Most of us believe we are better than we really are. Whether it is driving, athletic ability, IQ, or investing, we all believe we are better than average. Obviously, this can’t be the case. The blog A Wealth of Common Sense has a post up talking about a book written by William Bernstein. In it, he describes the three classes of investors that he comes across:
Group 1: The average small investor, who does not have a coherent asset-allocation strategy and who owns a chaotic mix of mutual funds and/or individual securities, often recommended to him or her by a broker or advisor. He or she tends to buy near bull market peaks and sell near bear market troughs.
Group 2: The more sophisticated investor, who does have a reasonable-seeming asset-allocation strategy and who will buy when prices fall a bit (“buying the dips”), but who falls victim to the aircraft simulator/actual crash paradigm, loses his or her nerve, and bails when real trouble roils the markets. You may not think you belong in this group, but unless you’ve tested yourself and passed during the 2008–2009 bearmarket, you really can’t tell.
Group 3: Those who do have a coherent strategy and can stick to it. Three things separate this group from Group 2: first, a realistic appraisal of their true, under-fire risk tolerance; second, an allocation to risky assets low enough, or a savings rate high enough, to allow them to financially and emotionally weather a severe downturn; and third, an appreciation of market history, particularly the carnage inflicted by the 1929–1932 bear market. In other words, this elite group possesses not only patience, cash, and courage, but also the historical knowledge informing them that at several points in their investing career, all three will prove necessary. Finally, they have the foresight to plan for those eventualities.
I can tell you that while most people think they are in Group 3, I would say it is a minuscule part of the population. Did you make any changes to your portfolio from 2007-2009. If you answered no, you are probably in Group 2 since you wouldn’t have been sticking to a disciplined plan. If you answered yes, unless it was only to buy stocks, you are probably in Group 2 as well. Group 3 is the Mecca of investing and where we try to guide our clients towards. Determining appropriate risk tolerance, establishing required returns to achieve goals, and constant education and perspective on the markets is key to a successful investment experience.
If you take an honest assessment of your “Investment Type” which group would you fall into?
“Simplicity Is The Ultimate Sophistication”- Leonardo da Vinci
The shift towards alternatives like hedge funds and private equity, especially among institutional investors has accelerated in recent years. After two bear markets in the last 15 years, you have to wonder if even the smartest investors are “buying high” right now; investing in products that are really designed to protect downside at a time when the market has been doing nothing but going higher. Here is a great chart from the Wall Street Journal on the shifting landscape of investment portfolios:
The increase in alternatives has come at the expense of traditional investments like stocks and bonds, which have done especially well for the past 5 years. Unfortunately, the retail investor tries to follow much of what these institutional investors do. The difference is that they do not have access to the types of managers these billion dollar pensions and endowments do. Believe me, no matter what your broker says, you are not investing alongside Harvard and Yale’s endowment when you buy that hedge fund-of-fund. We often say at Greenspring that simple trumps complex. I can think of no better example of complex than where seemingly sophisticated investors are allocating their portfolios. Do yourself a favor by avoiding these alternatives and keeping things simple.
Do you work with a financial advisor? If so, is that advisor required to put your interest ahead of his/her own? If you are like 99% of other investors out there, you probably don’t know for sure. There is a difference between having to act in a client’s best interest (being a fiduciary) and having to recommend suitable products (brokers). The vast majority of advisors are brokers or have the option to operate as a broker, and therefore don’t have to act in their client’s best interest. There are some policy makers that are pushing for EVERYONE who gives financial advice to be held to a standard that puts the client’s interest ahead of their own. Seems like it should be a no-brainer for law makers who are supposed to be representing the people. Nothing could be further from the truth. The New York Times has an article out that shows how hard it has been for those in favor of these consumer protections to make any headway. Wall Street firms and their related associations are stymieing every effort to even discuss/debate this legislation.
So what does this mean for the average investor? Quite honestly, most investors judge their relationship with their advisor on trust, not on whether they are a “fiduciary” or not. This is somewhat unfortunate, since we have seen countless situations where advisors have abused that trust without the client even realizing it. If you were sold a variable annuity, private REIT, closed end fund, IPO, load mutual fund, or structured product there is an almost 100% chance you are working with a non-fiduciary and could have been taken advantage of. These products generate gigantic commissions for their advisors and selling company, which is why they are fighting so hard to prevent legislation like this from passing. You see, if the law changed requiring everyone to act in their client’s best interest, it would be very hard to justify the existence of some of these products in their current form. In many cases more than 50% of large brokerage firm’s revenues come from selling products for a commission. These laws threaten the very business model they were founded on. In the movie, The American President, the president (Michael Douglas) in speaking about an upcoming political battle,says that they should “Fight the fights they can win”. His top aide (Martin Sheen) counters by saying they should “Fight the fights that are worth fighting”. As a true fiduciary to our clients, Greenspring believes that this is a fight worth fighting, even if it isn’t won in the end.
Regular readers of this blog will know our disdain for hedge funds. High fees and promises of active management delivering performance does not sit well with us (or align with any of the reputable data sources). We read through this presentation which validated many of our beliefs. There is no easy way to say this…hedge funds should be avoided. The promise of low risk returns just hasn’t played out after manager fees. Here is how all the profits of hedge funds were sliced up from 1998-2013:
You may need to put on your glasses to see how much of the hedge fund’s profits actually flow through to investors. Please read this presentation before considering a hedge fund investment. No matter how great they sound, the underlying data does not support participating in these vehicles.
When you think about investing, what are you afraid of? The last few years there have been no shortages. Let me just name a few of the concerns I have heard from clients:
- A Greek exit from the Eurozone
- Higher income taxes
- Debt ceiling showdowns/political stalemates
- Stock valuations are too expensive
- Slow job growth
- The sequester
- The Fed printing money
- The dollar is going to crash
- The stock market has gotten ahead of itself
- China’s hard landing
These are just a few I could think of off the top of my head, but there are countless others. With all that being said, the market has marched higher. Since the March 2009 low, the S&P 500 is up 193% (not including dividends!). This just reinforces two points we continue to stress to clients: 1) It pays to be optimistic; and 2) the stock market is not the economy
Information contained herein has been obtained from sources considered reliable, but its accuracy and completeness are not guaranteed. It is not intended as the primary basis for financial planning or investment decisions and should not be construed as advice meeting the particular investment needs of any investor. This material has been prepared for information purposes only and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. Past performance is no guarantee of future results.