Timeless Styles and Fickle Fashions
Any fashion aficionado will know how fickle and ever-changing that industry can be. New styles come out every season, rendering the hottest trends of the previous months suddenly passé. Those who wish to remain sartorially relevant end up caught in a frenzied cycle of emptying their wallets for trendy clothes they may never wear again.
Well, I would never be that silly, someone might say, before returning to the much more sensible activity of researching the latest hot stock that every investor absolutely needs to buy this year.
Thematic ideas; fleeting trends; built-in obsolescence; manufactured demand; celebrity endorsements; the financial industry is a lot like the fashion industry in more ways than you might think, and just as much of a trap to keep people buying things they do not need and will very likely regret.
But while the undiscerning fashion shopper may end up with a closet full of the same ugly shirt in different colours, oblivious investors may end up with a portfolio overly-concentrated on risky products that sounded exciting on paper but are now floundering in defaults and capital losses.
Why does the financial industry do this to people? To put it simply: it makes them money. The more products you buy or transact, the more they earn. The more you trade, the more trading commissions they receive. The constant pitching of new exciting investment ideas is designed with the sole intent of getting you to buy, and then keep switching to the latest idea every few months, so that you keep those commissions flowing.
Please do not misunderstand. For many people, receiving commissions is a legitimate way of earning income. The problem arises when customers are made to keep paying commissions for products where the costs clearly outweigh the benefits.
In early 2005, Reuters published an article about how banks were manufacturing exotic credit derivatives for investors looking for ways to boost their yield at a time of narrowing premiums over risk-free assets (Reuters, 18 Jan 2005, "Demand for Exotic Derivatives Seen Growing – Bankers").
We all know what happened in the 2008 crisis, which was caused in part by those same scary derivatives. If we fast-forward to the present day, when investors' memories of the crisis have faded, we realise that we are again seeing a rise in complex products being sold, not only to accredited investors, but also to the retail mom and pop investors. Again, the theme is similar – investors were "looking" for higher returns amidst the low interest rate environment.
Like clothes, many 'stylish' investment strategies are marketed to sound sexy and enticing. But you should always look beyond the clever design and copywriting to ask yourself whether your specific and long-term needs will actually be served by these products. It is important to discern whether a product is just capitalising on a passing fad or actually constructed to withstand the vagaries of time.
Fads can be fickle. Yet even in the fashion industry, which sees new styles come and go with frightening regularity, there are certain classic styles and staples that have remained elegant and tasteful throughout the years. Likewise, in investing, there are investment strategies that have stood the test of time and work as elegantly today as they did decades ago.
Here are some time-tested strategies that a smart investor should pay heed to:
Instead of investing according to the the latest 'headline' trend (e.g. best trades for a rising rate environment, trade war, etc) which capitalises on your fear and greed, invest based on principles that are predicated upon empirical long-term evidence which has been tried and tested to weather many market environments.
Rather than trying to guess whether the market is going up or down, in order to find 'mis-pricing' opportunities, accept that all available information is already reflected in the market price.
Take only the risks you are comfortable taking, diversify your portfolio, keep overall costs low, and manage your own emotions.
Choosing fashionable investment styles would mean churning your money and significantly pushing your transaction costs higher. What would you do when the trend goes out of fashion? Wouldn't it be better to simply invest in a diversified portfolio and let time give you the returns you are entitled to?
Don't invest blindly into a product just because you are enticed by its potential return. Instead, focus on the end game - what financial goals you need to meet - and then find the simplest and most suitable product that can get you there with as low a risk and overall cost as possible.
As legendary designer Coco Chanel said, "Fashion changes, but style endures."
(This article was partially-adapted from "The Devil Wears Nada" in Outside the Flags 5 (2017) by Jim Parker, Dimensional Fund Advisors.)
