Advice from notables (part 2 of 2)

"Don’t assume that a complex strategy is better than a simple strategy. The only thing extra complexity is likely to add is extra cost."

-Rick Ferri

It’s difficult to select just one piece of advice that Rick Ferri has offered over the years. He has written several books, including Asset Allocation and The Power of Passive Investing, which have both given investors a plethora of information on how best to navigate the markets. His advice couldn’t be more straightforward: keep it simple. There’s no reason to overcomplicate an investing strategy, especially when most of the time, an investor could buy and hold a basic S&P 500 index fund and enjoy returns that outpace the average investor who actively trades in and out of stocks.

Complexity does not mean you’re guaranteed large returns. It usually just means you’re paying top dollar to have someone create an unnecessarily complex plan to hopefully beat more than that simple index fund. Ferri’s advice is basic but profound; keep it simple and reap the benefits.

“The mutual-fund industry sits at the center of a massive market failure. The asymmetry between sophisticated institutional providers of investment management services and unsophisticated individual consumers results in a monumental transfer of wealth from individual to institution.” -David F. Swensen

Swensen manages a staggering $25 billion for one of the biggest endowments in the world. Yale University has entrusted Swensen for decades, so anytime he offers advice, pay attention. His most renowned work to date is entitled Unconventional Success: A Fundamental Approach to Personal Investment. In the book, Swensen discusses many failures of the investment industry, including the one vehicle that was ironically supposed to even the playing field for the average investor.

The mutual fund was a way for investors to pool funds to cut down on costs, broadly diversify, and give the everyday investor a chance to earn a return that wasn’t always available before its time. Fast forward to today and the mutual fund has become a vehicle by which institutions capitalize on individuals' lack of knowledge by extracting fees without much reservation.

In a perfect world, individuals would be the sole owners of the shares in a mutual fund, limiting the expense and thereby guaranteeing higher returns than if higher fees were incurred. As it stands, institutional fund companies market en masse, passing their advertising costs on to the investor. There’s a reason you rarely see fund companies such as Vanguard or Dimensional airing commercials during primetime slots on CNBC. The same cannot be said for Fidelity or BlackRock. To be certain, the latter are publicly traded fund companies that must increase shareholder returns at the expense of the investors in their funds. There’s no way around this. It’s a massive conflict of interest that often goes unnoticed. When possible, go direct from the fund actually offering the investment vehicle. Eliminate the middleman, and try to use fund companies that don’t rob Peter to pay Paul.

“The basic assumption that most institutional investors can outperform the market is false. Today, the institutions are the market. Institutions do over 95 percent of all exchange trades and an even higher percentage of off-board and derivatives trades. It is precisely because investing institutions are so numerous and capable and determined to do well for their clients that investment has become a loser’s game. Talented and hardworking as they are, professional investors cannot, as a group, outperform themselves. In fact, given the cost of active management—fees, commissions, market impact of big transactions, and so forth—investment managers have and will continue to underperform the overall market."

-Charles D. Ellis

Charles Ellis sums it up perfectly with this quote. Institutional investors cannot all be winners because most of the time they’re trading with themselves. If one institutional investor trades with another institutional investor, one will come ahead and the other will lose on the trade. Because the vast majority of trading is done by institutions—as opposed to individuals—the money managers, investment advisors, and marketing executives cannot claim to, as a whole, outperform the market itself. If we use the S&P as the benchmark for “the market,” institutional returns when taken in aggregate will not match the benchmark because payroll needs to be met, lights have to be kept on, and to prove their worth, institutions need to attempt to add value by spending big money on research to oust their competition. It’s better to be the market, than attempt to beat it.

"There are two kinds of investors, be they large or small: those who don't know where the market is headed and those who don't know what they don't know. Then again, there is a third type of investor: the investment professional, who indeed knows he doesn't know, but whose livelihood depends upon appearing to know."

-William J. Bernstein

This is one of our favorite quotes because it highlights how most talking heads in the media act when asked what they think is going to happen with the markets in the future. The really knowledgeable ones will admit that they have no idea what’s going to happen tomorrow, next week, or within the year. Pay attention to those people because chances are they know what they’re talking about. More often than not, though, market pundits will tell you exactly what they think you should do, right down to when and what to trade, with no limits to what they think will happen in the future.

Educated predictions are fine for extended periods of time, but when someone goes on TV and claims to know what a single stock is going to do the following day, it’s pure speculation and a disservice to anyone who heeds that advice. They pretend to know precisely because that is what puts food on the table. If they really did know, they wouldn’t need to be on TV pitching you about the next best stock to buy or the next big bust to avoid.