Why the investing industry loves complexity
Posted by Robin Powell on October 26, 2015
I was contacted the other day by a company asking if The Evidence-Based Investor would like to feature some research it had done into a new system of investing which it plans to bring to market. I was happy to take a look but I barely made it past the first paragraph.
The blurb I was sent was so complicated and so full of industry jargon that it had me completely lost. I wish the firm well and, hey, it may even be on to something, but this experience epitomises for me one of the biggest problems with the investing industry today.
Investment professionals love complexity. That, combined with a lack of investor education, is how they make their profits. As a former Goldman Sachs money manager once revealed, “The quickest way to make money on Wall Street is to take the most sophisticated product and try to sell it to the least sophisticated client.”
We already have far more investment products than we actually need. There are now upwards of 77,000 mutual funds to choose from worldwide — that’s more funds than individual stocks. Competition is hotting up in the ETF sector to produce the most obscure and complicated product imaginable; and despite the ever-mounting evidence that investing in hedge funds is a sure-fire way of losing money, the rate at which new hedge funds are being launched is actually accelerating.
Of course, all these new funds need explaining and evaluating, hence the need for armies of consultants to advise institutional investors. This proliferation of products also helps to explain why, at a time when most of the journalism industry has contracted, the financial media has grown.
But although it’s the industry’s friend, complexity is usually the investor’s foe, as Ben Carlson explains so eloquently in his excellent new book, A Wealth of Common Sense: Why Simplicity Trumps Complexity in Any Investment Plan.
“As the number of investment options available to investors continues to increase there is the assumption that complex approaches must be better,” says Carlson. “In fact.. less is always more and trying to implement a more interesting or clever portfolio strategy is akin to threading the needle. Sure, it can work, but trying harder and increasing the number of decisions you make only increases the odds that you’ll make a mistake.”
Yes, the financial markets are hugely complex — far more complex in fact than many investment professionals realise — but a complex portfolio is not the answer. On the contrary, the simpler and more low-maintenance your strategy is the better. In investing, simplicity really is the ultimate sophistication.
But Carlson goes on to explain how, counter-intuitively, it’s actually easier (as well as commercially beneficial) for the investing industry to maintain its culture of complexity. As Nassim Taleb explains in his book Antifragile:
“A complex system, contrary to what people believe, does not require complicated systems and regulations and intricate policies.. Yet simplicity has been difficult to implement in modern life because it is against the spirit of a certain brand of people who seek sophistication so they can justify their profession.”
Like fund managers, consultants and financial journalists, another group of professionals who might feel threatened by the growing trend in global investing towards greater simplicity are financial advisers. I’ve heard some advisers say the reason they won’t adopt a simple, transparent, evidence-based investing philosophy is that they’re worried their clients would refuse to pay them as much if they did.
But that completely misses the point. Picking funds is a very small part of proper financial planning, and continually moving clients’ money from one fund to another has nothing to do with it at all. Also, despite being simple, investing is not easy. There is a difference. Most of us need a financial adviser to keep us on track through thick and thin, to point out our emotional biases and to protect us from those self-destructive tendencies that all investors are prone to.
Yes, the industry is gradually moving towards lower costs, greater transparency and much more simple investment portfolios, but good financial advice is as valuable as it’s ever been.
The future belongs to advisers who embrace simplicity. It’s those who try to blind investors with complexity who should be worried.