Carl from Behavior Gap recently posed an important question over at Morningstar’s blog. He asks whether laziness is a significant motivator in investment advisors’ tendency to steadfastly recommend a buy and hold strategy. Carl writes,
“I have found that there is a subculture in the advice industry that dismisses any inquiry about the economy, the markets, or anything other than buying and holding, as speculation.”
He then continues,
“I have recently asked questions about:
- The fact that total debt to GDP is over 350% and that is 2x higher than it was in the 1920’s (see chart).
- Nassim Taleb’s great books: The Black Swan and Fooled By Randomness.
- The work of Benoit Mandlebrot on risk (see this book and this Morningstar Conversation).
…People dismiss the questions as foolishness without even considering them.”
I absolutely agree that it’s worth thinking critically about investment strategies. Whatever strategy you choose to follow, you must have a deep understanding of why you’re following it, otherwise you’ll be unable to stick with it.
Placing Bets
On the other hand, I have my doubts as to the value of attempting to work economic indicators into one’s investment strategy. Take, for example, the above-mentioned 350% debt to GDP ratio. What do you do with that piece of information? In order to make use of it, you need to actually change your strategy in some way.
You have to make a bet. Overweight or underweight something relative to a simple market-cap-weighted portfolio. Or, rather than buying and holding, attempt to use that information to predict where a particular asset class is heading next.
Instead, I choose to bet against anybody’s predictive abilities (including my own).
Planning for the Unpredictable
Incidentally, a large part of my reasoning is exactly what Carl referenced in his post: the concept of the “unknown unknown” or, to use the current catch phrase, the black swan.
Say you know Fact A, and you believe that A will cause Event X to occur. In a vacuum, you may be completely correct. But in the real world, there are also Facts B, C, D, and an infinite number of other facts that you’re entirely unaware of. And any one of those could potentially cause Event X not to occur.
And judging from history, what tends to happen is that while we’re debating whether Events X, Y, or Z will occur, Event Q sneaks up out of nowhere and screws up our plans beyond recognition.
My understanding is that the entire point of the black swan concept is that, rather than looking at some fact (350% debt to GDP ratio) and predicting a particular result, we should accept the fact that we’re not good at predicting major events. We should attempt to build a portfolio (and investment strategy) that recognizes that reality and deals with it appropriately.
My method of planning for the unpredictable is to:
- Create a portfolio consisting of thousands of companies from across the world,
- Minimize costs (because no matter where the market goes, costs matter), and
- Buy & hold rather than attempting to predict what the market will do next.
Do I think that’s the only way to respond to an unpredictable investment environment? No. Not at all. But I have yet to encounter any strategy that I’d say is better than this one.