I am continually amazed at the lengths to which investors and advisors go to make investing complicated. Now, I don't expect anyone to necessarily agree with my particular way of investing, but it's like people have no idea of what matters and what doesn't when it comes to investing.
A few years ago, for example, I got into a social media spat with a blogger about how long it took to learn “how to invest.” He was convinced it was a “lifetime process” that would take “at least five years.” I pointed out that the only requirement to invest other people's money is a Series 6 exam—for which a typical study regimen would be three hours a night for a couple of weeks. Even a “high-level” designation, such as the CFP, only requires about 200 hours of studying (approximately 2 1/2 weeks of residency) and three years of some kind of related experience (which can be 100% in sales of financial products).
Needless to say, I thought five years (not to mention a lifetime) was excessive.
Investing Doesn't Have to Be Complicated!
I do think a lifetime of “continuing financial education” actually IS required, but that is a relatively easy requirement to meet. Maintaining a good investment plan can be ridiculously easy.
Despite the ease with which one can manage one's own portfolio, I am often asked for referrals to financial advisors. Some people simply do not have the relatively low level of interest required to learn enough to manage their own portfolios, or they lack the discipline to stick with a good plan. Those people, perhaps 80% of doctors, can be best served by putting them in touch with those who give good advice at a fair price. That's why we have a pre-vetted list of financial advisors who give that good advice at a fair price and who are sufficiently interested in obtaining new physician clients to advertise on the site.
More information here:
Why Do People Partially Engage with the Financial Services Industry?
Physician's Quick-Start Guide to Personal Finance
Adding the Twist
What is incredibly interesting, as I go through this vetting process with dozens of advisors over the course of a year, is the different variations in the way they do investment management. Almost every advisor I run into acknowledges the merits of a “know-nothing” fixed asset allocation of low-cost, broadly diversified index funds.
But they all add their little twist, and it is always a different twist. Several years ago, I had three advisor applications to review in a single day.
- This first application actually had a very reasonable investment management strategy, but I had to turn him down since he hadn't advised a single physician in the prior year. I thought it would be hard to justify that to my readers.
- The second used low-cost index funds but added on an options strategy “to control risk.” When I went to pin him down, he said he was buying options every month.
- The third used actively managed mutual funds “where it made sense to do so.” That was pretty vague, so while pinning him down, it turned out he believed indexing didn't work with certain asset classes, which the SPIVA report card does a good job of disputing. It would do an even better job disputing that if it went out 20 or 30 years instead of just five. But if an advisor wants to use actively managed funds, I like to see them using low-cost ones, since the real story of indexing is about costs. This advisor wasn't doing that. Another frequent one is some version of tactical asset allocation—where the overall portfolio asset allocation is changed in response to, well, something (it varies quite a bit).
These twists are actually the usual story, and I always have to decide if the “twist” is enough to disqualify them from our recommendation. I figure if they're mostly doing things the “right” way, I can live with that. (There are no perfect advisors anyway.) If they're not, I disqualify them. But why do all these advisors have to try to implement their “edge” anyway?
Why Make It Complicated?
Here are four reasons advisors want “the edge.”
#1 Possibility of Increased Return
The first reason advisors try to always have a little edge is that they really think it makes a significant difference. Maybe it does, but I'm confident that it'd be nowhere near what they think. Most of these edges probably would just add expense and subtract from returns. Now, many individual investors also try to add a little edge to their portfolios. Maybe it's an extra asset class. Maybe it's a unique way to rebalance. Maybe it's a little tactical asset allocation or market timing or the use of individual securities. Advisors are hardly the only ones guilty of this.
#2 Distinguish from Competition
The second reason is that advisors need to find some way to distinguish themselves from the competition. The edges do a fine job of doing this. Now, nobody can tell what the heck anyone is doing when it comes to portfolio management. This has been studied in medicine, and it turns out that all those little variations generally result in substandard healthcare. But advisors want to avoid being a commodity because when you become a commodity, it becomes a race to unprofitability as everyone competes on price alone.
#3 Justify Fees
The third reason advisors use these little edges is to justify their fees. If all they were doing was managing a static allocation of index funds, rebalancing it occasionally, and maybe doing a little tax-loss harvesting, then they could be replaced with a robot. Hmmm . . . this might explain the rise of the robo advisors. But it turns out that the value-add for a “real” advisor isn't in the “edge” with the investment management; it's in the financial planning and in the “high-touch” aspects of investment management—building around the random investments in some doc's 401(k) and keeping them from selling low with every new political development.
#4 To Appear Active
Finally, the edge satisfies the demand of advisors, clients, and individual investors to tinker with their portfolios. We all have this idea that we can somehow add value to our portfolio if we just learn enough and work hard enough. We WANT to be active, even when we know the right thing to do is to invest our time actively and our money passively. If you really want to add work and want to add value with it, look to invest in real estate, websites, and other small businesses.
More information here:
From Broke to Multi-Deca-Millionaire – Lessons Learned from 42 Years of Investing
Best Investment Portfolios – 150 Portfolios Better Than Yours
What Really Matters with Investing
It seems a good time to review what really matters when it comes to investing.
- Setting appropriate and important goals.
- Earning more money.
- Saving a higher percentage of earned money.
- Taking an appropriate amount of risk (i.e., a reasonable asset allocation).
- Setting up a reasonable investment plan.
- Sticking with the investment plan.
- Minimizing taxes and fees.
If this list ends at #7, all of those “edges” start way down on the list of importance at #20. That stuff just doesn't matter much in comparison. It certainly doesn't matter enough where you should be paying money for it. If you're interviewing a potential advisor, walk away if they spend the whole time trying to sell you on their idea of an edge instead of basic nuts-and-bolts financial planning and investment management. If you're functioning as your own advisor, focus your time and effort on what matters and quit looking for an edge yourself.
What do you think? How long do you think it takes to learn to invest? Why do we try to be unique and edgy? Why does every advisor have their own version of “the best way to invest?” What do you think matters most in investing?
[This updated post was originally published in 2017.]