The Illusion of Activity

As a financial planner, a not-small part of what we do is manage money for clients. More than a hundred million dollars is placed in our responsibility, which is simultaneously a lot of money and also a very small amount of money by industry standards, where some firms are responsible for billions and even trillions of dollars. “It’s all relative,” you might say. A popular jab at the investment management crowd by the non-investment-managing crowd in the industry is “complexity is job security.” A fair observation that many investment portfolios are needlessly complex simply to create the illusion for clients that their investments are somehow being managed in a select and bespoke manner that only a true investment professional can understand.

Speaking as a relatively dispassionate manager of client money, I find myself largely in agreement with that sentiment. While we take pride in the money we make for our clients through investment, we’re rather clear in our belief and assessment that most trading activity is noise, and that activity itself can be largely counter-productive. We evidence this with regular due diligence and infrequent trading for our clients; being watchful but not being overreactive to the excitement or crisis of the day.

But in a nation of over 300,000 professionals calling themselves some variation of “Financial Advisor,” and in which the vast majority make their money from an investment management or brokerage process first and foremost, one must wonder: If clients “must” be assessing their advisor by whether they make them money or otherwise avoid losing their money, what’s all the “activity” for? Good question. This week, we’re talking about financial theater versus behaviors that actually move the needle, and the importance of what we can control and what matters.

Financial Theater

For those followers of the show “Your Friends & Neighbors,” starring Jon Hamm among other beautiful and talented performers, you’ll be familiar with a recent plot point. An otherwise unscrupulous businessman with some illegitimate interests wants to invest in the protagonist’s old hedge fund, the “Excelsior Fund,” which won’t just take anyone’s money. While the specific nature of the investment style or thesis of the fund is never explicitly described (it’s a show about finance people committing petty crime in a rich neighborhood, not high finance), a major plot point of the episode is that the fund is so exclusive that only a select few can get into it. This is, generally speaking, nonsense.

It’s nonsense because the amount of money in question ($400 million dollars) is more than sufficient to buy access to just about any publicly traded investment or hedge fund. Investment minimums in most of the investment world start at $1 million and often rise to $10 or $25 million, or even $100 million in select cases. But I’ve never seen or heard of a fund charging 2-and-20* turning away almost half a billion dollars; more importantly, though, what could be so special about a fund’s research or trading process to warrant such an exclusive club of investors? The probable answer: Nothing but the illusion of excellence. Not to say the fictional Excelsior Fund couldn’t be a top-performing gem in the marketplace for such investment products, but simply that any such fund would be more than incentivized to take money from anyone meeting its investment minimum; after all, $400 million would be a guaranteed $8 million in fees over the first year before the fund ever made a penny!

But the same happens even down here at the “retail” level of investor. Investment shops on every corner offer “bespoke” investment solutions that are little more than pre-packaged mutual fund wrap programs. As far back as my time at Waddell & Reed, we the advisors were being encouraged to put some if not all of our clients into automated ETF programs run by big names like State Street and Blackrock; not because they were superior products and services, but because those big companies would manage the accounts for us, charge their fees (0.25% + proprietary ETF fund expense ratios + our 1% advisory fee) to the client, and leave us the advisors to focus on finding the next investor instead of doing any actual work for our clients; and you wonder why I left, eh?

But you can imagine how such things sound to an unsuspecting client!

“Mr. & Mrs. Client, I’m very excited to present to you our Black State Street Rock Excelsior program. This investment portfolio will be managed exclusively by the top portfolio managers at one of the largest investment managers in the world, utilizing top-of-the-line products from their own ETF portfolio and given daily attention, provided by the best-in-class research their teams provide. My advisory fee won’t be changing at all, and it’ll only cost us a nominal fee to add your account to their suite of platinum-grade services.”

Translation: I’d like to outsource all the work on your account to a 3^rd party and get paid as much as I was getting paid before. Did I mention every dollar invested in this goes into a drawing pool with my fellow advisors for a trip to Napa?

It reminds me of Office Space. “The Bobs” come in to ask everyone the infamous question: “What is it you’d say you do here?” “Convince clients to buy multi-layered investment products so I can hit my quota” just doesn’t have the right ring to it, but it would be an A+ checkbox answer in a large part of the industry.

So what do you take from all that? Don’t invest your money with big firms? Sadly, that’s not the right takeaway, satisfying as it is to stick it to the financial Goliaths of the world. Rather, it’s that there is a direct and proportional correlation between the complexity of an investment strategy and the costs likely incurred to implement it, and in turn, an inverse correlation with the likelihood that your portfolio’s performance will meet your expectations long term. It’s also to acknowledge that your greatest point of cost is likely to occur both at the point of sale (the financial advisor) and that any attempts by that individual or level of firm to then outsource the actual work** being done for you should be viewed with intense skepticism.

*2-and-20 is a hedge fund norm, in which the base expense ratio of the fund is 2% and the fund also gets a bonus of 20% of profits measured on a quarter-over-quarter basis. So, for example, a hedge fund growing 10% in a quarter would be paid between 2%-2.5%, depending on whether the 0.5% quarterly fee from the 2% product fee was calculated before or after the 20% performance fee.

**Fun fact, the same investment management wrap programs being offered to our clients for 0.25% at W&R at the time were available for free to independent advisors and for free directly to consumers who knew where to look. In fact, they still are.

What You Can Control

In contrast to the high activity example shared in the case of complex financial products or outsourced investment managers, let’s look at the most meaningful needles we can control when it comes to financial outcome: saving, rate of return, and expectations.

It’s no surprise that saving behavior is going to have a significant impact on the outcome. Save everything you own, and you’ll be as wealthy as you could possibly be, and save nothing, and you’ll fail to build any wealth. The natural medium for a lot of people revolves around rules of thumb, such as “saving 10% of your income,” or in other cases, is the throughput of a budgeting or reverse budgeting process. Regardless of how you set the benchmark, the more meaningful components that contribute to the success of your savings behavior are going to be consistent frequency over time and time itself. That is to say, it’s more meaningful to reliably save almost any amount over the long term rather than trying to spot-check your long-term saving and investing behaviors.

The challenge with trying to eyeball it on a quarterly or annual basis is that the subjective need of the short term can too easily overpower your long-term objectives. If you’re saving $1,000 a month into your 401(k) like clockwork, that money is effectively “spent” in your subconscious. But make a conscious decision to invest $3,000 a quarter in the same 401(k), and suddenly, questions arise. “What about that repair I think is coming up? I’m taking a vacation next month, maybe I should hold onto the cash in case an emergency pops up? I know I didn’t contribute last quarter, but now it’s April, and I have a tax bill I have to pay, so maybe I’ll wait until next quarter.” On and on the rationalizing goes until suddenly you’re sitting on a pile of less valuable cash and little interest to show for it, or worse, you’ve reabsorbed what should have been saved back into your expenses.

The rate of return seems paradoxical in that we just tried to emphasize heavily that investments are important, but keeping it simple is just as important as in the past segment. However, people often misunderstand the rate of return as existing on a spectrum from 0% into infinity. I can not invest, and I’ll get a 0% return, or I can invest, and I’ll get [something]. That’s a lovely notion, but when you account for inflation, your default rate of return is actually more like -3%, and your top line is commensurately lower. Gross returns of 10% have been achievable based on an aggressive and equity-heavy orientation, particularly over long-term periods of time. But in turn, while you might think the safer thing is not to be so aggressive and not take on so much risk, the world is full of institutions happy to trade you a sense of security for a margin on your capital.

Corporations are not offering bonds to the public because they can’t make payroll, generally speaking. They’re offering bonds because they’ll happily pay you a “guaranteed” coupon of 3% or a bit more based on their credit score in return for converting your capital into assets and products that will yield 10%, 20%, or 30% margins. As the author Nick Murray puts it, “The best return on your money is to be the owner of the company, not its lender.” That isn’t to say more conservative assets don’t have their place! But there is often a human hunger to experience an unrealistic expectation: “I wish to lose zero money at any time, and also I wish to get or exceed the return of the S&P 500.” It’s a desirable outcome to be sure, but the S&P 500 itself doesn’t get perfect returns day over day, week over week, or year over year. It shows a strong positive growth over a period of years and decades, and not one that is so easily ignored by the normal person on an emotional level!

What Matters

It’s a keen indicator to us as financial planners that our happiest and best clients are those who least often bring up the subject of their investments. They don’t forward us articles about novel products or profiles of fund managers or podcast interviews with someone claiming 10x returns with a “little-known strategy.” They come and sit with us to talk about their family, their career, their hopes, and their ambitions.

A truism you learn early on as a financial planner is that no one is ever convinced solely by the numbers you present them. How easy our jobs would be if it were the case! Instead, we find ourselves discussing that which matters to our clients. While money is often the measuring stick by which we measure the permission we have to do what we want with our lives, we’ve never observed that our clients with $5 million are any happier than our clients with $1 million. Clients in both camps are somewhere on the continuum of “getting to my enough” to “having my enough”, and there’s more in common in those categories between households than there is in the number at the start of their account balance or the number of digits in their account balance.

Ultimately, money leads us to temptation to overcomplicate our lives. We’re tempted by offers of 13% “guaranteed returns” from Facebook ads not because the number is bigger than normal, but because the lifestyle they couple the number with looks like a life worth living. We see a fit gal on a mountaintop, or a father laughing with his kids in a waterslide, and we associate these positive images as being meaningful in the pursuit of our own great lives. “If only I had more money, I could…” The thought goes.

But you can. If you’re the type of person to be reading this blog, I’d ask the question, “What’s stopping you?” I’d all but guarantee it isn’t money. We fall for the illusion of activity, that “doing something more” is going to be the thing that gives us permission to do that thing. But doing something different in pursuit of what we actually want is merely falling into the trap that “more activity” is going to make the difference that we couldn’t already simply give ourselves permission to enjoy now.