Well known investment advisor James O'Shaughnessy was profiled at 25iq by Tren Griffin. Griffin cited a dozen quotes from O'Shaughnessy and then weighed in on those insights. A couple of the quotes were of particular interest and I wanted to add my own two cents.
... So we don’t make forecasts in terms of what the market’s going to do over short periods of time because quite frankly, we don’t know. And if others were honest, they would have to admit that they don’t know, either...
A related point is that the stock market will average some annual return over the period of time relevant to your financial plan. You have no control over what that number will be. With history as a guide, maybe it will be between 7% and 10%. Some investors will of course exceed that average but most won't and it isn't prudent to have a plan that relies on outperforming that long term average relevant to your time frame. A good bet is that you will have some years that you outperform, some where you lag and overall maybe be a little behind on an annualized basis. That average return you get plus your savings rate will be what you draw upon when you need access to your money. One way to boost your average return is to avoid stupid behavior like panic selling or learning you took too much risk after something bad happens. An adequate saving rate and just going along for the ride with the equity market subject to proper asset allocation can absolutely get the job done.
I think I know that the majority of active stock market investors—both professional and aficionado—will secretly believe that while these human foibles that make investing hard apply to others, they don’t apply to them.
He's probably right but I do believe that at least some of this can be overcome. The first step is awareness of what you're vulnerable to. I've said many times that I am a sucker for a good story. They all sound good, well many of them. I've trained myself to tune out the hype. I make no claim of infallibility of course but as one example, I am aware of a flaw and have made attempts to mitigate the consequence. An easier one that is probably a more global issue is people believing that "this time is different." I've written more times than I can remember that every so often the market goes down a lot and scares the hell out of people, then it stops going down (often for no reason at all) and then it goes on to make a new high. The only variable is how long that all takes. If you're asking me, that will always be the case, the only variable is how long it takes. If you don't believe that then you may want to sell while we're in spitting distance of the all time high.
It is the emotional side of investing that destroys even the greatest minds. If you can’t master your emotions all the data in the world can’t save you.” “I know that, as a professional investor, if my goal is to do better than the market, my investment portfolio must look very different than the market. I know that, in the short-term, the odds are against me but I think I know that in the long-term, they are in my favor.
Again, behavior. But also I would push back on an advisor's goal to outperform the market. As an advisor, my first priority is that clients can maintain a reasonable lifestyle (reasonable in relation to their career earnings). My next priority is to do all I can to make sure clients don't succumb to their emotions. One way I have addressed this issue before is to ask a question like "quick, without looking, how'd your portfolio do in the third quarter of 2015?" No one ever knows because it doesn't matter unless something catastrophic happened. Having been at this a little while and gone through the worst financial crisis in 80 years with clients and come out the other side with a long bull market all the while retired clients continuing to access their money as needed, it is clear to me that lifestyle matters more than basis points.
If you look back to the most spectacular blow ups in history, you can always tie them to a couple things: They were extraordinary complicated strategies that maybe even the practitioners themselves didn’t understand, and they were overleveraged.
Leverage is a tool to be used or misused as we looked at a week or so ago. While everyone knows they should keep it relatively simple, that can be easier said than done. Back to behaviors, there is an allure to relatively sophisticated strategies that appeals to people's sense of vanity by having access to something that appears to be exclusive. Buying one broad based equity index fund can get the job done in terms of getting pretty close what you think you need in retirement. Beyond that how much do you want to do to make it less simple than that. Personally, I want to smooth out the ride to help manage volatility which in turn plays into my comments above about clients' experience and needs. I spend a lot of time studying to improve that aspect of what I do as well how to have a reasonable upcapture in clients portfolios. My guess would be that most investors do something similar in terms of capturing the market's gains, monitoring portfolio holdings and how to do things a little better. What is simple versus what is complex in following the path of that last sentence will vary depending on who you ask but ideally if you are managing your own account you think what you're doing is simple, ditto if you're an advisor managing for others.