There was an interesting article in the New York Times a few days ago (“Testing What We Think We Know”) that discussed the exorbitant amount we spend on medical procedures that don’t do what we thought they would. Often times they turn out to be less effective than originally thought, and frequently there are unpredictable negative consequences that result from these procedures. The article makes the point that we should spend more effort determining if a particular course of action is likely to achieve its intended results before advising to do the procedure. Doing so could save an incredible amount of money while improving healthcare overall.
So what is the connection to the world of investing, you might ask? Investment professionals regularly advise courses of action to investors with very little concrete evidence that the particular advice will achieve the intended results. In fact, often times there is ample evidence that the advice is unlikely to achieve the desired results yet the advice is given anyway, either due to poor judgement, ignorance, or a variety of other less honest reasons. When I see investors flocking to today’s popular strategies: low-volatility, tactical allocation, fundamental indexing, absolute return, inflation-hedging, principal protection, and anything classified as “alternative”, I am amazed at the inability of those investing in these products and strategies to explain what they are, how they work, why they think they should/could/would work, or what evidence there is to support the strategy. And when you do find support for a particular strategy, it is often one-sided and fails to address the tough and most important questions about it.
Financial engineering today is as significant as it ever has been, and the marketing efforts behind a given strategy are very convincing. Investors who aren’t appropriately skeptical, knowledgeable, and analytical might easily believe the hope and hype that comes along with each new thing.
So to mimic the author of the NYTimes article, my proposal is that investors adopt a healthy skepticism for any and all “new” strategies that are brought before them and even review what they currently own even if it’s been around a while. Chasing an investment idea that looks good on paper or sounds good in a sales pitch, even if accompanied by lots of fancy charts and data, should be considered flawed until the support for it is verified independently and all costs of the strategy are taken into account when figuring performance results.
We in the investment industry are in a far more beneficial position than those in the medical industry in that we have ample data and years of history to help us understand whether a particular strategy is likely to deliver the desired results. We just need to have the intellectual courage coupled with a little analytical capability to identify the difference between reality and marketing hype. In the end, significant costs can be avoided and portfolio performance improved.
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