one. People tend to lump everyone in the finance industry together as if thereâs one big entity called âWall Street.â There are plenty of great people who work in finance. Most firms just need a change in culture and incentives.
Further Reading:
Whatâs Right With Finance
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