KISS – Keep It Simple, Stupid.
That advice can apply to most things in life. It may be true for investing as well.
As financial advisors we have access to tons of academic research, white papers and other sources of navel gazing.
But the reality is that most investors prefer to KISS. And maybe they’re onto something. Yes, we try to demonstrate our added value through complex algorithms for developing portfolios that hew to the orthodox investing principles of Modern Portfolio Theory (MPT). Yes, we can create a portfolio which includes the tiniest slivers from this or that asset class because the statistical analysis shows an improvement in lower betas or covariance or some such other high math concept when we add this or that asset into the mix.
But maybe we’re all a little too cute and clever for our own good. Maybe all that’s needed is boiling things down to simple choices, simple decisions.
Finance Is Not Rocket Science
Recently, I watched Apollo 14 with Tom Hanks again. This is an awe-inspiring film about courage, perseverance and ingenuity in the face of long odds and adversity. There are a lot of heart-pumping moments in the film. But to make my point, consider this: Launching three human beings into space on the top of an explosive firecracker held together by innumerable complex systems comes down to this question and word answer. Do we launch, asks the flight director by running through the roll: GO or NO GO.
In a much less dramatic fashion, I can recall a poignant lesson in finance from a corporate finance class case study years ago at Bentley. In dealing with a decision to invest or not invest corporate resources into a particular project, we had to develop a detailed spreadsheet of the expenses and revenues resulting from the investment. We then had to figure out the Net Present Value (NPV) of these cash flows by discounting the net income or loss to the present. Lots of moving parts involved (not as many, certainly, as an Saturn rocket).
We also calculated the Internal Rate of Return (IRR) and figured the Return on Investment (ROI) and all manner of decision metrics.
With the precision of fully-immersed left-brainers we calculated these numbers with precision to the fourth or fifth position to the right of the decimal point (i.e. the IRR for the project is 4.17662 or the ROI is 15.87772). We had absolute certainty and faith in the numbers telling us all we needed with such scientific precision.
Art, Science and Investor Behavior
What we learned that day from our professor, a veteran of real world corporate finance, was that nothing in life is that precise and predictable when it comes to finance. Finance (and by extension investing) is as much art as it is science. (It may actually be more art than science especially if you look at technical analysis).
So, the best that one can sometimes get when making a financial decision with imperfect and incomplete knowledge in a world filled with uncertainty is boiling it all down not to a precise string of numbers after the decimal point but to a simple set of choices: GO or NO GO, SAVE or DON’T SAVE, INVEST or DON’T INVEST.
Because behind all the fancy math and software, all investing comes down to for most investors is behavior. Too many choices in a 401(k) simply causes confusion or bad choices or no choice at all. Who’s better off with that choice then?
We have more and more technology allowing an almost limitless number of investments into our 401(k) plans. Politically and to avoid being sued, most advisers will probably suggest 15 or 20 to a plan sponsor. But the reality is that we can do more with fewer.
A Simple Choice: One and Done
With fewer choices confronting a plan participant, the decision is easier to make: Invest or not. Save or not.
And while they may not be the “best” examples of a perfect “efficient frontier” embodying the Capital Asset Pricing Model (CAPM for those finance wonks), there really are a number of very good “ONE and DONE” options for investors. This number of potentially appropriate qualified default options includes: Global Funds, Balanced Funds, Lifestyle Funds, Target Date Retirement Funds.
In a Linked In group discussion on fiduciary investing matters, there were a number of responses with the most unique being this from Mark Griffith, CPC, AIFA an independent fiduciary in the greater Boston area:
“I believe the right answer is ‘1’ (per participant). The only justifiable argument against this theory is which one. By ‘1’ I mean a properly diversified portfolio, the construction of which is certainly debatable.”
Sometimes the best thing is to KISS. And ‘1’ is as simple as you can get.