Keep It Simple

With more than 5,000 stocks, 7,700 mutual funds, 1,700 ETFs, 600 closed-end funds, 11,000 hedge funds and 3,000 private equity firms to choose from, investors could be excused for feeling a little overwhelmed. Throw in the industry jargon, the myriad investment approaches and the plurality of slick salesmen and investors are understandably intimidated by the financial markets and the financial services industry.

With that being the case, it is all the more important to cut through the clutter and reduce the investment equation to a manageable exercise. And so it doesn't hurt the case that the primary reason to ‘keep it simple’ is due to the fact that added complexity does not necessarily translate into added returns in the investment realm.

At a base level, the most simple form of investing is the passive index fund. You buy all the companies in the index in proportion to their weight. There is no attempt to beat the index. There is no attempt to pick stocks. It does not require selecting an active manager. It is simply “getting the market.” Beyond index funds everything else increases in complexity and sophistication (and cost). 

What 50 years of theory, research and empirical evidence point to is the inability of active management on average to beat the market. In fact, given the market is a zero sum game (one investor’s gain in another investor’s loss) it is a mathematical tautology that the average active manager will under perform the index by their fees over time. The industry is expert at adding layers to obfuscate and increase charges. 

With these facts known, the question then becomes why do most investors continue to pursue active management. The answer lies not in the evidence presented, but in the nature of man and the desire to ‘beat the market.’ The industry knows this and preys upon it. In fact, the industry expertise has always resided in sales and marketing. Investment management and the promise of returns is simply the cart by which the industry fastens itself to investors in order to generate high returns for itself and its shareholders. 

The promise of returns and beating the market is much more alluring that honestly conveying the odds of that endeavor and the reality of helping investors wait patiently. But there are other reasons why keeping it simple is a great principle to subscribe to. In a world of increasing complexity, a more simple approach is not only more reasonable and provides better odds of success, but is much easier to understand and manage (not to mention measure performance against). Complexity and added sophistication goes hand in hand with lower transparency and higher costs. And a vast body of research demonstrates, that all else being equal, higher costs equal lower long term returns. 

In summary, a simple approach increases the odds of success, is easier to manage, creates understanding and engenders greater trust. It isolates the factors that count and strips away the ancillary noise as it gets to the heart of the matter.