The New York Times published a great article titled ‘The Folklore of Finance‘ last week. The article is based on a study done by State Street Global Advisors, a large custodian and financial research firm. There is much to discuss in the article, and we encourage anyone who wonders about our industry to give it a read. Because it covers topics that are important to us and important for our clients to understand, we discuss some of the findings below.
- The way individual and professional investors make investment decisions [is] so skewed that achieving both high returns and long-term objectives is impossible.
We completely agree, and anyone who has sat down with us at KH knows that we believe that focusing on benchmarks – “high returns” or “chasing returns” is counter to the goal of achieving clients’ long-term objectives. We view our charge as helping our clients achieve their financial and life goals, keeping them on track and being a partner in their lives and a steward of their assets.
- People [are] overconfident in their investing ability, unable to focus on their stated long-term goals when distracted by short-term noise in the markets, and have come to distrust their advisers and lose interest in receiving professional investing help.
Removing the recurring distraction of the markets is difficult, but ironically easier for professionals, we believe. At KH we have seen how much time and energy can be wasted trying to understand the noise of the market; we are students of this problem. In our office hangs a quote that reads, “We failed to anticipate Pearl Harbor not for a lack of relevant materials but because of a plethora of irrelevant ones.” It comes from Roberta Wohlstetter’s seminial anlaysis of this tragedy “Pearl Harbor: Warning and Decision”. (review) We take our lessons in humility and planning from beyond the field of finance, and certainly far from the financial press.
- True ‘alpha’ or outpeformance is disappearing.
We agree, but also note this study looks at alpha against a narrow market index – say the S&P 500 or the like. This is like cramming ever more chess players into a room; with each additional player the likelihood that he or she will be the best declines. We ignore these superfluous benchmarks and instead test our managers for evidence of true skill against a benchmark based on their own history and choices. Only when we find that ‘best fit’ benchmark do we test for skill. And it is indeed rare. Rarer still is the manager who passes the rest of our tests, such as being invested alongside their investors, having reasonable fees, low turnover of the investment team, etc. What we find is that these few remaining ‘needles in the haystack’ are a rarefied bunch who also do not think in the short term and who think of themselves as stewards of capital focused on long-term goals. Sound familiar?
- The solution is to invest in low-fee indexes.
We agree – we keep nearly half of our portfolios in the cheapest, free-to trade index products we can find. However…
- Investors are very short-term-oriented in the sense of how the markets are performing. . . That takes away from their ability to stay the course.
This has been well studied by industry thought leaders such as Vanguard, Morningstar and Dalbar. Consistently the actual returns of individual investors are far worse than the published returns of either index funds or mutual funds. Why? Simply put it is very hard to accept the “ride” and stay in for the long term without the ability to stay very focused on one’s plan.
- . . .if investors could focus on their long-term goals and understand that it is not going to be a straight line to get there, they would have a greater chance of achieving those goals.
How is this possible? We believe the solution has two parts. First, investors need to work with someone who can keep them on track. Whether this is a Schwab consultant, a Vanguard person, a fee-only finanical planner or just a concerned family member. This is a recommendation to find a partner, just as one might partner up in weight loss, training for a marathon or even getting through a tough time. But perhaps as important as a partner is the ability to stay the investment course. If there is one thing that is deeply embedded in the DNA of KilterHowling it is this notion that neither we nor our clients can any longer afford to jump ship when the markets roil, sit in cash while markets rebound, and vacillate between sitting in cash and being invested. So we endeavor to build a different path, one that is perhaps less exciting but also more likely to be more palatable. We aren’t risk seeking teens anymore; let’s stop acting like them.
- The study does not pull any punches in blaming the investment management industry for the pickle investors are in. It criticizes investment managers and advisers who are focused on short-term gains as a way of proving their worth. Fifty-four percent of institutional investors said they feared they could lose their job if they underperformed for only 18 months; 45 percent of people managing money at asset management firms said they felt the same.
This is a sobering observation, but it rings true for most of the advice industry. Chasing performance, showing short term gains and earning fees quickly before getting fired. If you haven’t met KH yet, we tell you we may underperform in a rising market. We measure performance in terms of risk we spend to earn return – risk adjusted returns. We believe that a dollar not lost is worth more than a dollar gained. We know that individuals feel the pain of a loss twice as intensely as the pleasure of a gain. We are in it for the long term with straightforward fees, a low-cost structure that enables us to focus on the long-term, and a requirement to invest alongside our clients.
- 65 percent of investors did not feel much loyalty to their investment adviser, while 93 percent of respondents to another State Street survey said they believed they would be better off investing on their own.
It is hard to argue with this after so much disappointment for investors, except multiple studies have shown that investors do worse on their own, and State Street found generally the same.
- Investors want to invest with a long time horizon yet react to short-term swings that derail the strategy. Think of investment return markers, like one, three and five years — hardly the time needed to get people from their first job to retirement.
We believe that the right solution is finding the right partner for your financial life. Here are some things to think about:
- Are the advisors qualified?
- Are the advisors’ interests aligned with my own? If so, how? Can they prove it?
- Are the advisors concerned with short-term performance?
- Have the advisors demonstrated a long-term focus?
- Are the fees I’m paying transparent, easy to understand and reasonable?
- Is the advisor’s business model sustainable? Are they patient and long-term focused?
- Can the advisor help me focus on the long-term? How?
- Will the advisor be a true partner in my financial life? In what way?
- Do others speak well of this firm and its employees?
- Do I like the people I will be working with?
- Is the portfolio management and financial planning process straightforward and easy to understand?
- Is my money held with a third-party custodian? Are my data and personal details safe?
Get the full report from State Street Advisors: Folklore Report