“Another example of a foundational value is I don’t believe in any short-term thinking or dealing. Let’s say I’m doing business with somebody and they think in a short-term manner with somebody else, then I don’t want to do business with that person anymore. I think all the benefits in life come from compound interest, whether in money or in relationships or love or health or activities or habits. I only want to be around people that I know I’m going to be around with for the rest of my life. I only want to work on things that I know have long-term payout.”
Naval Ravikant
Angel Investor
“After more than 35 years in the financial services industry, I have found that having an investment philosophy—one that is robust and that you can stick with—cannot be overstated.”
David Booth
Chairman, Dimensional Fund Advisors
“We have shown that disclosure cannot be assumed to protect advice recipients from the dangers posed by conflicts of interest. Disclosure can fail because it (1) gives advisors strategic reason and moral license to further exaggerate their advice, and (2) the disclosure may not lead to sufficient discounting to counteract this effect. The evidence presented here casts doubt on the effectiveness of disclosure as a solution to the problems created by conflicts of interest. When possible, the more lasting solution to these problems is to eliminate the conflicts of interest.”
Daylian Cain, George Loewenstein and Don Moore
The Dirt on Coming Clean: Perverse Effects of Disclosing Conflicts of Interest
Markets
Despite the zaniness in US politics, the markets continue to perform well both in the United States and worldwide.
Below are the indices we track.
The broad US equity market posted positive returns for the quarter but underperformed both international and emerging markets. Value underperformed growth indices in the US, international and emerging markets across all size ranges. Small caps in the US and in emerging markets underperformed large caps, although they outperformed in international developed markets. From a diversification standpoint, it is nice to see international starting to outperform after some dismal years.
Discipline
One of the key tenets in successful investing is discipline. David Booth emphasizes having an investment philosophy and “sticking with it” is most important for long-term success.
As one can see from the chart below from JP Morgan’s Guide to Markets, June 30, 2017 (showing 20 year annualized returns by asset class), the average “investor” has seriously underperformed most asset classes as well as diversified portfolios because he or she cannot stay invested during volatile periods, especially negative volatile periods.
Daniel Kahneman showed in his research that on average, losses are twice as painful as gains, so psychology wreaks havoc on an investor’s behavior unless he or she can stay disciplined. Advisers provide much needed discipline when investors’ emotions get the best of them.
Professor Andrew Ang deals with discipline in his treatise, Asset Management:
Professor Benartzi of UCLA continues, “when people get frequent updates on their portfolios, they increase the likelihood of getting news of a short-term loss. Because these losses have an outsized impact on our behavior, frequent checking can lead us to abandon our long-term investing plans.” Albert Einstein recognized the importance of long-term discipline, as he stated: “compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.”
Fiduciaries/Conflicts
Historically, transparency has not been a hallmark of the investment industry. Broker/Dealers and insurance agents historically have not been required to do what is best for their clients, but only what is suitable. Hence, higher cost products, commissions, hidden fees, etc. This is not a very good solution for investors who want to maximize their wealth.
Investment advisers are fiduciaries, and are required by law to put their clients’ interests ahead of their own, and to do so with much more transparency. It is best to avoid conflicts of interest. Unfortunately, even some registered investment advisers deviate into conflicts of interest that should be avoided. I heard of one situation where a “conflict free” adviser provided planning advice to the senior executives of a fund company whose funds they were recommending to clients. Such conflicts should be avoided by an investment adviser so the client’s interest is never in doubt. As one lawyer said to me, imagine what would happen if the fund company senior executive ever had an ethical problem at the fund company. The planning firm would have a duty to maximize the senior executive’s wealth as a planning client while at the same time protecting its clients from potentially adverse effects of the funds of the fund company. As John Bogle says, it is impossible to serve two masters.
Therefore, it is with great interest that I have been following the Department of Labor’s fiduciary rule, which applies to the retirement portion of everyday investors’ portfolios. Basically, the rule applies to investment professionals who provide investment advice for retirement account owners. The rule will touch upon most financial advisers who work on commissions, such as brokers and insurance agents, who have traditionally used very high cost products for their investors. After the rule goes into effect, if a “broker” desires to continue charging commissions to the client, the broker will need to provide a full disclosure agreement titled the “Best Interest Contract Exemption” or “BICE” to disclose any conflict of interest.
However, as the professors’ quote at the beginning shows, this is a fool’s errand. The research on disclosing conflicts of interest found that:
“disclosure cannot be assumed to protect advice recipients from the dangers posed by conflicts of interest. Disclosure can fail because it (1) gives advisors strategic reason and moral license to further exaggerate their advice, and (2) the disclosure may not lead to sufficient discounting to counteract this effect. The evidence presented here casts doubt on the effectiveness of disclosure as a solution to the problems created by conflicts of interest. When possible, the more lasting solution to these problems is to eliminate the conflicts of interest.”
Unfortunately, the DOL and regulators were not strong enough to counter the broker/dealer and insurance lobby. The best advice is to avoid BICE, and ensure you have a true conflict free Registered Investment Adviser advising you on all your assets. Your long-term compounded wealth will be the better for it.
Some Charts to Ponder
As the charts below indicate, it appears that both the domestic and world economies are performing well. Because things can change quickly, we always want to be diversified as long term investors. Nevertheless, the story looks pretty good according to the charts below.
Until next time,
Mike