The Globe and Mail, Report on Business
Published October 21st, 2006
There are plenty of sports analogies that are appropriate to investing, but I find golf provides the most fertile ground. With both golf and investing, it takes only a small taste of success to keep us coming back for more. No matter how bad we are at either, we feel obligated to share our secrets of success with others (and we actually think they care). And both golf and investing turn us into prolific liars.
This column focuses on one other similarity. When at the driving range, most golfers practice the wrong things. We feel obligated to whale away on our humungous driver, knowing full well that we'd be far better off if we spent the time practicing our chipping and putting. Too often when we talk to our clients as investment professionals, we are talking about the wrong things. This valuable time is spent discussing matters that, at best, add little to the investment process, and at worst lead to poor investment decisions. We, too, are whaling away on our driver. We need to change the kind of dialogue we have.
Here are some examples of what I'm referring to.
Think about the time spent discussing what happened in the most recent quarter. For most firms, the reporting cycle is quarterly, so it's natural to talk about what happened since the last report. We talk about recent economic data, how the markets and portfolio did and what stocks or industries contributed to the results. To an investor, three months is a very short period and returns over that time frame are virtually random. In-depth analysis of the last quarter can only be described as noise.
When talking about where to invest new money, we like to talk about what has been doing well. I liken it to the sports predictions that come out prior to a new season. Last year's champion is always amongst the top picks. That makes sense if it's a team that has a profound competitive advantage such as the Yankees' payroll, the Oilers' number 99 or Duke University's Coach K. But if last year's winner was a solid playoff team that happened to put it all together for four weeks, it's quite a different matter. Unfortunately, in the investment management field, recent results don't reveal competitive advantage (i.e. superior research, a savvy portfolio manager). Long-term performance does. The single biggest reason that individual investors achieve poor returns is performance chasing. They too often buy last year's winner and end up with next year's loser.
What are the markets going to do for the rest of the year? The answer to this question shouldn't take up any air time, but it often dominates the conversation. It shouldn't take time because the answer should always be the same - "I don't know".
I talked to Doug MacDonald recently. Doug is one of the pioneers of the fee-only financial planning community. He was reflecting back on the development of his firm, MacDonald, Shymko & Company, when he said "it became much easier to do our job once we realized that nobody, including us, knows what is going to happen in the future".
There are other examples. Too often we talk about principal protection instead of building wealth by taking prudent risk. In the case of income trusts, the talk is mostly about current yield and very little about what the business is worth. And as for investment products, there is plenty said about convenience and all-in-one solutions (i.e. WRAPs, structured products, balanced funds) and very little about cost.
Looking ahead, it won't be easy to change the dialogue. I know from experience that clients want answers, even if the questions are unanswerable. For twenty years my father-in-law has been asking me which way the bond market is going. It's one of those things he expects me to know, and I'm starting to feel the pressure to make a prediction. Advisors have to deal with the same pressure on a daily basis.
Progress can be made if the investor, advisor and money manager all play a role. Individual investors can take a stronger hand in guiding the conversation by asking lots of questions. How is the portfolio positioned for the future? Are the mutual funds I own still being managed by the same people and with the same approach I bought in to? Rather than investing in a new product, should I put more money into something I already own? How much am I paying each year for advice and money management?
For our part as investment professionals, we can say "I don't know" more often. We can use unanswerable questions as a segue into what will make a difference to future returns: where the portfolio sits compared to the client's long-term asset mix; what the fundamentals look like for the firms in the portfolio; and how the client's future cash flows will be deployed.
Improving the dialogue will require more discipline on the part of both clients and advisors, but it's time we stop worrying about our distance off the tee and start sinking a few putts.