Dirty Little Secrets

John Churton Collins, a British literary critic, once said “If we knew each other’s secrets, what comforts we should find.”

Frank Ocean, an American hip hop artist (who may or may not know anything about British literature) says, “I don’t have any secrets I need kept anymore.”

Well, the financial industry has a few secrets that probably shouldn’t be secrets anymore. Here’s a start on peeling back the curtain…

1) A lot of the time, nobody really knows what’s going on while it’s happening.

You already knew that nobody can predict the future. Perhaps you’ve even heard about the time when world famous psychic June Field had to cancel a show in Lancashire, England “due to unforeseen circumstances.”

Obviously the financial world is no different. There might be a guy who’s figured out some algorithm that predicts exactly what’s going to happen in the market every day, but if that guy exists, he’s quietly amassing enough money to buy his own island, not shooting his mouth off on CNBC every night.

There are some people who can very eloquently explain why things happened in the market after they’ve occurred. Although even in those cases, you might hear a couple of very compelling, but also very contrary narratives, with an explanation of what happened in the past. The truth is that it’s really hard to pinpoint the real causes and effects.

And there’s almost nobody who can tell you why things are happening while we’re in the throes of it.

If you’ve seen The Big Short, it actually depicts this concept pretty well in its chronicling of the 2008 housing crash. In retrospect, we all have a pretty clear picture of why and how that whole debacle was as bad as it was. But at the time, as you saw in the movie, only a select few really understood. In a town filled with skyscrapers full of hedge fund managers, you could count on one hand how many people actually knew what was happening while it was unfolding.

Lesson: If too much of your money is exposed to vehicles that move around in wild swings without logical or predictable explanation, you could be in trouble.

2) A lot of the arguments you hear in the financial world aren’t actually all that important.

Just what is the right percentage of international exposure to have in your portfolio?

Term life or permanent life insurance?

Should you buy front load, back load, or no load mutual funds?

Should you avoid mutual funds altogether and buy ETFs instead?

Pay off the house early or not?

And sure, to really refine your financial plan, you need to find the right answer to these questions for your situation. But those questions are comparing the merits of an apple and an orange, which may seem like two totally different things. Until you learn that you don’t need an apple or an orange, but instead you need a coffee table. Suddenly the differences between the apple and the orange don’t seem so vast.

Lesson: Don’t get caught up in the minutiae until you’ve really explored the big picture and you know exactly what you’re trying to accomplish. Once you do that, a lot of the details will either take care of themselves, or won’t matter nearly as much. But if you start with the minutiae, it’s possible you might never graduate from it so that you can move on to the big picture.

3) With a small sample size, it’s hard to differentiate between skill and luck.

In most cases, it’s virtually impossible to tell if someone was exceedingly wise in the investment that they picked, or if they just got lucky. Did that particular investor get lucky by having money in the right asset at the right time, or were they very skillful and took advantage of an opportunity? Or maybe some of both?

The problem is that I’ve seen some advisors build an entire career based on one or two risky decisions where they made the right call.

There’s one particular fund manager who famously moved almost all of his fund’s assets to cash in October of 2007, right at the absolute peak of the market before the bottom fell out. His fund’s performance prior to that had been underwhelming, and the performance since has been underwhelming, but if you look at the last 15 years as a whole, the average return is really good because he avoided the huge drop.

Is he incredibly skillful or incredibly lucky? Who knows? But he’s built quite an empire for himself, now charging well-above-average management fees, thanks to what was essentially one really good decision, surrounded by a bunch of average-at-best decisions. We’ll see if he gets it right again before the next crash. But “wait and see” is the only way to find out.

Lesson: Don’t base the foundation of your retirement on someone who hangs their hat on one or two good decisions. Body of work is important.

4) The bolder the opinion, the more people pay attention to it.

In the cable news era that we’re living in, the more confidence and false-bravado you have, the more people are attracted to your opinions.  “I don’t know” is one of the least used phrases in the financial industry, but many times it’s the correct one.

Lesson: Just because someone seems to see everything in very clear black and white terms, that doesn’t mean that their advice is better than someone who sees the gray area. You need an advisor who can help you understand all sides of an issue.