Nov. 2020 – The Limits of Investment Knowledge

Successful investing is unlike many other endeavors. Because investment outcomes can be random and unpredictable, learning more
and trying harder don’t necessarily lead to better results.

Contrast that with activities in which working harder statistically leads to better results. Some people like running. The average runner might run a few times a week in the summer, and maybe a couple of times a week in the winter, weather permitting. To get better at running, the answer is simple – practice more. A runner can eat better, increase training frequency and distances, and research and develop a training plan to increase speed and endurance. One could also incorporate strength training and eat better. To be very competitive, one could even hire a coach.

This isn’t necessarily the case for investors. While it’s important to have a basic of understanding of markets, additional knowledge doesn’t assure better results. Once you master the fundamentals, there isn’t much you can do in hope of outguessing the market with any consistency. It’s said that Warren Buffett only makes a handful
of investment decisions every year, utilizing about five or six fundamental data points. He can assess an investment in a few hours. He doesn’t need to spend his days agonizing over the direction of markets.

Consider actively managed mutual funds as an example. Typically, these mutual funds are managed by highly trained financial experts. They spend their days analyzing individual companies in an attempt to identify those that will outperform the market. Mutual fund management companies often hire top-of-class graduates of
elite business schools. Analysts have tremendous analytical capacity, utilizing sophisticated and often proprietary technology to create complex statistical models when evaluating the companies under consideration.

Despite their all of their knowledge, training, and effort, data reveal that, on average money managers fail to outperform their benchmark indexes. According to the semi-annual SPIVA study, almost 80 percent of all large cap U.S. equity mutual funds underperformed their benchmark index (the S&P 500) over the last five years.

Harder work, greater expertise, and state of the art technology simply doesn’t ensure success.

This reality is tough to accept, especially for accomplished people. Doctors advance their abilities though years of practice. Engineers need years of training and practice before they are ready to build a bridge. Tiger Woods reportedly started playing golf at age three and practiced constantly. Those of us who aren’t engineers, doctors, or pro golfers wouldn’t dream of building a bridge, performing surgery, or winning the Masters.

This begs the question: Why pay up for a professional money manager? A good investment advisor will acknowledge the futility of trying to outperform the collective wisdom of the market and focus instead on the client. For many investors this personal understanding and guidance is well-worth paying for.

A true professional will first and foremost maintain a well-diversified portfolio customized around certain asset classes suited to the client’s goals and capacity to withstand volatility. A sound plan based on empirical research is the best way to avoid the dangerous temptation to act impulsively. The advisor will also bring financial planning expertise regarding taxation, income planning, and future family wellness, all the while keeping a wary eye on the corrosive effects of investment-related costs.

In a nutshell, a good advisor will focus on your financial objectives rather than his or her forecasting prowess. The true professional will strive relentlessly to provide discipline, diversification, and financial planning at a cost intended to fall below industry averages.

Also In this Issue
The Pre-Retirement Checklist: Insurance and Annuities
Planning for College: The Basics of Financial Aid
The High-Yield Dow Investment Strategy
Recent Market Statistics
The Dow Jones Industrials Ranked by Yield
Asset Class Investment Vehicles