Learn How The Inherent Complexity Of Investing Makes Over-Simplified And Free Investment Advice The Most Expensive Alternative Of All.
We desire simplicity and comprehensibility. We wish things worked the way they were supposed to. We long for black to be black and white to be white.
Why do we want these things? Because it gives us confidence in the outcome. It creates a sense of certainty in an uncertain world. It feels secure.
“Illusion is the first of all pleasures.”
That is why we want investment advice that is succinct, conclusive, accurate and understandable. We don’t want to muck around in financial mud. The human mind wants security in financial affairs and is uncomfortable with exploring all the subtle shades of gray inherent in a complex, uncertain investment world.
Unfortunately, reality doesn’t care what you want: it just is. The future is unknowable, investment decisions are complex, and risk management is subtle shades of gray. That’s reality. Sorry.
If you want to invest profitably then your strategy must be congruent with reality regardless of how you wish things were. Investing based on how we want things to be rather than how they actually are can be a very expensive indulgence.
Why Simple, Free Investment Advice Is The Most Popular
The investment marketers and media give us simplistic investment advice because that’s what sells best. It is what people want regardless of whether or not it is profitable. Investment marketers and media are focused on their profits … not yours. This is not some big conspiracy theory: it’s just business common sense.
For example, visit your newsstand and review the cover articles in the financial magazines. Notice the sizzle in the headlines designed to capture you attention:
- “Ten Funds to Own for the Next Decade”
- “The Bull is Back: What You Must Own”
- “Five Stocks That Could Double This Year”
The headlines will vary but the formula remains constant. Each article promises a powerful benefit delivered in a brief and easy to digest format. No research or specialized knowledge required. The implication is you can unlock the vault to profits for very little effort. Nonsense.
“To read a newspaper is to refrain from reading something worthwhile. The first discipline of education must therefore be to refuse resolutely to feed the mind with canned chatter.”
The only reason these articles are written is because that is what sells best. People want to believe it is true so marketers and promoters provide it. Their job is to sell magazines, and they know darn well that very few people are going to rush to the checkout counter for factual headlines like the following:
- “Ten Funds with an Unpredictable Future”
- “Bull or Bear? Your Guess is as Good as Mine”
- “Five Stocks with No Better Odds of Doubling than Any Other Stock”
Would you pay for that kind of information? Probably not. Why? Because there’s no promised benefit and no allure. Accurate titles don’t motivate people to take action and purchase the product. People need a benefit to drive them to action – whether or not it is true. That is the way marketing and sales works so the media responds by promising that benefit. Their job is to sell you on consuming their product – whether it is good for you or not.
“The man who reads nothing at all is better educated than the man who reads nothing but newspapers.”
Numerous studies have analyzed the value of such advice and the results are universally unimpressive. Sure, there is an occasional accurate forecast, but a broken clock is correct twice a day and you wouldn’t be foolish enough to use it to tell time. Why should sound-bite investment advice be any different?
Maybe I’m naïve, but I want investment advice that maximizes my profits and not the vendor’s. I want investment advice consistent with reality even if reality is complex. For that reason, I don’t want sound-bite investment advice if it is incongruent with the reality of investing.
What about you? What do you want from your investment advice?
The Thin, Gray Line Dividing Fraudulent Investment Advice From Deceptive Half-Truths.
Suppose someone came to you and claimed you could earn 100% guaranteed every six months following their simple, proven, investment advice. Just plunk down the cash and watch your money grow. Would you take the bait and invest? Probably not.
A smart investor would investigate deeply and perform thorough due diligence before risking a dime because above market returns, guarantees, and “something for nothing” are all red flags signaling potential investment fraud. They are marketing tools designed to make your greed glands salivate so that caution and common sense are forgotten.
Simplistic, one decision, investment advice is just one step removed from the above scenario. It is the same thing, but it is less obvious because it is less extreme. It is designed to appeal to the same human weaknesses of wanting simplicity when complexity is the rule, wanting certainty when risk is unavoidable, and wanting something for nothing.
“The truth is always a compound of two half-truths, and you never reach it, because there is always something more to say.”
Simplistic investment solutions should serve as a red flag triggering greater due diligence on your part because it is out of congruence with the inherent complexity of a competitive investment world. Examples of such simplistic investment advice include:
- Buy and hold for the long term.
- Buy stocks on splits for immediate gains.
- Stocks outperform bonds.
- Stocks outperform real estate.
All of these statements are partially true and all of them are partially false: they are investment half-truths. To understand how they can be both true and false you have to dig behind the simplicity and unmask the inherent complexity of the underlying subject matter … investing.
“Buy And Hold” Is An Investment Advice Half-Truth.
“The greatest obstacle to discovery is not ignorance – it is the illusion of knowledge.”
Daniel J. Boorstin
For example, “buy and hold for the long term” is simple, understandable, actionable, investment advice that is so widely believed to be true that it approaches religious dogma within the retail financial community.
What is amazing, however, is that the very people who preach this investment advice don’t walk the talk. Mutual fund companies have average annual portfolio turnover rates of 107% for U.S. stock funds according to a 2003 issue of the Wall Street Journal. John Bogle, founder of Vanguard and champion for the mutual fund industry, admits the average mutual fund turns over its portfolio roughly every eleven months. This is hardly “buy and hold” for the long term.
Why do the very people who preach buy and hold to you as a simple, one decision investment model do exactly the opposite? Because the issue is much deeper and more complex than they lead you to believe. Here are some of the facts they aren’t telling you when they deliver this sound-bite investment advice…
The Hidden Statistics Behind Buy And Hold Investment Advice That Nobody Ever Told You … Until Now.
Buy and Hold Fact 1:
Based on historical results, a 20 year “average holding period” is required to be confident that you will eventually profit from buy and hold investment advice. Historical holding periods of 15 years or less have resulted in capital losses. In fact, both Malkiel and Siegel (buy and hold proponents) show that after adjusting for taxes and inflation the 15 year period from 1966 to 1981 would have actually showed negative returns for stocks. If you wanted to beat bonds for the same time period it would have taken many more years, and if you wanted additional return to compensate for the added risk of stocks you would need to wait even longer. Other time periods in history show similar results. The point is buy and hold for the long term is really long term.
“If a man is offered a fact which goes against his instincts, he will scrutinize it closely, and unless the evidence is overwhelming, he will refuse to believe it. If, on the other hand, he is offered something which affords a reason for acting in accordance to his instincts, he will accept it even on the slightest evidence. The origin of myths is explained in this way.”
Buy and Hold Fact 2:
A 30 year “average holding period” (necessary to be statistically confident of a profit) is so hard to achieve for the average investor as to be statistically meaningless unless you wear diapers and watch Teletubbies on television. That’s because “average holding period” is very different from how long you invest.
Most people think that if they invest for thirty years then they will have an average holding period around thirty years, but in fact it’s much shorter. The bulk of most people’s savings occurs later in life and they often begin spending principle upon retirement causing their average holding period to equal a small fraction of their total investment career. What this means is most investors are being led into a strategy that has a much higher risk of loss than they expect because their holding periods are much shorter than statistically required to assure a profit.
Buy and Hold Fact 3:
The often quoted expected returns from buy and hold are meaningless averages. The likelihood your return will equal the average is close to zero for two reasons:
Reason A: Your actual mathematical expectation for buy and hold is a function of the overall valuation level of securities at the time you begin your holding period. All times are not created equal. To expect average returns the market would have to be valued at the average when you began your “average holding period”. Higher valuations offer lower mathematical expectation and lower valuations offer higher mathematical expectation.
Reason B: Even if valuations were average when you began your holding period, the reality is average returns are a statistical fiction that rarely occur in practice and should not be expected. Nassim Taleb, author of Fooled by Randomness, determined the average return for the Dow Jones Industrial Average from 1900 to 2002 to be 7.2%; however, only 5 of the 103 years had returns between 5% and 10%. The bottom line is you should not expect anything close to the average return you are quoted over any time period meaningful to the average investor.
I could continue on and on about all the statistical fictions and half-truths used to support buy and hold as a simple, one decision, investment strategy, but that is not my purpose.
My point is to show the inherent complexity that hides behind even the simplest investment advice. Probably less than one in a thousand buy and hold investors really understand the risk and variability of returns associated with their investment strategy; yet, they are staking their financial future on it.
“Reality is that which, when you stop believing in it, doesn’t go away.”
Philip K. Dick
Buy and hold is so complex despite its surface level simplicity that two highly educated, very intelligent, well reasoned experts can study the topic and come to diametrically opposed conclusions despite having access to the same data and statistics.
Why Two Top Experts Can’t Even Agree On The Simplest Investment Advice…
At the 2004 New Directions for Portfolio Management Conference, Jeremy Siegel, a professor at the University of Pennsylvania and author of “Stocks for the Long Run,” squared off directly opposite Rob Arnott, a hedge fund manager and editor of “The Financial Analysts Journal”. These two learned and respected authorities had the same data and research at their disposal and arrived at opposing conclusions about the long run prospects for stocks. Their only significant agreement was to agree to disagree.
If two highly credentialed experts immersed in extensive research on the subject can’t agree then what does that imply about the validity of your broker’s opinion?
“As far as the laws of mathematics refer to reality, they are not certain; and as far as they are certain, they do not refer to reality.”
I believe buy and hold provides an adequate risk/reward ratio only under certain specific market conditions and even then is only appropriate for investors with certain risk tolerances and objectives. It is not an investment strategy appropriate for the masses at all times as it is commonly marketed, and it may be totally inappropriate for you.
Does this answer sound more complex than the sound bite investment advice fed to you by the media, mutual funds, or your financial adviser? Probably. But remember, I’m not trying to sell you on buying an investment product from me so I’m not trying to oversimplify the discussion. My only job is to help you retire early and wealthy by teaching you what works, what doesn’t, and why.
Albert Einstein provided sage advice when he recommended keeping analysis as “simple as possible, but no simpler.” Why? Because simplicity can deceive when the subject is inherently complex, and Albert should know a thing or two about simplifying the complex.
Profitable Investment Advice Is Reality – Not Simplicity.
In case you think that over-simplified investment advice is limited to buy and hold, I will lampoon one more sacred cow to make the point that this problem is pervasive.
Studies are occasionally published claiming to prove which investment class offers superior returns: stocks or real estate. The analysis appears simple and conclusive on the surface. Simply compare price changes in each investment class over long periods of time to see which one grew more. Usually stocks come out on top depending on the time period analyzed.
“I believe in looking reality straight in the eye and denying it.”
Unfortunately, this is pure rubbish. The real question is not percentage price change but return on investment net of taxes and expenses. By oversimplifying they are asking the wrong question.
Stocks are customarily purchased for cash so return on investment is a combination of dividends and price change. But real estate is very different. It is usually purchased with financial leverage magnifying price changes five or ten times over a cash purchase. In addition, it has significant tax advantages not available to stocks further adding to total return. Any analysis comparing stocks to real estate that doesn’t account for these differences is oversimplified and meaningless.
In short, there is much more complexity to analyzing return on investment than simple price changes. Once again, real world investing differs markedly from simplistic, sound bite, investment advice.
How Is Personal Financial Advice Different From Investment Advice?
It is important, however, to complete this discussion by contrasting the complexity of investment advice with the straightforward simplicity of personal financial issues like savings, insurance, tax strategy, and personal record keeping. Investing is complex: personal finance is simple by comparison.
Personal financial advice can be safely generalized into black and white truths that fit into sound bites. Below are some examples from my Seven Steps to Seven Figures course:
- Lifestyle should lag income so that you can invest the difference for long term financial security.
- You should only insure what you can’t afford to lose.
- Run your personal financial life like a business … because it is.
So why can personal financial advice be safely simplified while investment advice is inherently complex?
Common sense provides the answer. Investment results are determined by a competitive, free market. You are not in control of the outcome of your portfolio … the market is. Additionally, the future for the markets is unknowable and determined by an infinite number of forces outside of your control.
“To succeed at anything you need to have passion for it and devote yourself to it – not be constantly looking for ways to cut corners.”
You may want investing to be black and white, but the truth is subtle shades of gray. Investing is filled with risks and unknowns that are unpredictable. The markets are dynamic and constantly evolving. Simplistic investment advice is incongruent with that reality.
Contrast investment markets, where you have no control, with your personal financial affairs where you are solely in control. Nobody but you determines your savings rate, debt, or which mortgage and insurance you buy. The principles of successful savings, insurance and record keeping have changed little in decades. It is a relatively static and stable environment that is not transacted in competition like investments are.
The competitive, free market, uncontrolled nature of investing is the difference. Investment advice can never be black and white because if it was then everyone would do the obvious causing the obvious to no longer work. That is the nature of supply and demand in the free markets. Any competitive advantage that can be exploited by the masses through simplistic investment advice will be exploited into non-existence.
Bummer, but that’s the way it works.
How Quality Investment Advice Creates Ambiguity.
Sigmund Freud described the neurotic nature of most investors when he stated “neurosis is the inability to tolerate ambiguity.” I believe you can’t understand an investment until you reach the point of ambiguity. In fact, in my own investing I have found my confidence and clarity are inversely correlated to my results. Typically, the more confident I am at the point of decision the more likely I will be wrong.
Why? Because my confidence is a symptom of my ignorance to reality. It means my depth of knowledge is insufficient to know all the ways I can lose money with that particular investment. Gaining that missing knowledge offsets blind confidence and creates ambiguity. Yet, ambiguity is what most investors avoid because it makes them feel uncomfortable. They want clarity and simplicity.
I’m not alone in these thoughts. Robert Rubin once observed that some people are more certain of everything than he is of anything. Excessive confidence in investing is dangerous because you don’t reassess flawed conclusions. Nobody can know all the facts, yet some people see the world full of certainties when in reality it’s only probabilistic.
“What is important is to keep learning, to enjoy challenge, and to tolerate ambiguity. In the end there are no certain answers.”
When you embrace probability then reality appears as subtle shades of gray rather than black and white, and most people don’t like that. It is psychologically difficult. People prefer certainty because it breed confidence… even if it’s wrong. Uncertainty can be paralyzing because you only know enough to know how little is really knowable. You recognize that everything beyond the limits of your understanding represents risk – risk of loss. Simplicity fades away and is replaced by complexity.
However, the advantage of uncertainty is it motivates due diligence. You realize you cannot ever really know thus you gain as much knowledge as possible in pursuit of the unattainable goal of eliminating all doubt. A healthy dose of uncertainty motivates you to pursue enough knowledge to attain reasonable conviction. Your eyes are wide open.
I encourage you to embrace ambiguity as investment truth. Seek it as the antidote to ignorance. The future is unknowable. Life is uncertain. Only when you reach the point of ambiguity are you fully informed and capable of balancing risks with rewards to make consistently profitable investment decisions.
This may feel uncomfortable at first and it certainly isn’t the simple answer, but it is congruent with reality.
In Summary …
You need to learn how to sort what works in investment markets from what doesn’t. Your financial security depends on this skill.
“A lie told often enough becomes the truth.”
You will be confronted with every kind of investment advice you can imagine on your path to retire early and wealthy. The sources of this advice will appear confident, qualified and knowledgeable. Despite this air of expertise, the quality of the advice will range from great to garbage.
One way to separate good investment advice from bad investment advice is to know whether or not the advice is consistent with the inherent nature of the subject matter. That is why I created the distinction between personal financial advice and investment advice.
(1) Investing is a complex subject filled with subtle shades of gray. For every point, there is a counterpoint. For every truth, there is an exception. Every investment strategy has its Achilles Heal. Even the supposed experts frequently fail miserably at investing because of the competitive nature and complexity of the game; therefore, simplicity and sound-bite investment advice should be viewed with caution.
(2) Personal finance issues, on the other hand, are relatively simple by comparison. Truths can be distilled down to simplistic rules that will hold up in practice. While few experts will agree on best investment practices, most experts will agree on how to manage debt or save for college.
You must be clear on this distinction because without it you are prone to fall prey to simplistic, sound-bite investment advice when it is inappropriate or inaccurate. Nobody can give you the how-to’s of investing in a single article, book or worse yet, sound-bite interviews on television. Yet, that is exactly what you see in the financial media every day. Don’t let it influence your decisions.
Simplicity is antithetical to investing. It is a sales tool used by marketers to get in your pocket. The people who profit from selling you stocks want you to believe equities are superior to real estate because they can’t sell you real estate. They want you to believe you can profit from simplistic models like buy and hold because then you will invest your money with them.
If the salesman can make it sound simple then he is far more likely to get the sale. Complexity breeds indecision and is the nemesis of the investment marketer. This is not some big conspiracy theory. It is just the way business works.
It is reality, and your job as an investor is to learn how to profit from it. I hope this helps.