I started off with the idea of writing a blog on the worst habits of investors. And whether we’re talking individual investors or institutions it’s not hard to quickly come up with a long list of bad habits that have eaten away at returns (Ben Carlson already did a pretty good job of this here ).
But why make the investor the bad guy here? The investment industry is at least as culpable here, and in fact as the specialists entrusted to help our clients invest better, many of investors’ worst habits have their roots in the practices of the industry.
So where does the industry commonly go wrong, and what can we all do to make things better?
I would have written a shorter note, but I did not have the time.Blaise Pascal
We complicate everything. Sadly this is often because (as Morgan Housel has pointed out) complexity sells. Complex, technical stuff feels like real work, and length/volume is often used as a bad proxy for quality and thoughtfulness. In investing however it is simple things that usually matter the most, and complexity creates a fog that obscures or misdirects.
Consequence: investors focus on the wrong things, investing incorrectly for their needs, churning their portfolio excessively, chasing performance, reacting incorrectly and too often, paying too much in fees or missing opportunities. This is why initiatives like the simpler annual statement and related ideas for more informative factsheets are so important to keep pushing through. Sure, rules and compliance are a factor here, but shouldn’t be used as a reason to be lazy and retain the status quo.
Oh we do love a good bit of jargon don’t we. Would you like an SMA, a BDC or a DCF with your IRR? We love absolute or total returns, idiosyncratic risks, opportunistic, fundamental strategies, alpha, beta, volatility, secure income, strategic income, strategic growth, diversified growth, alternative assets, value, high-yield, securitised, commoditised, leveraged , yield compression, steepening, flattening, re-flating, stagflating, diversifying and re-correlating. Even the adjectives used to describe relatively simple things can muddy the waters even further: were your returns muted or robust? Resilient or lacklustre?
Consequence: investors lack understanding, have less confidence in their decisions, believe products are more sophisticated than they actually are and are more prone or open to manipulation into bad choices: excessive churning, or paying excessive fees
Unfortunately things one doesn’t understand create a mystique around those that do, so it’s easy to sound smart when you use jargon. But it’s unhelpful.
3. Perfectionism, over-precision and overfitting
Maths and science – in which so many in our industry have studied – deals in precise laws and relationships: Pythagoras triangle or Newton’s laws of motion. So we insist on neat, tractable relationships that can be written down mathematically when it comes to investing (and undervalue things that don’t fit that) , which is often a huge mistake in an ambiguous, uncertain and random domain where human psychology matters as much as equations. We give the impression that unknowable quantities such as “risk” can be measured, as opposed to merely estimated (or guessed).
Consequence: investors have products or strategies promoted to them on the basis of false-certainty, this can promote over-confidence. Things that fit into neat equations have excessive focus put upon them (such as the one-year standard deviation of returns, which can trigger loss-aversion), whereas things that don’t have been absent from discussion (such as the environmental impact of a company – although thankfully this is now changing).
It means we talk with absolute certainty too often when humility and nuance should be the standard. We tend to get obsessed with definitions and getting them perfect. Assumptions should be more exposed and challenged than they often are.
What we wear reflects how we see ourselves, and says something whether we mean to or not. Nothing screams “I think the same as the other guy” as much as turning up dressed the same in a suit and tie.
Conformity in the industry runs much deeper than this of course, firms hire similar people, with similar qualifications from similar universities and get them to do similar roles in similar cities running similar products. Conformity also extends to biases, it lies behind business models, and narrow ways of thinking. But it can be so hard to challenge as norms perpetuate themselves so strongly.
Consequence: investors end up with a large choice of almost-identical investment products run according to narrow sets of ideas and models. Products chase benchmarks and managers chase each other leading to sub-optimal behaviors that cost investors. The marketing of products focuses excessively on the skill of individuals
When so many underlying variables are random , at least on a day-to-day basis, and with news and media sources to ubiquitous and consumable there will always be so much to say. The market somewhere is up or down, corporate earnings are higher or lower than expected, some economic data is always surprising. Someone somewhere is calling a bubble or an opportunity or a crash. We have an inherent desire to try and see patterns, we are pattern-recognition machines (which has served us well through our evolution), however it leads us astray under randomness. As Nassim Taleb pointed out we are all too often Fooled by Randomness and so much of what gets said and written in, and outside of, the industry falls into this category.
Consequence: investors are flooded with meaningless noise, making it hard to see clearly and make good long-term choices they get triggered emotionally and react to the wrong things, at the wrong times.
Recognise any of the above in your firm or your work? Sure you do. We all do. Why aren’t they called out more often? The answer is complicated and profoud: there’s an issue here – because speaking the truth and standing up for what is right is an implicit rebuke of the status quo, it challenges others’ identities, it indicts them for not doing the same. It carries a social cost. Thats why things don’t change the way they should and a status quo continues. In some cases those perpetuating these habits might even be doing so with the best of intentions believing they are doing the right thing.
Now obviously I’m being a little provocative here, deliberately so. I’m not out to take cheap-shots, float up strawman arguments. But can you really say that any of the above is not true? The question is what to do about it. I’m not saying we should cast the industry into eternal damnation, point the finger of blame, or require an immediate radical revolution. But real change starts with recognising a need to change, and a call to action. We can create a positive catalyst for change.
We can all help, you can help, by fighting back and carefully but forcefully calling these things out when they happen. It might make life tricky, and it might be a bit awkward. Gradual evolution can get us to a much better place. But it would make for a much better, clearer investment world, and it would do investors one hell of a favour. Wouldn’t that be something worth aspiring to?
How else can investors fight back against these bad habits? Focus on what really matters.