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

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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 that 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’s 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 really add a ton of value. The problem is that there’s a caveat for every argument. There are always going to 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, but those in the profession that focus exclusively on the minutiae instead of the big picture issues are usually trying to confuse their clients from 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 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

Now here’s the stuff I’ve been reading this week:

  • Dumbing things down (AVC)
  • The benefits of international diversification (Novel Investor)
  • Which investment strategies really work? (Alpha Architect)
  • Yes, invest in your 401(k) (Morgan Housel)
  • Why indexing is the future of investing (Prag Cap)
  • 6 people you can ignore when it comes to investment advice (Malice for All)
  • Investment decisions aren’t all or nothing (Rick Ferri)
  • Transparency will have its day in finance eventually (Above the Market)
  • 4 ways to make better investment decisons (Cordant Wealth)
  • What is dumb money really? (Inner Scorecard)
  • Quit worrying so much about interest rate risk with your bonds (Irrelevant Investor)
  • Also, if you missed it, Tren Griffin wrote a very nice piece on me for his Dozen Lessons series (25iq)
  • And be sure to listen to the podcast I did with James Osborne where we try to fix the 401k (Bason)

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  2. Grant commented on Apr 24

    Ben, I think it’s a stretch to call the finance industry a profession. With some notable exceptions, of course, sadly it seems to be a business whose sole mission is to transfer as much wealth as possible from those who own it to those who manage it. A profession acts in the best interests of it’s clients – a fiduciary standard of care. Until that becomes the standard of care I don’t think the finance industry can be regarded as a profession.

    • ST commented on Apr 24

      @Grant — I work in the financial sector (it’s not an “industry” because industry produces actual goods…it’s debatable just what the FS produces) and from what I’ve seen, it’s more self-serving than almost any other “profession”, save perhaps politician.

      I’ve struggled a LOT with how to operate in good conscious within such a…what’s a polite word for corrupt?…environment. It can be done and it takes hard work every single day to avoid all the junk and keep focused on the needs of the client.

      I’m not convinced the good guys will ever dominate the finance sector, because it lends itself to being manipulated too easily, but that doesn’t mean we should give up as easily.

    • Ben commented on Apr 24

      I think there are more good people in finance than most assume, but it’s just that the incentive structures have always pushed many to pursue bad tactics. There are people trying to change this, but it’s an uphill battle and I think the profit motives are always going to be there, especially for the large firms.

      • Grant commented on Apr 24

        Yes, I agree with you completely. There are good people in the industry, but too many bad apples. The AUM fee model is a big part of the problem. It results in massive fees and it continues because the majority of people don’t understand how much money is lost in fees. 1% just doesn’t sound much.

  3. Scott Boone commented on Apr 24

    Such a good article, and a reminder to all of us “professionals” not to take ourselves too seriously. Clients always seem to expect that we have all of the answers (if not, why would they hire us?), but as I have constantly reminded my clients, if I had all of the answers, I’d be fabulously rich and be a client rather than an advisor!

    • Ben commented on Apr 24

      I’ve always thought the finance profession could use a little more humility and self-awareness. Getting people to understand that no one has all the answers is a good first step.

  5. Jim Haygood commented on Apr 24

    The most important thing the finance industry doesn’t want you to know is whether the person you’re dealing with has a fiduciary obligation to you or not.

    With a couple of honorable exceptions, Finra’s members have disgraced themselves by opposing the interests of their own customers, to defend their dying wirehouse business model.

    Here’s hoping the Labor Dept. bulldozes Finra right into the ground.

    • Ben commented on Apr 24

      Good call on this one. So true. We’ll see how far their lobbying efforts get them. I feel like this is something we’ll look back on in the future and wonder why things were ever structured this way.

  6. ronregan commented on Apr 25

    I mostly agree. Particularly annoying is the “markets fell after…” explanations (Markets fell as traders took profits after the Greek government…). However, there is an idea, championed by Jim Cramer et al, that financial professionals have no advantage over non-professionals. This is the “do your homework” meme. It suggests that Grandpa can spend a few hours reading about a company and have as much insight as an an analyst with academic degree(s) in the field, decades of experience, and an extensive network of industry contacts. Just not so.

    • Ben commented on Apr 25

      good point. I like to say that trying harder in the markets doesn’t ensure you anything. it’s tough for people to grasp this because that’s what you’re told in almost every other life endeavor.

    • James Madelin commented on Apr 30

      I disagree. A bright Grandpa can and often does have as much insight, if they’re spending a few hours gleaning information from many analysts, then adding their own dose of wisdom and most importantly long-termism, before making their decision. The data proves that the pros don’t outperform. The data shows it is so.

  7. Dash of Insight | Weighing the Week Ahead: Time for an Upside Breakout? commented on Apr 26

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  8. Kurt Fischer commented on Apr 28

    Thanks for this ‘truth-teling.’ I agree that ‘experts’ often have a difficult time explaining what’s happened in the past, as you wrote in your first point. What’s funny is that their failure to accomplish successfully that presumably less complex task doesn’t translate, for most, to compunction about predicting the future!

    • Ben commented on Apr 28

      Yes, somehow this doesn’t stop people from trying. And if they’re wrong most blame outsdie forces not their own biases.

  10. James Madelin commented on Apr 30

    This is so true. I used to work in the media (and banking). So here’s how it goes. The market does something. The media HAS TO report why. NOW. So they call an analyst or three. The analyst generally has no idea from day to day why Mr Market is wandering up or down. But they have a big media outlet on the line! They have to say something! So they do! And it gets reported. And millions of people read it and think… Huh! That’s why today this is happening. And the day ends. And everyone’s happy and no-one’s any wiser.

    • Ben commented on Apr 30

      Very true. If only more individuals understood how this really works. Most hear a few smart soundbites and think they’re getting good advice. Not only are these people wrong most of the time, but they can’t possibly know the time horizon of the person on the other end taking the advice.

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