I found your review of Wealthfront and Betterment very interesting. I have also been following the new start-ups in personal investing, including SigFig, Covestor, and Personal Capital. I am surprised that none of them have ventured into the 8 areas where I have the greatest need (for my own investing style) -- please see full description here: http://diaryofawimpyinvestor.blogspot.com/2012/03/getting-ready-for-broker-customer.html I would appreciate your thoughts on any or all of these new product concepts.
My Reply
Thanks for writing. I'm afraid you won't like my opinion of most of the investment areas you listed. That's probably not surprising to you since yours and my philosophies on investing appear to lie at the opposite ends of the active-passive spectrum. In a nutshell, I believe your philosophy is to take the bull by the horns, to actively improve your trading and investing skills, to seek out undervalued investments, and to try to time the market, whether as contrarian or as a trend-spotter. My philosophy is that any and all such active management has 50% chance of generating alpha but 100% chance of generating very significant frictional trading costs (not to mention taking a lot of time and effort) so the logical thing to do is instead to follow lowest possible cost (with potential taxes being a major cost component), most possible diversification buy-and-hold with equities/bonds split appropriate to your particular need and ability to take on investing risk.
My philosophy, of course, comes with a rather big asterisk. As a successful trader I do know there are truly great active investment strategies out there (much more so in the past than now, but perhaps I've simply been left in the dust by the new generation of Wall Street's best and brightest -- or, ahem, their severs co-located with exchange computers). Unfortunately, these opportunities have always been exceedingly rare and fleeting and they most definitely do NOT lie in the crowded fields scrutinized by tens of thousands of professional investors, tens of millions of amateur ones, and trillions upon trillions of CPU cycles.
If you look where everyone else is looking your chance of success will be determined purely by luck -- and that holds whether you are a trend-follower or a contrarian -- because "everyone else" includes plenty of individuals and institutions who are at least as smart as you are, just as capable of analyzing both the long and the short aspects as you are, and likely have access to far more capital and resources than you do. I have a soft spot in my heart for contrarian strategies but realistically it's still a losing game relative to buy-and-hold because of those ever-present frictional costs, though if you held a gun to my head and forced me to choose to be a trend-follower or a contrarian I'd choose the latter.
To have a better than 50% chance of generating positive alpha you have to stop looking where the rest of the crowd is looking -- and it does not matter whether you are looking and nodding or shaking your head. The crowd's looking at and arguing about an investment is your first and only sign to not even bother. Call it the Crowd Test. Think of an analogy with science: do you think a given scientist has a better chance of making a major discovery in an established, crowded field with thousands of other researchers or in a brand new field that only he and a handful of others are even aware of? Sadly, such new fields are very hard to come by, which is why consistently generating alpha year after year and decade after decade -- in face of those ever-present frictional costs -- is such a monumentally difficult undertaking. But because so many millions of investors do play the active management game of near-impossible odds it is inevitable that some of them do win it -- just like somebody does win the lottery. And determining whether they won the game through skill or through luck is far from trivial. A simple test of whether a game is that of skill or of luck is to see if you can intentionally lose it. It's trivially simple to intentionally lose a game of basketball or chess. It's a little harder to intentionally lose at Blackjack, but still very doable on average. But just try to intentionally lose money in the market by picking poor investments. You will find that it's every bit as difficult as picking good ones. But anyway now I am really digressing... Let me get back on topic and go through your list of 8 under-served investing areas and give you my opinion of each.
Suite of Sentiment Indicators. Right off the bat, this one fails the Crowd Test. The very fact that there's a sentiment concerning investment A means that there are many investors looking at A, which in turn means that if there ever were opportunities here, long or short, they are all gone and what's left is that statistically inevitable 50% chance of alpha with 100% chance of expense drag. I.e. casino odds where the house always wins.
Proforma P&L by Decisions. This one I can sympathize with a lot more. It is hugely important for all investors -- and definitely all active investors -- to continually scrutinize their past performance. I wrote several posts about that, including http://www.longtermreturns.com/2012/03/benchmarks-for-investors.html. Of course I come at this from the angle of benchmarking own performance against the market as opposed to against other active management, but almost any benchmarking is better than none -- and most investors do none. Note that it is not in any investment advisor's interest to help you gather this information since it will clearly show that vast majority of advisors are a guarantee of poor returns over long enough period of time.
Behavioral Economics Applications. This one feels a bit ironic to me since the way I see it the biggest behavioral investment mistake is to engage in active investing in the first place. But this does fall in the same generally useful bucket as the previous one -- a way of checking oneself to avoid making the same mistakes over and over.
GTAA, Absolute Return, Risk Parity. No kind words for these. GTAA and Absolute Return are marketing buzzwords, not strategies. Any random set of trades can be correctly described as GTAA and any combination of long and short positions can be described as Absolute Return. Risk Parity is an obviously horrible idea -- see http://www.longtermreturns.com/2012/06/dividend-yields-risk-parity.html.
Market Map / Flow of Money / Who Owns What. Don't really have a comment for this one besides that it fails the Crowd Test since by definition what is owned and what is traded is what crowds own and trade. I doubt any useful information can be gleaned from this.
Social Investing / Web 2.0 Analytics. Color me deeply skeptical. Again, if people are talking about it, there is probably no point bothering. Now, if you are talking about starting a financial services company that sells aggregated web 2.0 state-of-the-minds to
Advisor / Client Relationship Management Tool. This will happen because it's a great marketing idea for the said advisors. There are myriads of ways that all these web 2.0 (3.0, 4.0, ...) whiz-bang technologies can enable them to sell still more useless strategies and harmful advice to naive individual investors generating ever more revenue for the advisor/broker. Obviously, this isn't such a great deal from the individual investors point of view. But yes, this is already happening with tools like ThinkOrSwim that bombard you with invitations to various live on-line seminars throughout the trading day to "learn" to trade still more markets with still more strategies. The pace will only accelerate.
Modeling Various Playbooks. These are great to play with. By the way, here is my contributions to this space: http://www.longtermreturns.com/p/historical-investment-returns.html , with built-in benchmarking of own results if you are so inclined! I think the availability and feature set of these tools will continue to grow, just because there are so many individuals who have the skill and interest in creating them. Once they are widespread enough they will probably become part of the standard features for most brokerages. Again, these can be great selling tools when used by the advisors/brokers. "Here is a strategy you could have followed from the peak of the housing bubble to the resolution of the Euro crisis that netted 450% return! Now sign these forms, transfer your funds over, and get ready to be rich!"
As I warned you, these have not been overly complimentary observations. But I do want to thank you for writing and for at least trying to present the world of investing from the other point of view. As I said, our idealogical divide is probably far too wide for meaningful common ground.
No comments:
Post a Comment