I have to admit that I’m a little bit biased since part of my business is to manage portfolios for a select number of clients. Knowing that about me, it probably wouldn’t surprise you that I find it both laughable and disturbing when I read articles, some of which appearing in major media outlets, advising people to ditch their financial adviser. I can tell you that it’s misleading and potentially destructive advice but you could easily argue that I’m biased. That would be a fair argument so I thought I would, instead, give you a little test so you can gauge how ready you are to manage your own money. What do you know about each of these topics?
Modern Portfolio Theory
MPT is the gold standard by which most money managers operate. They’ve studied its history and they can even quote to you the article and the author who started the movement decades ago. The armchair investor will tell you that MPT is about diversification. That’s true but it’s more about efficiency in a number of areas including diversification, risk, and taxation. Why would you pick a municipal bond fund with a lower yield over a corporate bond fund with similar risk? There are plenty of reasons why a muni could end up paying you more in yield than a corporate. That’s efficiency.
Why doesn’t the medical community allow individuals to evaluate themselves for possible mental illness? Because it’s impossible to have an unbiased, objective opinion over your own thoughts and feelings. If somebody were to ask you about your risk tolerance you would certainly give them an answer but how do you know if you’re right? I’ve seen this over and over. Somebody tells me they want an aggressive portfolio but as soon as the market drops 200 points, they’re calling me in a panic.
Day traders have a high risk tolerance, right? Wrong! They’re unwilling to keep their money invested more than one day and they set their exit points so tight that if they lose even a quarter of a percent, they’re out. That’s an exceedingly low risk tolerance.
There is another component to risk: Investors often act what in ways that statistically end up not being in their best interest. Studies show that investors tend to sell low and buy high resulting in 80% of do it yourself investors losing money. This comes from risk. They haven’t studied the markets long enough to know what is a short term correction and what is a systemic problem that requires action.
Do you have an academic understanding of risk? What do you know about behavioral finance? Portfolio managers don’t make money for you. They manage your risk which leads to profit in a way where you feel comfortable.
Efficient Market Hypothesis
What do you know about EMH? How many books have you read on this? Have you read Charles Ellis’ book, Winning the Loser’s Game: Timeless Strategies for Successful Investing? Did you know that statistically speaking it’s nearly impossible to beat the market over a prolonged period of time? Did you know that only a select few of the best investing minds have been able to beat the market over a prolonged period?
Efficient market hypothesis states that any information that you and I learn about a stock or other investment has already been priced in to it before we can react to it and sense you can’t tell the future, any forward looking positions calls you make on a stock are bets.
If that’s the case, why is it that so many non-professional retail investors choose to stock pick? Because they don’t know about EMH and how to use it to their advantage.
Here’s what I want to ask those people who are writing these articles: How many books have you read on investing and portfolio management? How much experience do you have managing money? If you were looking for somebody to help you manage the money you will live on in 20 years, would you hire you?
I completely understand that there are a lot, and I mean a lot, of financial advisers giving bad advice but that doesn’t mean that all of them are bad even some of the bad ones will do a better job than you, with little knowledge, will do for yourself. What you need to do is find the right adviser. Have you sworn off doctors because some aren’t very good? Do what you did when you were single and keep looking. Learn what to look in a high quality adviser. Hint: Say no to paying somebody commission!
And to the article writers who are giving this advice: You may be qualified to manage your own money and I applaud you for it but telling people who can’t even keep their credit card debt below five figures that they should manage their own investments is irresponsible and wrong.