30 Chapters
Medium 9781626561625

Deadly Temptation #2

Edesess, Michael Berrett-Koehler Publishers ePub

We told you in Rule #3 that if someone—a friend of yours, perhaps—tells you that a particular broker or financial advisor has done very well for her clients, and you should consider hiring her, you should tune it out. Wouldn’t it be great, though, to have someone take care of your investments? They would grow nicely, and you wouldn’t have to worry about a thing. It sounds very comforting to have someone just deal with the whole realm of investing for you, especially if you’re convinced it’s all too complicated and you just don’t want to think about it.

But is it worth giving up one-third to three-fourths of your investment gains for this comfort? If you knew that another, lower-cost advisor—offering simpler, less technical-sounding investment advice, or even no advisor at all—would provide you half again to three times more in investment gains, then how comfortable would you feel?

Because that is, indeed, how much it costs—even when the cost appears low as a percentage of your assets. Let’s go through the numbers to show what we mean.

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Medium 9781576754078

10 Idle, Greedy Hands and Too Much Data Do the Devil’s Work

Edesess, Michael Berrett-Koehler Publishers ePub

Given the abundant evidence that trying to beat the stock market is a waste of time and effort, I have often wondered how smart people can do so much of it. Those who are professionals in the business do it, of course, because they are paid very handsomely to at least pretend to try. Thousands upon thousands of people are engaged one way or another in the effort.

When I was a child, I would look out on the roadway and see all the cars going to and fro. I would wonder where each and every one of them was going. Now I wonder what each and every one of those would-be market beaters is doing, day after day after day. Of course, I have been involved in the investment business in one way or another for most of my career, so I have some idea what they are doing.

But I have never been so close to a group of people in a corporate environment who were determinedly trying to beat the stock market as I was a short time before starting to write this book, in the fall of 2004. The experience was, in fact, what provoked me to write it.

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Medium 9781626561625

Rule #3

Edesess, Michael Berrett-Koehler Publishers ePub

Rule #3 will be short, because the chapters in Part II will explain in detail why it’s so important to follow this rule. For now, we’ll simply identify some of the noisy opinions and recommendations you’ll hear if you follow the two-asset portfolio route, and to all of it we say, “Tune it out.”

You’ll hear that you can and must beat the market, yet you aren’t trying to beat the market. Tune it out.

You’ll hear that you must diversify among many asset classes and many mutual funds or ETFs, yet you’re only investing in one or two. Tune it out.

You’ll hear that you must rebalance regularly to maintain constant allocations to asset classes, yet you aren’t rebalancing regularly. Tune it out.

You’ll hear that you must use a mathematical optimization model to perform an asset allocation, yet you haven’t run an asset allocation model. Tune it out.

You’ll hear that gold is a hedge against inflation, yet you aren’t investing in gold. Tune it out.

You’ll hear that scientifically designed funds perform better than total market index funds, yet you’re investing only in the global market index. Tune it out.

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Medium 9781626561625

Deadly Temptation #6

Edesess, Michael Berrett-Koehler Publishers ePub

Wealthy and “sophisticated” investors actually get more wrong than ordinary investors. What they get wrong is that they think that because they’re fielding a lot of money, they can buy the best expertise—and that, of course, will get them the best return. But in the investment management business, there’s no relationship between what you pay for professional help and what you get in investment returns. We suspect it’s going to be hard to convince you how wrong this idea is.

Wealthy and sophisticated investors got wealthy somehow, right? Presumably because they knew how to make money. So is it possible that they don’t know how to make money better than the rest of us when it comes to investing?

Yes, that is exactly so. But it’s worse than that. They know how to lose money by paying the highest fees you can possibly pay. It’s understandable why they would make that mistake.

Let’s start with a humorous light-hearted fictional example, which also has an air of truth about it.

In the 1986 movie Down and Out in Beverly Hills, Nick Nolte plays a homeless drifter named Jerry, who accidentally wanders into a rich man’s backyard and somehow winds up getting intimately involved with his whole family. At one point Dave, the rich man (played by Richard Dreyfuss), proudly—but a little sheepishly—shows Jerry how he got rich: coat hangers. OK, someone has to make coat hangers. If you sell enough of them you’ll get rich. This was an ironic touch of realism in the film. It implied that many rich people get rich on what seems like a tiny little business niche—and in fact it’s true.

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Medium 9781626561625

Deadly Temptation #3

Edesess, Michael Berrett-Koehler Publishers ePub

We told you in Rule #3 that if you hear that asset allocation is the most important investment decision you can make—and that you must do it using a scientific optimization model—you should tune it out. Now we will tell you why you should tune it out.

Financial advisors will often give you the idea that they can very precisely control the risk and return of your portfolio. Their spiel often starts with “The most important thing is asset allocation.”

Back in 1986, a paper titled “Determinants of Portfolio Performance,” by Gary Brinson, Randy Hood, and Gil Beebower, was published in the Financial Analysts Journal.1 It got a huge amount of attention. It was cited, and re-cited, and cited again and again. Almost all of the references made to the article got its message completely wrong. It became conventional wisdom that “94% of investment performance is due to asset allocation.”

Well, that’s not what the paper said. The coauthors thought it must have been their title that threw people off—“Determinants of Portfolio Performance.” But, really, the confusion about what the paper actually said was largely due to the fact that misinterpreting it gave financial advisors a new lease on life. It offered them a new marketing pitch, which often sounded right to them but was a misconceived mish-mash of half-truths and falsehoods that they frequently passed on to clients for very substantial fees.

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