Lots of misconceptions in Finance?

A bit of background first. I am a 30 y/o who works in corporate finance. Degree with concentrations in both accounting & finance. A majority of my course work was around Modern Portfolio Theory & the work of Markowitz. I am in no way a stranger to the framework.

After working and saving for retirement for 5 years (2011 - 2015) I began to get upset with my basic S&P 500 - 10% annual return. I had my Roth with an Ameriprise agent and 401K was just company issued (Trowe, Fidelty, etc) so you have to go with their funds. I started asking some tough questions of my agent and began to realize I didn't really like her answers. So, I fired her (as did my father) and I began interviewing other people. I interviewed over one dozen advisers, with credentials from CFA to CFP - from Ameriprise to Edward Jones. I heard the same bullshit from everyone. I thought it might be interesting to discuss some of the stupidity that has seemingly become dogma in this profession.

1 - You can't beat the market.

When I hear this I ask people, "What is the market to you?" Sometimes you get a slightly better answer, but the typical default benchmark is the S&P. I am going to just steal Graham's argument from the Intelligent Investor because it's easiest. The notion that an arbitrarily constructed index of companies can beat a portfolio created with thorough analysis is dumb.

The fall back defense I usually get at this point is the fact that actively managed funds don't beat the market indexes. The evidence certainly indicates this. This is followed by, "The guys working at these funds are pretty smart. Do you think you can do better" Well, I would not call them idiots. However, there is evidence that investors (in this study traders at CBOT) still fall prey in inconsistencies in internal logic (albeit less often than students). Sauce: http://ift.tt/2uIak7o Furthermore, I did place 79th percentile on the GMAT hungover and without studying. (Did you realize they don't give you a fucking calculator for that thing?) So, I am not slouch myself. Actively managing my own fund I save at least 1% in fees; about 0.25% - 0.48% for ETF's. So let's consider that as my handicap?

2 - You can't predict the market/the market is a random walk

In small time frames I absolutely hold this to be true. If you are relying on timing, good luck to you. There is just too much force from the speculation in the market. However, this conclusion comes from Eugene Fama's Efficient Market Hypothesis. To keep the debate on this point short, upon further inquisition I've found no professional that can cite for me studies supporting this conclusion. It's merely rhetoric.

3 You need a diversified portfolio

I don't actually disagree with the principles of those I've interviewed on this subject. It's their application that I have issue with. Now, this isn't going to be politically correct... if you can't tell I am a rather condescending person. When this part of the conversation starts I begin mimicking each time they say "diversification," but I slur my words like a mentally challenged person or someone who had a stroke might. Mathematically speaking every time you add a security that isn't perfectly correlated to your portfolio you lower your risk down toward market. However, this is diminishing returns. Arguably after 20 you aren't getting much, definitely once you break into the 30's it's not doing a lot. To diversify yourself across economies and sectors in only 30 securities isn't that feasible. Here is where I like ETFs.

I want to make this point very clear, because at face value it seems like I might be contradicting myself. There are many goals for investing; not just generating the largest ROI that you can. Remember we agreed in #2 that in the short term the market is going to do some wonky things. Everyone needs a "savings" account and it should grow larger as they get older. However, most professionals are going to attempt to do this with your entire portfolio. Funds hold a small portion of my portfolio... and at age 30 my 401K is perfect for that. I am definitely going to contribute enough to get my employer match and it lowers my margin tax bracket from 25% to 15%. However, remember #1. Through thorough analysis we can earn better returns (and I'd argue less long term risk).

4 - Ex Post vs Ex Ante; A Gambler's Fallacy

This is actually one that most professionals verbalize correctly. I think it's because of all the disclaimers saying past performance doesn't insure future success of the the funds they are selling. Yet in their analysis, typically with Beta/variance analysis, they fall back on historical results. I won't dwell because it's a minor sin.

5 - Using CPI for inflation

This is one relates to their "estimate" of what you will have & need at retirement. You have to pick a number, but honestly the CPI is just being lazy. For starters, the purchases of 7,000 American households over two weeks is not going to be representational of what I spend my money on when I am retired (cocaine & whiskey). In the early 2000's medical costs were rising nearly 10% a year. Even 2016 to 2017 they were 4.3% (according to Milliman). The rate is extremely important for us youngins, but also older people. Do some quick annuity factor calculations on a 1% error over 20 years. That translates to about a 17.5% reduction in value. Telling a 65 year old with 750K and a life expectancy of ~85 that they will have more money when they die than they do today is borderline negligence. This is exactly what was said to my father by the way.

I hope you guys find this at least a partially interesting read. I also hope there is some discourse that occurs because of it. Granted in this market Helen Keller could make money. In 2016 I earned 27.9%. I had a baby this year, so less contributions made dollar averaging a bit more difficult. As of 3:23 pm today I am sitting at 19.0% for 2017. I am heavily in pretty high yield dividend stocks right now (5.4% on TTM). So if the market goes sideways here out and no one cuts dividends, I will end at about 20.9%.

Submitted July 21, 2017 at 03:31PM by PresentDayPolymath http://ift.tt/2tnQMBi