I suspect that the concept of simplicity will become increasingly popular in the coming years. This may take many forms, including simplicity in eating, working and living. But one of the most important aspects of this trend will be investing simplicity.
As it stands now, most of the world’s investment vehicles are ridiculously byzantine. Against a more benign economic backdrop, this financial complexity might not be a big drawback. Unfortunately, we live in an era rife with excess, corruption and incompetence. All of this means that investing complexity, a trend that has grown exponentially over the last four decades, is rapidly becoming a global headwind. Your financial future will be much, much more secure if you get a head start on the trend toward investing simplicity.
Most of today’s popular financial vehicles, including mutual funds, ETFs and pensions, are not actually assets themselves. Instead, they are best described as empty shells that are filled with assets – usually stocks, bonds or real estate. Notice that most retail investors (that’s you and me) don’t own any assets directly, only these shell vehicles filled with assets. This layout exposes average investors to a host of risks that are omnipresent, yet poorly recognized at the present.
Pensions, for example, are at the mercy of a board of trustees. These board members may or may not know anything about investing. They may also be motivated to approve or deny pension investments based on peer pressure, political leanings or even outright bribery. This can cause pension funds to be stuffed with complex derivatives or illiquid, poorly vetted venture capital positions.
These situations can easily lead to rapid investment losses that can quickly drive a pension fund into insolvency. Indeed, pension funds are so underfunded at the present that they are experiencing an existential crisis. The Pension Benefit Guarantee Corporation, a Federal agency that insures corporate pensions, may go bankrupt within the next decade due to the number of insolvent corporate pensions it must bail out.
Unfortunately for pension holders, a pension’s board members all get to drive home in their German luxury cars to their gated communities regardless of how poor their decisions may have been. Meanwhile, average people like you and me are left to pick up the pieces of our shattered retirement dreams.
“Actively managed” mutual funds are another financial vehicle in dire need of investing simplicity. “Actively managed” simply means that a professional money manager makes the decisions about what individual securities will be held in a mutual fund. It could range from shares of Proctor and Gamble to mortgage bonds to anything in between.
Now, you might be wondering what the problem is. After all, the money managers making these decisions are “professionals”, right? Unfortunately, most money managers are subject to a psychological force known as “performance anxiety”. This is a fancy way of saying that they are under a lot of pressure to match the returns of their performance benchmark. This is important because a money manager who underperforms his benchmark for a year or two is at great risk of being fired.
The major effect of performance anxiety on money managers is to force them to buy assets that are similar to those contained in their benchmark index. This phenomenon is known as “closet indexing” and it is a bad thing.
Why? Well, closet indexing is terrible because you are theoretically paying for the seasoned opinion of an experienced financial professional. But what you are actually getting is the opinion of an index. Even if your money manager thinks investing like the index is a bad idea, he really can’t deviate from it very far if he wants to keep his job. And your money manager really, really wants to keep his job.
Of course, when the benchmark index inevitably plummets later in the economic cycle, your mutual fund will also plummet. However, as the famous British economist John Maynard Keynes once wrote, “…it is better for reputation to fail conventionally than to succeed unconventionally.” And your mutual fund’s money manager wholeheartedly agrees.
But perhaps the biggest reason to pursue investing simplicity is because all of these complex investment vehicles cost money. Mutual funds, ETFs, 401-Ks and pensions all charge fees. Worse than that, sometimes these investment shell vehicles hold other shell vehicles within them. For instance, an actively managed mutual fund might hold some ETFs or a pension might hold a hedge fund. In these cases, you will be charged double fees, usually without even knowing it!
I think the argument for investing simplicity is self-evident. Complex corporate or investment structures are never created for the benefit of average investors. Instead, they are always intended to either obfuscate risk or suck extra fees out of the unsuspecting.
This is one of the reasons I like precious metals, gemstones and fine art and antiques as investment vehicles. They are items you take direct physical possession of. And they are tangible, meaning they can’t be squandered by an inept board of directors or plundered by a self-interested money manager or lost in a market crash. Art and antiques are the very embodiment of investing simplicity. And that is something we desperately need more of today.
