Things People in the Finance Industry Don’t Want You to Know

Like most professions, everything is not always as it appears in the finance industry. Here are a few truths you will rarely hear from anyone who works in finance.

No one really knows what’s going on most of the time. It’s been well documented that not many people are very good at predicting the future, especially in the financial markets. But even seasoned financial professionals have a difficult time explaining what happened in the past. Don’t get me wrong, there are always compelling narratives. But the truth is, most of the time it’s very difficult to discern the real reasons as to why many market relationships exist or change over time.

There are plenty of examples from the past few years. Oil dropped like a rock last year and no one really knows why. Most of the reasons cited have been known now for a number of years. Just this week regulators were still trying to piece together what caused the flash crash that occurred almost five years ago as they brought charges against a guy who day trades from home for manipulating prices and trades.

Financial professionals do a really great job convincing others (and themselves) that they have all the answers. The truth is much of the time no one really has a legitimate explanation for how it all adds up. There’s more guesswork involved than most care to admit.

Most of the things we argue about aren’t all that important. Does it really matter if you have 25% of your portfolio in foreign stocks instead of 35%? Does social security count as a bond? What really constitutes passive investing? What’s the optimal asset allocation for retirees? Should you choose mutual funds based on active share?

These topics make for interesting debates among finance types, and I’m just as guilty as anyone else when it comes to focusing on the minute details. But for most financial consumers and clients, these arguments don’t add much value. The problem is that there’s a caveat for every argument. There will always be historical scenarios that will either support or refute nearly every investment strategy ever concocted, and if not, the future surely will.

The details will always need to be ironed out. Still, those in the profession who focus exclusively on the minutiae instead of the big picture issues are usually trying to confuse their clients with the things that really matter.

There’s no such thing as “smart money.” Everyone likes to poke fun at mom and pop investors, but the professionals are just as likely to succomb to performance chasing and cognitive dissonance. There are countless examples of intelligent investors blowing themselves up through the misuse of leverage or a trade gone wrong. Somehow the smart money is always more than willing to give these same people millions of dollars when they decide to raise a new fund a few years down the line.

I know many individual investors that perform far better than most of the large institutional funds because those individuals are able to admit their limitations, while the smart money rarely does.

You can be right for the wrong reasons but still be compensated for it. The markets don’t discriminate. A PhD dissertation isn’t required for every trade or investment. Every day people make investment choices for the wrong reasons and still make money. Many fund managers have made their careers in a single good year where they probably got lucky. It’s not fair, but these things have a way of working themselves out eventually.

It’s very difficult to differentiate between skill and luck. Interest rates have been falling for three decades. Many fixed-income managers have cemented their legacy during this time as legendary investors. Were they lucky to be in an asset class with the wind at their backs? Amazing investors that took advantage of an opportunity? Both?

It can be difficult to distinguish between relatives and absolutes. You can lose money, but lose far less than the market and still be considered a hero. Or you can also make money, but make less much than the market and you’ll be considered a loser. Sometimes it makes sense to pay attention to risk-adjusted returns while other times it’s a useless diversion for underperforming managers. It’s never black and white with investment performance metrics.

The bolder the pundit, the more people who listen to them. People are attracted to confidence and false bravado. Wall Street understands this better than anyone and is happy to oblige. “I don’t know” is one of the least used phrases in all of the finance, but most of the time, it’s the correct one.

Further Reading:
The Secret Sauce of the Investment Business
What’s Right With Finance