Investing Is Hard

Posted by Brad McMillan, CFA, CAIA, MAI

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This entry was posted on May 24, 2018 11:05:42 AM

and tagged Investing

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investingAfter last week’s posts on how I invest, I have been talking with a number of people, in person and online, about how they approach investing. It has been a very interesting and educational week, and I have come out from it with one conclusion: investing is hard.

Now, this may not seem like much of a conclusion. What makes it interesting is that, for most people, the facts behind investing are not that hard. But success over time requires us to go against what almost everyone else thinks—and that is hard.

Onion in the fruit salad

I know this personally. My job, in many respects, is to be the onion in the fruit salad. If I tell people something they already know and are acting on, then I am not really adding much value. If, instead, I can make them think of something few people are thinking of—or, even better, make them act on something meaningful—then I have actually added some value.

As an example, I first got the nickname “Eeyore” in 2007, when I was pointing out that housing was overheated and markets were very expensive. It wasn’t a popular view at the time, and the nickname wasn’t necessarily a compliment. On the other hand, in 2011 or so, I turned positive and have been so since. Most recently, with the pullback in 2016, I stayed positive. All stances that, at the time, were not all that popular.

This isn’t to toot my own horn. I got lots of things wrong, including staying negative for too long. I continue to get lots of things wrong, especially in the short term. Investing lies at the intersection of human behavior, economics, and pure chaos. With all of the data we have, no one can predict the madness of crowds. One of the major factors driving portfolio performance is random chance, which we can’t control.

Limiting the effects of uncertainty

Because of that, it is important to focus on what we can do. The goal of my research is not so much to eliminate uncertainty (not possible) but to manage and limit the effects of uncertainty. To that end, data is useful, if not completely definitive. This is why I do the monthly economic and market risk updates: to quantify risk. This is also why I start paying attention when the indices hit their 200-day moving average: to quantify uncertainty. By looking at the data and at history, we can get a pretty good idea of where we are in the short term and then decide if that makes sense and is consistent with what markets are saying.

This approach works most of the time. But then comes 1987. Or the flash crashes. Just when investing looks easy, is exactly when it can turn hard. The comparison I use is with Waze. It is a wonderful tool, I use it a lot, and it is perfect for stable conditions. When we get a snowstorm, though, when trees are down and roads are closed? Not so much.

The discussion around my recent posts reflects that difference. Many people have different approaches, well-reasoned and thorough. They make a lot of sense and may well end up being better. For me, though, many of them also presuppose a level of knowledge we simply cannot attain, especially about the short term.

Managing risks in the short term

My own approach acknowledges that limitation and is focused on managing the risks in the short term, while using data to drive the long-term results. This very often—unavoidably—means going against current trends (i.e., being the onion in the fruit salad). It can also mean worse short-term results, with dollar-cost averaging a great potential example of this. Do I like this? No, but I understand the alternative may well be worse.

When I look at the single solutions out there, I wish I had that certainty. But I don’t. It would certainly be easier to invest that way and stay with the crowd—but I know the world doesn’t work that way.

Add value over time

This is a key part of the value that I and other financial professionals provide: to stay apart from the immediate trends and navigate even when conditions get difficult. When investing is easy, it does look easy. The Nifty Fifty, the E-trade baby, and more recently bitcoin all looked like easy roads to wealth. They turned out not to be. If we, as a profession, can keep our eyes on what matters, regardless of fashion, then we will certainly add value over time. The short run can be a little tougher though. Indeed, investing is hard.

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