Good-Enough Returns: Financial Advisors' Daily Digest

Summary

• Cullen Roche shares a few lessons he’s learned from the financial crisis.
• Nicholas P. Cheer shows five ways to beat an index fund.
• PagnatoKarp, a new contributor, looks at the downside of indexing.

Continuing our discussion on implications of the financial crisis, today Cullen Roche shares three things he’s learned from the financial crisis. The first is to be opened-minded and avoid doctrinaire thinking; a second, related idea is to beware of emotional biases.

Both are good points, but I like his third best, which is that the “perfect is the enemy of the good.” He actually sneaks in a fourth point under No. 3, but there doesn’t seem to be a “four things I’ve learned” genre. Though they’re wrapped together, I will untangle them because both are important. First, he writes as follows:

The financial crisis led to a voracious appetite to better understand our monetary world. And while this learning was good, it could also be destructive. For instance, I found myself watching financial TV every day during the crisis, only to realize over time that none of that was helping me learn. It was mostly just filling my brain with things I didn't need to know and exposing me to emotional short-termism. I turned off the TV 5 years ago, and I've learned infinitely more since. But this is just one example of how trying to learn too much can be destructive.”

Roche is to be commended for coming to this realization and making such a constructive change. But I think he greatly understates the problem. TV is not about learning. TV is about pictures. Thus, TV is about entertainment. Even if the commentators are smart people saying interesting things, the screen is always flashing new pictures, and pictures are more about prompting emotional reactions than knowledge building. So if the aim is to increase learning, then shutting off the TV is imperative.

That said, Roche’s main point (under lesson No. 3) was this:

In portfolio management, the pursuit of perfection is a pitfall in that the grass will always look greener elsewhere. There's a certain freedom and comfort in knowing that you have a good understanding, a good process and that you don't need to chase the very best investments or the absolute perfect economic theory.”

I think this is a critical and underappreciated investing idea. In any quantitative area, such as shopping or investing, people can be easily misled by comparing higher vs. lower numbers. You need a bottle of ketchup. Instead of going to the neighborhood grocery store where it costs $2.99, you go to the local discount place to save 50 cents, but end up making 10 impulse purchases and consuming an hour of your time. What was the gain?

So too in investing: You reason that 20% is better than 10%, so you listen to this expert and that expert (probably on TV), wasting lots of time in the process, then take unintended risks for which you incur investment losses.

Whether it’s the seductiveness of juicy returns or the lure of the great bargain, our vulnerability to overreaching derives from a culture of “perfection.” Take a look at how many times you see the word “perfect” in the titles of books and articles, or TV interviews. But the folks looking for the perfect date are the ones who never marry, and the folks trying to raise the perfect children are the ones whose kids are paying therapists for the rest of their lives.

And so it is with investing. People lose more money trying to make the most money. The remedy for this is a good-enough process that yields good-enough returns. Indeed, there is no perfect portfolio.

Your thoughts, as always, are welcome in our comments section. And here are additional financial advisor-related links:

• Nicholas P. Cheer shows five ways to beat an index fund.
• PagnatoKarp, a new contributor, looks at the downside of indexing.
• John Lohr: Dealing with a fiduciary is no guarantee of superior quality.
• Follow-up on Illinois fiscal crisis: One day of substitute teaching will net $1 million pension.

For more content geared to FAs, visit the Financial Advisor Center.