Gil’s Musings

Investment Performance & Expectations

An old friend, with whom I have never done business, was recently sharing his frustrations with investing and others in my business. It was revealing and a few things struck me as worthy of reflection. This individual was slightly cynical about investing, but wanted to be invested. Remarkably, he had been out of equities since he “got stung” in 2008. He went on to explain how the manager he had hired had “done so great prior to me coming on board, then the wheels came off”.

After asking many questions about expectations and discussing costs and the like, I came to the conclusion that the issue causing his problems was not with the former manager, but with this person’s perspective and pre-disposition. He was essentially his own worst enemy. One thing was clear; his emotional psyche had been damaged by the experience. Worse, he was now damaging himself emotionally and financially once again by feeling the emotional regret of being out of equities and by watching them scream northward without him. Who wants to bet that he will simply cogitate on the prospect of re-entering the market hoping that luck will fix his problem with a vindicating decline? He will sit tight until the weight of evidence against inaction is so unbearable he will capitulate and re-enter at precisely the next market top.

This is a common pattern with investors, and it all seems to start with expectations. I continue to find that the individuals with the highest expectations for return tend to have the worst results. With this man it started at a deeper level; he also wanted something for nothing. He wanted to be compensated for risks he was unwilling to endure, and he wanted the services required to attain it to be free. He explained early on that he thought that investment management fees were high and needed to be justified by excess performance. I didn’t dare ask what he thought the costs were of having not been invested for the past seven years; a million or two? But he sure saved the fees.

He also made it clear that he went looking for superior performance. He ran across a manager in 2006 with a recent history of beating the market by several points. If repeated, those several points would cover the costs, making the services virtually free. That was the genesis of his problem; the expectation that he could make the services he valued “free” by way of the excess performance. That all works well until it doesn’t. It’s like holding an important wet bar of soap. The tighter you squeeze it to ensure its safety, the more likely it is to jump out of your hand. This person never sought to “attribute” the excess performance to anything besides mental horsepower. It never dawned on him that the manager could be merely lucky, or more often, simply taking larger risks that had yet to turn on him. It turned out to be the latter. A tad bit of leverage on a bet gone bad, and he made a small fortune out of a larger one. That’s like hiring the CPA who claims to be able to get you a greater refund than you are entitled to, justifying his services as free. That’s a great gig right up to your first audit. You think the IRS plays for keeps? You ain’t seen nothing yet.

If you are like most investors, the wealth management process is about having someone more knowledgeable than you to be on your team and advocate for you. It’s about that person being responsible for forward thinking so you don’t unwittingly walk into a trap you couldn’t foresee. It’s also about sleeping well at night because you’ve hired someone else to worry about it. Performance is important, but unlike my friend, it clearly isn’t the only thing and may be a trap unto itself.

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