April 22

Weekend reading: three different views on the folly of active investing

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Weekend reading: three different views on the folly of active investing post image

What caught my eye this week.

I have ruffled feathers before by remarking that in my – purely anecdotal, totally unscientific – experience, engineers make the worst stock pickers.

On reflection, perhaps the push back I got was fair. I should have included doctors too.

We could spend a lot of time debating why my observation about engineers and doctors is not very useful. For example, I know a lot of engineers, and there are an awful lot of doctors about.

Perhaps flautists make even worse stockpickers than engineers? Perhaps but they so rarely pipe up.

Luck looms large

Instead I want to point to a great post at Fortunes & Frictions.

The author Rubin Miller asks whether chess players make good investors. However the question is sneakily rhetorical because Miller – a minor chess whiz, incidentally – already knows there’s no reason why they should:

It’s easier for people who aren’t great chess players to be great investors. They don’t expect things to always work out perfectly.

Disruption of well-laid plans, and navigating the unexpected, are familiar. That’s how life works.

Whereas people who invest their time in a niche pursuit like chess, where perfect execution leads to ideal outcomes…have a potentially warped version of what drives success.

Chess players are familiar with wins and losses being honest feedback loops on the quality of their strategy and decisions.

But investing outcomes are often not helpful feedback loops, and completely unhelpful in the short-term. There is too much noise.

The post makes a compelling argument that luck looms too large in some pursuits – Scrabble, Backgammon, investing – for anyone to stay on top for long.

In chess, by contrast, the greatest winners keep winning.

That’s nothing like with investing. Just think of all those tumbling league tables and stories about the latest fallen investing guru.

Perhaps I’d argue that as you extend out the time horizon of investing, maybe the skill-signal becomes more apparent. (I say this, as most of you know, as a naughty active investor).

But in the short-term term investing is more like a game of Hungry Hungry Hippos.

And this is where the engineers and doctors go wrong, I suspect.

Engineers tend to think in terms of certainties, which is death to good investing.

Doctors do (rightly) have a capacity for fuzzier thinking, as anyone who has received a maddeningly vague prognosis on their lump, cough, or bump will know.

But their differential diagnosis rarely reverses back to first principles.

Perhaps medics also believe (thankfully) that they can fix things.

In contrast, good active investors can be more like the brutal backstreet butchers of yore. Real chop and chuck merchants.

Too good to be true

Coincidentally, Joe Wiggins at Behavioural Investment warned this week that consistent performance from a fund manager is actually a giant red flag.

After all, we know that the market is capricious.

We also know that different investing methods prosper under different regimes.

Given that, you should run for the hills if your fund manager posts market-beating returns year in, year out. In that case you probably don’t own a fund but a bit part in a Ponzi scheme.

Wiggins advises:

Fund investors should stop focusing on and thinking about consistent excess returns – it tells us nothing meaningful – and instead concentrate on consistency of philosophy and process.

In a complex, unpredictable system that is all that can be controlled.

(Incidentally, in case anyone cites Renaissance Technologies’ infamous Medallion fund as a consistent performer I’d say (a) fair and (b) to me ultra-high frequency trading looks more like financial systems plumbing if you’re generous and rent extraction if you’re more cynical. Either way it’s not really active investing as we’re discussing it here).

Thrills and skills

An alternative piece of advice to Wiggins’ for active fund managers – or those who would try their hand at stock-picking – is the one we’ve espoused for years.

Don’t bother.

The chances you will turn out to be even a legitimately inconsistent market-beating stockpicker are slim. It will be years before you have a sense of whether any gains you make are due to luck or skill.

And as Jack Raines at Young Money pointed out this week, you could have been doing something more predictable with your time and effort instead of signing up to an existential crisis:

Investing is one of the few fields where an inexperienced novice often has an advantage over an ‘expert’.

You can spend 1,000 hours honing your skill, studying markets, and backtesting your strategies. Then market conditions change, and you underperform anyway. Your 1,000 hours of knowledge may even be a disadvantage, if your trading strategy was reliant on a specific asset class or market environment.

Meanwhile, if you spend a year learning French, the language won’t change overnight. If you become proficient in Python, you won’t wake up one day unable to code. If you write a blog, you won’t suddenly become illiterate.

You can quickly tell if your French, Python, or writing is improving.

With trading? Maybe you’re good, maybe you’re lucky. It’s hard to tell, and you won’t know for a long time.

To his credit Jack seems to have gone through the investor hero’s journey – from meme stock chaser to tracker fund investor – in about 18 months of blog posting.

Whereas 15 years on I’m still stuck on third base…

Was it worth it?

My friend Lars Kroijer ribbed me about this years ago.

Spending a lot of time researching and picking stocks made sense if you were paid to manage other people’s money, he said. You took a small percentage of a huge number as your reward.

But I wasn’t rich enough for even 10% outperformance on my nest egg to beat simply earning more from a career or starting a business. So why not just invest in a tracker fund and do something else more profitable instead?

Why not indeed?

Because active investing had become a passion and a game long before I knew enough about it to understand any of this.

Perhaps you’re the same. If you’re going to do it, you’re going to do it, right?

Even though most of us know we shouldn’t – and many of you reading this sensibly don’t!

Have a great weekend all, and enjoy the links below.

From Monevator

Confession: I used to juggle multiple bank accounts to score the highest savings rates – Monevator

Paying for social care using your investments – Monevator

From the archive-ator: Sticking to your financial goals when the funk comes to visit – Monevator

News

Note: Some links are Google search results – in PC/desktop view you can click to read the piece without being a paid subscriber. Try privacy/incognito mode to avoid cookies. Consider subscribing if you read them a lot!1

UK consumer confidence even lower than in the 2008 financial crisis – Guardian

Retail sales fall as the cost of living crisis bites – BBC

Distance from London leads list of house price determinants, study finds – ThisIsMoney

FCA flags concerns over challenger banks’ financial crime defences [Search result]FT

Simplifying retirement income planning using the ‘spending risk curve’ [Nerdy]Kitces

Products and services

Energy-saving criteria high on UK homebuyer checklists – Guardian

Retirement village life: your own Thursday Murder Club? [Search result]FT

Open a SIPP with Interactive Investor and pay no SIPP fee for six months. Terms apply – Interactive Investor

Will getting a water meter save you money? – Be Clever With Your Cash

Don’t delay if you’re looking for a cheap mortgage – Guardian

The pros and cons of [actively-managed] one-stop multi-asset funds in retirement – ThisIsMoney

Homes with roof terraces and balconies, in pictures – Guardian

Comment and opinion

Q&A with author of The Bogle Effect, a new bio of Vanguard’s founder – Abnormal Returns

Why is active management so difficult? – Advisor Perspectives

Learned from the best – Humble Dollar

When cash is king – Compound Advisors

Zeroing in on your workplace pension returns – Banker on FIRE

So, interest rates are going to rise – Klement on Investing

North star – Indeedably

Sorry, collectibles are a terrible investment – Full Stack Economics

Portfolio pain isn’t a four letter word – A Teachable Moment

Mortality beliefs and savings decisions [Research, PDF]SSRN

Crypt o’ crypto

Is cryptocurrency really a portfolio diversifier? – Morningstar

Naughty corner: Active antics

Three things to learn from Bill Ackman’s brilliant Netflix trade – MoneyWeek

Unpacking Elon Musk’s Twitter play… – Musings on Markets

…and back to the future of Twitter – Stratechery

The investment case for energy stocks over ESG – Freedom Day Solutions

Value factor comes back – Two Centuries Investments

Kindle book bargains

Shackleton’s Way: Leadership Lessons from the Antarctic Explorer by Margot Morrell – £0.99 on Kindle

Hillbilly Elegy by J.D. Vance – £0.99 on Kindle

Who Moved My Cheese? by Dr Spencer Johnson – £0.99 on Kindle

The Art of Gathering: How We Meet and Why It Matters by Priya Parker – £0.99 on Kindle

Environmental factors

“As a scientist, I’m reconsidering having kids and I’m not the only one”Guardian

ESG: do other risk factors explain returns? – The Evidence-based Investor

An ocean of noise: how sonic pollution harms marine life – Guardian

Off our beat

The end of sick days: has WFH made it harder to take time off? [Search result]FT

Could viruses cause Alzheimer’s? Covid-19 studies offer new clues – National Geographic

Home ownership changes you – The Atlantic

Debating at the Oxford Union created today’s political class – Guardian

How Birds Aren’t Real took on the conspiracy theorists – Guardian

Young people are lonelier than ever – Vice

How My Big Fat Greek Wedding became the highest-grossing rom-com of all-time – The Ringer

And finally…

“Spending money to show people how much money you have is the fastest way to have less money.”
― Morgan Housel, The Psychology of Money

Like these links? Subscribe to get them every Friday! Note this article includes affiliate links, such as from Amazon and Interactive Investor. We may be compensated if you pursue these offers, but that will not affect the price you pay.

  1. Note some articles can only be accessed through the search results if you’re using PC/desktop view (from mobile/tablet view they bring up the firewall/subscription page). To circumvent, switch your mobile browser to use the desktop view. On Chrome for Android: press the menu button followed by “Request Desktop Site”.

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