Compounding works because somebody started something decades ago and never stopped. When you combine consistency with a simple investment plan some wonderful things happen.
Unfortunately, simplicity is often overlooked.
And I’m not just talking about investment plans. Yes, the finance industry is notorious for coming up with complex strategies to warrant the high fees they’re charging. Can a simpler strategy produce similar results? Most likely. But who would pay a similar high fee for it?
I may be going out on a limb here, but it seems to me that if the industry spent more energy on getting clients/customers to maintain consistency and less energy on creating elaborate strategies, both the industry and their clients would be better off in the long run. Conveniently, consistent compounding benefits both investors and those who charge low fees too.
But the lack of simplicity goes further than that. You see it in the language of the industry. The refusal or inability (take your pick) to simply explain things abounds. I can use big finance words like the best of them, I might even sound convincing but how helpful is it? What’s gained by pushing complex strategies using financial nonsense words (that’s how most see it)? How much consistency will that generate?
Some of the best explainers of finance and investing put things into simple terms for a reason. They understand it better than anyone (no surprise that many — Buffett, Graham, Greenblatt, Mauboussin, to name a few — actually taught it at some point).
Dean Williams elaborated on this in a speech to financial analysts in 1981. Two key areas of importance he focused on were simplicity and consistency. Here’s what he had to say on the two:
Albert Einstein said that “…most of the fundamental ideas of science are essentially simple and may, as a rule be expressed in a language comprehensible to everyone.” The first time I heard that I thought, “Sure that’s easy for him to say.” But as long as there are people out there who can beat us using dart boards, I urge us all to respect the virtues of a simple investment plan.
How are most of us organized? To gather information and use it to make predictions. We have security analysts. We get research reports from brokers. We get forecasts about the economy, interest rates, the stock market. We process that information and act on the basis of it. For all of that to make any sense, we all have to believe we can generate information which is unknown to the market as a whole.
There is an approach that is much simpler and probably stands a better chance of working. Spend your time measuring value instead of generating information. Don’t forecast. Buy what’s cheap today. Let other people deal with the odds against predicting the future.
The reason for dwelling on the virtue of simple investment approaches is that complicated ones, which can’t be explained simply, may be disguising a more basic defect. They may not make any sense. Mastery often expresses itself in simplicity. Werner Heisenberg…said, “Even for physicists, the description in plain language will be a criterion of the degree of understanding that has been reached.”
My favorite paper on this subject was also written by our leg-pulling friend J. Scott Armstrong. It’s called “Unintelligible Management Research and Academic Prestige.” I couldn’t possibly improve on his words, so I’ll read the first page to you:
Dr Fox was an actor who looked distinguished and sounded authoritative. He has provided with a fictitious but impressive biography and was sent to lecture about a subject on which he knew nothing. The talk, “Mathematical Game Theory as Applied to Physician Education,” was delivered on three occasions to a total of 55 people. One hour was allowed for the talk and 30 minutes for discussion. The audiences consisted of highly educated social workers, psychologists, psychiatrists, educators, and administrators. The lecture was comprised of double talk, meaningless words, false logic, contradictory statements, irrelevant humor, and meaningless references to unrelated topics. Judging from a questionnaire administered after the talk, the audience found Dr. Fox’s lecture to be clear and stimulating. None of the subjects realized that the lecture was pure nonsense.
If an intelligent communication is received from a legitimate source and if this communication claims to be in the recipients’ area of expertise, recipients might assume that they are wasting their time because they receive no useful knowledge. In terms of knowledge, they would be wasting their time. But their involvement in this activity may lead them to try to justify the time spent. Furthermore, the greater the unintelligibility, the greater the need to rationalize about the time spent (e.g. if you cannot understand a paper, it must be a high level paper). This might be called the Dr. Fox hypothesis: An unintelligible communication from a legitimate source in the recipient’s area of expertise will increase the recipient’s rating of the author’s competence.
He then goes on to conclude that, “Overall, the evidence is consistent with a common suspicion. Clear communication of one’s research is not appreciated.” His final advice is “Lack of clarity is especially helpful when content is poor.” Because there’s maybe two billion dollars in fees at stake in our business, we can be tempted to avoid simple investment methods, which can be simply explained to our clients. Dr. Fox is not a good role model for us.
Look at the best performing funds for the past ten years or more… What did they have in common? It sure wasn’t their investment philosophies. It was that whatever their investment plans were, they had the discipline and good sense to carry them out consistently.
The last of the mental qualities we talked about was consistency and who it seemed to be present in nearly all outstanding investment records. You’re familiar with the periodic rankings of past investment results published in Pensions & Investment Age. You may have missed the news that for the last ten years the best investment record in the country belonged to the Citizens Bank and Trust Company of Chillicothe, Missouri. Forbes Magazine did not miss it, though, and sent a reporter to Chillicothe to find the genius responsible for it. He found a 72 year old man named Edgerton Welch, who said he’d never heard of Benjamin Graham and didn’t have any idea what modern portfolio theory was. “Well, how did you do it,” the reporter wanted to know. Mr. Welch showed the reporter his copy of Value Line and said he bought all the stocks ranked “1” that Merrill Lynch and E.F. Hutton also liked. And when any one of the three changed their ratings, he sold. Mr. Welch said, “It’s like owning a computer. When you get the printout, use the figures to make a decision — not your own impulse.” The Forbes reporter finally concluded, “His secret isn’t the system but his own consistency.” Exactly. That’s what Garfield Drew, the market writer, meant forty years ago when he said, “In fact, simplicity or singleness of approach is a greatly underestimated factor of market success.
Trying Too Hard — Dean Williams