your advisor should act like a good doctor

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
Post Reply
Topic Author
larryswedroe
Posts: 16022
Joined: Thu Feb 22, 2007 7:28 am
Location: St Louis MO

your advisor should act like a good doctor

Post by larryswedroe »

Thought piece hope you find of interest

http://www.etf.com/sections/index-inves ... octor.html

Best wishes
Larry
User avatar
cfs
Posts: 4154
Joined: Fri Feb 23, 2007 12:22 am
Location: ~ Mi Propio Camino ~

Re: your advisor should act like a good doctor

Post by cfs »

Thanks Larry.

Thanks Larry for the good article (you did a lot of work on this long article), I like the part on advisors Eat[ing] Their Own Cooking.
~ Member of the Active Retired Force since 2014 ~
Topic Author
larryswedroe
Posts: 16022
Joined: Thu Feb 22, 2007 7:28 am
Location: St Louis MO

Re: your advisor should act like a good doctor

Post by larryswedroe »

Thanks CFS, glad you enjoyed. And yes a lot of work went into, helped by my co-author Andrew Berkin, director of research at Bridgeway. Andy is also the co-author of a paper that will be published in next Summer's edition of the Journal of Investing: Is Investing a Science. And he is also the co-author of the new book we are just finishing off, The Incredible Shrinking Alpha (why generating alpha is getting persistently harder, and more and more of a loser's game)

Best wishes
Larry
leonard
Posts: 5993
Joined: Wed Feb 21, 2007 10:56 am

Re: your advisor should act like a good doctor

Post by leonard »

Personal Finance can be made simple, understandable and actionable. Understanding what needs to be done is pretty straightforward - without the use of analogies.

"Physician", "Buckets", and any other analogy simply cloud the issue.
Leonard | | Market Timing: Do you seriously think you can predict the future? What else do the voices tell you? | | If employees weren't taking jobs with bad 401k's, bad 401k's wouldn't exist.
Tamales
Posts: 1644
Joined: Sat Jul 05, 2014 10:47 am

Re: your advisor should act like a good doctor

Post by Tamales »

Hi Larry, could you elaborate on this excerpt:

"Similarly, you should only work with a financial advisor who provides a fiduciary standard of care. The fiduciary standard is the highest standard of care under the law, requiring the advisor to give only advice that is in your best interest.

Most financial advisors, however, provide only a suitability standard of care, which merely requires them to give advice that is “suitably” consistent with your investing objectives. There’s simply no reason ever to work with an advisor who will not offer the fiduciary standard."


Is there some certification or 3-letter-acronym in the advisor's title? Or maybe there are several suitable certifications?

You note there's no reason to work with an advisor not offering the fiduciary standard, but often times people are stuck in brokerage accounts they have held for years and don't want to uproot or rock the boat. I don't imagine the advisors at most large firms are officially following a fiduciary standard since it probably conflicts with their parent company goals of maximizing shareholder value. How would you advise a person to make the best of the situation if they are using a "suitability standard of care" advisor? (assuming "get a new advisor" is not a feasible answer)
Topic Author
larryswedroe
Posts: 16022
Joined: Thu Feb 22, 2007 7:28 am
Location: St Louis MO

Re: your advisor should act like a good doctor

Post by larryswedroe »

Tamales
Yes, RIA must provide fiduciary standard of care.

As to stuck in brokerage, that is just nonsense. No one is stuck. You can simply transfer the holdings to an RIA who will arrange for the transfer of holdings to another custodian. Nothing else must happen. There's little to no inconvenience. It's just an excuse. And as to not rocking the boat, that's the point, you want to rock it!!
As to making best of situation, sorry but the only right answer IMO is to run as fast as you can. LIterally no reason to ever work with someone who would not offer it. Would you work with a doctor who didn't swear to the Hippocratic Oath and wasn't held to that standard by the law as well as his profession? So yes get a new advisor is always a feasible answer. There are tens of thousands of advisors that provide that standard.
Larry
Tamales
Posts: 1644
Joined: Sat Jul 05, 2014 10:47 am

Re: your advisor should act like a good doctor

Post by Tamales »

Hi Larry, per your article, I think you need to work on your bedside manner. :happy Elderly people who know little about investing and don’t desire to learn and have socked their money away at a brick-and-mortar advisor for years consider such a thing a stressful event, regardless of whether you or me or anyone else thinks they should.

They first don’t really understand what’s wrong with what they have (try to discuss high expense ratios and over-diversification via too many redundant funds with them and their eyes glaze over), don’t know how to evaluate it, and don’t know why they should switch or what it will improve. They also put a lot of weight in the brick-and-mortar aspect of it, rightly or wrongly.

You may consider this nonsense, but it happens and I’m looking for a way to work within their comfort zone. Using your doctor analogy, you are allowed to tell your doctor you don’t want to worry about the side effects of a drug or treatment they recommend, and the doctor (even if they think your objection is nonsense) would be expected to give you a viable alternative. So Dr Larry, help me figure out some alternative or compromise. Never having used an advisor myself, I don't know much about the options available to recommend to them. For example, do most RIAs require that you open an account with them, or do they all allow you to maintain an account (in this case it would have to be converted from a managed account to an unmanaged account first) at the same firm you currently use, and the RIA just advises on what to own in a buy and hold portfolio and the AA, but it is up to the account owner to make the initial trades to get there? Are RIAs generally paid by fixed fee or percent of the portfolio value or something else? Is there a database of RIAs with info on their investment philosophy, fees, location, etc? You can reply via PM if you feel this has strayed off topic.
User avatar
nisiprius
Advisory Board
Posts: 52219
Joined: Thu Jul 26, 2007 9:33 am
Location: The terrestrial, globular, planetary hunk of matter, flattened at the poles, is my abode.--O. Henry

Re: your advisor should act like a good doctor

Post by nisiprius »

larryswedroe wrote:Tamales
Yes, RIA must provide fiduciary standard of care.

As to stuck in brokerage, that is just nonsense. No one is stuck. You can simply transfer the holdings to an RIA who will arrange for the transfer of holdings to another custodian. Nothing else must happen. There's little to no inconvenience. It's just an excuse. And as to not rocking the boat, that's the point, you want to rock it!!
As to making best of situation, sorry but the only right answer IMO is to run as fast as you can. LIterally no reason to ever work with someone who would not offer it. Would you work with a doctor who didn't swear to the Hippocratic Oath and wasn't held to that standard by the law as well as his profession? So yes get a new advisor is always a feasible answer. There are tens of thousands of advisors that provide that standard.
Larry
Some time ago in another thread, How to tell who is bound to a fiduciary standard? I explored the question of whether a layperson can even tell whether they are dealing with a fiduciary or not, and also whether being in a fiduciary relationship made any practical difference with regard to having been given bad advice.

In particular, I was trying to find out whether Vanguard's financial advisors are fiduciaries, yes or no.

I still don't know, so let me open this up again and see if Larry or anyone else can answer it.

1) Vanguard says that you receive "Straightforward advice from professionals who receive no commissions and have only your interests in mind."

2) Vanguard's services appear to be provided by Vanguard Advisers, Inc ("VAI")

3) VAI is a federally registered investment adviser

The more I drilled down, the less it became clear.

Furthermore, when others weighed in, I got the impression that "fiduciary" mostly comes into play when something really grotesque happens--when your adviser steals your money; or when your adviser, with transaction authority on your account, buys you large amounts of a security his firm owns and is trying to unload.

It doesn't really seem to have much to do with plain old "advice" in the usual sense of the term. Does anyone have an example of a fiduciary being disciplined for giving bad advice, such recommending a high-expense mutual fund instead of a low-expense fund, I wonder? It seemed to be more about doing bad things than about giving bad advice.

Another poster said that being an RIA, or representing a firm that is an RIA, means nothing; unless your adviser gives you a personally signed document indicating that his relationship to you and your particular account is a fiduciary relationship, he is not a fiduciary.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.
User avatar
VictoriaF
Posts: 20122
Joined: Tue Feb 27, 2007 6:27 am
Location: Black Swan Lake

Re: your advisor should act like a good doctor

Post by VictoriaF »

A critical difference between medicine and finance is that in medicine treatments are based on double blind controlled experiments. In finance such experiments are impossible.

Victoria
Inventor of the Bogleheads Secret Handshake | Winner of the 2015 Boglehead Contest. | Every joke has a bit of a joke. ... The rest is the truth. (Marat F)
dbr
Posts: 46181
Joined: Sun Mar 04, 2007 8:50 am

Re: your advisor should act like a good doctor

Post by dbr »

Another part of this analogy is that the best advice might be to not use a financial adviser at all. Not seeking care from a doctor for a medical condition and/or for wellness care would be unusual and not recommended by most. In some cases it is even illegal not to seek care, such as for a sick child.

A different point is that most of the non-illegal but objectionable practices in the financial industry have been generally recognized in our society as appropriate business practices that are even admired and rewarded. It is no wonder that people are easily confused between what is supposed to be good and what is actually very bad for the customer. The "high status" of bad advisers and the social network that aids and abets their nefarious activities is a good part of this.

It is true that the medical profession sometimes arrives at recommendations and treatment protocols that are wrong and need to be corrected. There are also well-meaning quacks and ill informed alternative practitioners. There are also effective alternative practitioners. The FA profession has some bad practitioners who actually believe they are doing the right thing. Maybe they are the analog to quacks.
User avatar
nisiprius
Advisory Board
Posts: 52219
Joined: Thu Jul 26, 2007 9:33 am
Location: The terrestrial, globular, planetary hunk of matter, flattened at the poles, is my abode.--O. Henry

Re: your advisor should act like a good doctor

Post by nisiprius »

Consider the article's recommendation:
...you should only work with a financial advisor who provides a fiduciary standard of care. The fiduciary standard is the highest standard of care under the law, requiring the advisor to give only advice that is in your best interest.

Most financial advisors, however, provide only a suitability standard of care, which merely requires them to give advice that is “suitably” consistent with your investing objectives.
Now consider Wealthfront. Suppose I am a layperson (which I am) considering using Wealthfront (which I am not).

I wish to determine: does Wealthfront follow a "fiduciary" standard of care or only a "suitability" standard of care?

Wealthfront's "Full Disclosure" web page says:
Wealthfront Inc. (“Wealthfront”) operates an online financial advisor at http://www.wealthfront.com (the “Site”) and is registered with the Securities and Exchange Commission under the Investment Advisers Act of 1940, as amended.
Their form ADV part 2 says:
Wealthfront’s paramount ethical, professional, and legal duty is to act at all times as a fiduciary to its Clients. This means that Wealthfront puts the interests of its Clients ahead of its own, and carefully manages for any perceived or actual conflict of interest that may arise in relation to its advisory services.
Does Wealthfront provide a fiduciary standard of care?
Last edited by nisiprius on Tue Oct 28, 2014 8:15 am, edited 1 time in total.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.
Topic Author
larryswedroe
Posts: 16022
Joined: Thu Feb 22, 2007 7:28 am
Location: St Louis MO

Re: your advisor should act like a good doctor

Post by larryswedroe »

Tamales
Yes human behavior is often a hurdle to overcoming mistakes and avoiding them in first place. And you can only bring a horse to water but you cannot make it drink. I have seen many examples of the type behavior you describe, and they are examples of human beings not always acting in their own best interests. You cannot always get people to realize or accept that they are doing things that are harmful. Just think about overweight people who keep behaving in ways that prevent losing weight no matter how much they are educated.

Having said that, there is a he simple way to address this and that is by asking questions. Something like, can you explain to me why anyone should work with a financial advisor who is not required under the law to give advice that is not solely in your interests? What rationale can you provide? You can also ask the same type question, can you explain to me why anyone should work with an advisor who doesn't eat his own cooking, doesn't invest in the same vehicles he/she is recommending to me? The issue is simple--don't "lecture" just ask questions and use analogies, which is what I do. In the vast majority of cases it works. But not always.

Nisiprius
I truly don't understand why this is a difficult issue. It's very simple to tell. All you have to do is ask the advisor to put in writing that they provide a fiduciary standard of care. Nothing more is required. Just as someone else told you.

Victoria
In investing/finance we can do out of sample tests to see if results hold up.. So you can test
A) different time periods
B) different geographical regions
C) Different countries
D) different asset classes

The more of these tests that are met the more confident you can be in your results. Think about MOM for example. It holds up in tests on all four. Value does as well (cheap assets outperform expensive ones wherever we look).

Larry
User avatar
nisiprius
Advisory Board
Posts: 52219
Joined: Thu Jul 26, 2007 9:33 am
Location: The terrestrial, globular, planetary hunk of matter, flattened at the poles, is my abode.--O. Henry

Re: your advisor should act like a good doctor

Post by nisiprius »

larryswedroe wrote:Nisiprius
I truly don't understand why this is a difficult issue. It's very simple to tell. All you have to do is ask the advisor to put in writing that they provide a fiduciary standard of care. Nothing more is required. Just as someone else told you.
If Vanguard sends me an email that says:
All Vanguard planners are salaried and not paid commission. This ensures the planners are able to provide recommendations that are in the best interest of our clients.

Vanguard Advisors, Inc. operates under a code of ethics that complies with Rule 17j-1 of the Investment Company Act of 1940 and Rule 204A-1 of the Investment Advisors Act of 1940.
are they fiduciaries?

It sounds as if you need to know to ask. The words "registered investment advisor" on a website or brochure aren't good enough.

So, you ask. You get something in writing, such as the material I quoted from Vanguard. How do you know if it is the right kind of document? Is there some specific SEC or FINRA document with a number on it that you are supposed to get? If you get it, does everyone you talk to at the firm have a fiduciary responsibility to you, or only the specific advisor who signed the document?
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.
User avatar
VictoriaF
Posts: 20122
Joined: Tue Feb 27, 2007 6:27 am
Location: Black Swan Lake

Re: your advisor should act like a good doctor

Post by VictoriaF »

larryswedroe wrote:Victoria
In investing/finance we can do out of sample tests to see if results hold up.. So you can test
A) different time periods
B) different geographical regions
C) Different countries
D) different asset classes

The more of these tests that are met the more confident you can be in your results. Think about MOM for example. It holds up in tests on all four. Value does as well (cheap assets outperform expensive ones wherever we look).

Larry
Larry,

At the Bogleheads conference that has just ended someone said that theories that are formulated based on experimental data are useless, only theories that are first formulated and then supported by experiments have value. Financial theories are all rooted in the past data. I am not aware of any financial theories that are well formulated and well documented a priori, and then tested over a large number of samples. In contrast, in medicine, formulation and testing of hypotheses is the mode of operation.

Victoria
Inventor of the Bogleheads Secret Handshake | Winner of the 2015 Boglehead Contest. | Every joke has a bit of a joke. ... The rest is the truth. (Marat F)
Tamales
Posts: 1644
Joined: Sat Jul 05, 2014 10:47 am

Re: your advisor should act like a good doctor

Post by Tamales »

Nisiprius commented:
"It sounds as if you need to know to ask. The words "registered investment advisor" on a website or brochure aren't good enough.

So, you ask. You get something in writing, such as the material I quoted from Vanguard. How do you know if it is the right kind of document? Is there some specific SEC or FINRA document with a number on it that you are supposed to get? If you get it, does everyone you talk to at the firm have a fiduciary responsibility to you, or only the specific advisor who signed the document?"


And Larry commented separately:
"Nisiprius: I truly don't understand why this is a difficult issue. It's very simple to tell. All you have to do is ask the advisor to put in writing that they provide a fiduciary standard of care. Nothing more is required. Just as someone else told you."
---
Larry: it seems to me Nisiprius raises good questions and I'm not seeing the simplicity. Ultimately this mystery document for fiduciary obligations serves as the contract, so the wording must pass legal muster. It seems unlikely a non-lawyer could craft such a document, and there are potentially very large penalties and obligations involved. Surely some lawyer has created a template for this, which uses all the correct words relative to legal precedent, and doesn’t use the wrong words. Words matter---for example, in patent enforcement, the word “use” has a distinctly different legal interpretation than the word “utilize,” and enforcement has turned on which word was chosen.

Equally important, what body enforces the fiduciary standard, and how would one file a claim, and what are the penalties? For that matter, where is the fiduciary standard written into law, if at all (I believe Larry has stated it is a legally binding obligation so it must be written somewhere)? The use of the word “standard” implies some body has documented at the very least the best practices. If the language of this standard has been so diluted by special interest groups that it can’t be enforced and is too vague, then the so-called fiduciary standard has no teeth. Perhaps this is why Vanguard avoids using the word “fiduciary,” since it attaches their obligations to a standard they don’t believe is sufficient (I am of course only speculating on this). Another possibility is there are "multiple standards" and you have to pick and choose which one you want to govern behavior.
leonard
Posts: 5993
Joined: Wed Feb 21, 2007 10:56 am

Re: your advisor should act like a good doctor

Post by leonard »

VictoriaF wrote:
larryswedroe wrote:Victoria
In investing/finance we can do out of sample tests to see if results hold up.. So you can test
A) different time periods
B) different geographical regions
C) Different countries
D) different asset classes

The more of these tests that are met the more confident you can be in your results. Think about MOM for example. It holds up in tests on all four. Value does as well (cheap assets outperform expensive ones wherever we look).

Larry
Larry,

At the Bogleheads conference that has just ended someone said that theories that are formulated based on experimental data are useless, only theories that are first formulated and then supported by experiments have value. Financial theories are all rooted in the past data. I am not aware of any financial theories that are well formulated and well documented a priori, and then tested over a large number of samples. In contrast, in medicine, formulation and testing of hypotheses is the mode of operation.

Victoria
Precisely my point above. Every analogy for personal finance tends to sidetrack to discussion of the "aptness" of the analogy.
Leonard | | Market Timing: Do you seriously think you can predict the future? What else do the voices tell you? | | If employees weren't taking jobs with bad 401k's, bad 401k's wouldn't exist.
Topic Author
larryswedroe
Posts: 16022
Joined: Thu Feb 22, 2007 7:28 am
Location: St Louis MO

Re: your advisor should act like a good doctor

Post by larryswedroe »

Victoria
Sorry but I totally disagree. While data mining does happen--they find a correlation and then look for an explanation---that isn't not only always true, no good researcher does that. Fama and French for example don't and neither do any of the people I know in the industry who are respected. They formulate an hypothesis and then test it.


Tamales
The SEC enforces the RIA standard. Obviously there are lawsuits based on suitability and fiduciary though I don't have the history on them.

Nisiprius
Like I said, just ask for it in writing

Larry
User avatar
nisiprius
Advisory Board
Posts: 52219
Joined: Thu Jul 26, 2007 9:33 am
Location: The terrestrial, globular, planetary hunk of matter, flattened at the poles, is my abode.--O. Henry

Re: your advisor should act like a good doctor

Post by nisiprius »

larryswedroe wrote:Nisiprius
Like I said, just ask for it in writing
Larry
I did. And Vanguard gave me this in writing:
All Vanguard planners are salaried and not paid commission. This ensures the planners are able to provide recommendations that are in the best interest of our clients.

Vanguard Advisors, Inc. operates under a code of ethics that complies with Rule 17j-1 of the Investment Company Act of 1940 and Rule 204A-1 of the Investment Advisors Act of 1940.
Are they fiduciaries?

If you don't want to answer that directly yourself, can you tell me who to ask? The email address of the appropriate office at FINRA? The SEC? Whose job is it to clarify for me whether this written reply is a legalistically precise way of saying "fiduciary" or an evasive way of saying "not a fiduciary?"
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.
Topic Author
larryswedroe
Posts: 16022
Joined: Thu Feb 22, 2007 7:28 am
Location: St Louis MO

Re: your advisor should act like a good doctor

Post by larryswedroe »

Nisiprius
I find it strange
But I would send that right back and just ask directly
But if they are an RIA then by definition they are fiduciary. That's rule of RIA.
Being salaried and not commissioned doesn't make you a fiduciary however, it just makes you fee only advisor.
And not being a technical expert on the subject, we have compliance officer who is, cannot say more. But I did ask our guy for some help on the question
I'll let you know if I learn anything further
Larry
User avatar
VictoriaF
Posts: 20122
Joined: Tue Feb 27, 2007 6:27 am
Location: Black Swan Lake

Re: your advisor should act like a good doctor

Post by VictoriaF »

larryswedroe wrote:Victoria
Sorry but I totally disagree. While data mining does happen--they find a correlation and then look for an explanation---that isn't not only always true, no good researcher does that. Fama and French for example don't and neither do any of the people I know in the industry who are respected. They formulate an hypothesis and then test it.
Larry,

In medical trials, researchers define the null hypothesis a priori. Then they gather hundreds or even thousands of subjects. Some of these subjects get the treatment; others get a placebo. The researchers don't know which subjects get which until the trial is completed. After the trial period ends, the results are analyzed and the null hypothesis is either rejected or not.

Nothing like that is possible in finance.

Victoria
Inventor of the Bogleheads Secret Handshake | Winner of the 2015 Boglehead Contest. | Every joke has a bit of a joke. ... The rest is the truth. (Marat F)
Fallible
Posts: 8798
Joined: Fri Nov 27, 2009 3:44 pm

Re: your advisor should act like a good doctor

Post by Fallible »

larryswedroe wrote:Thought piece hope you find of interest

http://www.etf.com/sections/index-inves ... octor.html
Best wishes
Larry
Thanks for the article.

Is there a complete transcript of Statman's comments at NAPFA? I could find only an "Investment News" article on his doctor/advisor talk and the reference to "treat your clients like kids." That, plus a few other comments on the behavioral left me wanting to know more.

Thanks.
"Yes, investing is simple. But it is not easy, for it requires discipline, patience, steadfastness, and that most uncommon of all gifts, common sense." ~Jack Bogle
Topic Author
larryswedroe
Posts: 16022
Joined: Thu Feb 22, 2007 7:28 am
Location: St Louis MO

Re: your advisor should act like a good doctor

Post by larryswedroe »

Victoria of course that is true, but it doesn't mean that hypotheses are not thought of BEFORE you run the data, and that you can run out of sample tests and apply the very same mathematical techniques as used in science/medicine. In fact today many if not most finance researchers are Ph.Ds in science (like physics) or math and they use the same scientific methods they used in prior lives. Legendary hedge funds, such as Renaissance Technology, SAC Capital Advisors and D.E. Shaw, hire Ph.D. scientists, mathematicians and computer scientists. And another good example is Eduardo Repetto, the co-CEO of Dimensional Fund Advisors, who has a Ph.D. from Caltech and worked there as a research scientist, and DFA’s co-CIO Gerard O’Reilly also has a Caltech Ph.D. in Aeronautics and Applied Mathematics. And my co-author Andrew Berkin, the Director of Research at Bridgeway Capital Management, has a Caltech B.S. and University of Texas Ph.D. in physics, and is a winner of the NASA Software of the Year award.
They all use the same scientific methods they used before.
Larry
User avatar
White Coat Investor
Posts: 17413
Joined: Fri Mar 02, 2007 8:11 pm
Location: Greatest Snow On Earth

Re: your advisor should act like a good doctor

Post by White Coat Investor »

It's a good article Larry, with significant improvements from the draft I think I briefly discussed with you a while back.

Three comments: 1) Financial advisor pricing is better than doctor pricing because you can get it ahead of time, mostly because you can determine the needed services ahead of time and there are no third party payors obscuring prices.

2) Financial advisor pricing (even among fee-only, fiduciary advisors) is often worse than doctor pricing because it is based on assets under management rather than a straight fee for service model. Imagine if the doctor promised you all the advice and services you needed from him for the next year for just 1% of your total assets. You'd laugh and walk out. Likewise, if financial advisors want to really charge like doctors, an hourly rate (for financial planning) or a flat annual retainer (for investment management) seems a better model. The nice thing is you can relatively easily convert between the two (1% a year on a $1 Million portfolio = a $10K annual retainer) and when your portfolio gets so big that the AUM fee is too high, you can either negotiate a lower one or go see a flat-fee guy.

3) It's tough to be a DIY doctor, even if you have an interest in medicine. Yet it's relatively easy to be a DIY investment manager if you have an appropriate temperament and knowledge base. It's just not that complicated to put together an appropriate portfolio of passive funds and rebalance it once a year. The real bang for your buck in financial advising is the financial planning in my view.
1) Invest you must 2) Time is your friend 3) Impulse is your enemy | 4) Basic arithmetic works 5) Stick to simplicity 6) Stay the course
User avatar
speedbump101
Posts: 999
Joined: Thu Oct 18, 2007 10:54 pm
Location: Alberta Canada

Re: your advisor should act like a good doctor

Post by speedbump101 »

Fallible wrote:
larryswedroe wrote:Thought piece hope you find of interest

http://www.etf.com/sections/index-inves ... octor.html
Best wishes
Larry
Thanks for the article.

Is there a complete transcript of Statman's comments at NAPFA? I could find only an "Investment News" article on his doctor/advisor talk and the reference to "treat your clients like kids." That, plus a few other comments on the behavioral left me wanting to know more.

Thanks.
Not the article you're looking for, however this (circa 2002) covers Statman's comments re financial advisors being "financial-physicians'

(Sorry for the naked link, however I'm unable to copy a snippet)

http://www.scu.edu/business/finance/res ... icians.pdf

SB...
"Man is not a rational animal, he is a rationalizing animal" -Robert A. Heinlein
Fallible
Posts: 8798
Joined: Fri Nov 27, 2009 3:44 pm

Re: your advisor should act like a good doctor

Post by Fallible »

speedbump101 wrote:
Fallible wrote:
larryswedroe wrote:Thought piece hope you find of interest

http://www.etf.com/sections/index-inves ... octor.html
Best wishes
Larry
Thanks for the article.

Is there a complete transcript of Statman's comments at NAPFA? I could find only an "Investment News" article on his doctor/advisor talk and the reference to "treat your clients like kids." That, plus a few other comments on the behavioral left me wanting to know more.

Thanks.
Not the article you're looking for, however this (circa 2002) covers Statman's comments re financial advisors being "financial-physicians'

(Sorry for the naked link, however I'm unable to copy a snippet)

http://www.scu.edu/business/finance/res ... icians.pdf

SB...
Yes, it's probably the gist of his recent presentation at NAPFA and it's a good read, good references to Buffett, happiness, the wealthy, plus Q&A at the end.

Thanks!
"Yes, investing is simple. But it is not easy, for it requires discipline, patience, steadfastness, and that most uncommon of all gifts, common sense." ~Jack Bogle
afan
Posts: 8195
Joined: Sun Jul 25, 2010 4:01 pm

Re: your advisor should act like a good doctor

Post by afan »

The problem with many financial studies is not lack of a priori hypotheses but lack of out of sample data. In medicine and in finance the hypotheses are formulated based on prior knowledge. They are influenced by then-current theories about the disease or markets. In medicine one replicates studies on new patients whose results were not part of the earlier sample. One tests these hypotheses on new data (not just data not previously analyzed in a particular way). In finance this is really tough to do since you have to wait so long for the markets to unfold. The effects sought are generally very weak, and the noise high, demanding many observations to determine whether there is an effect at all. In medicine the most interesting results are for powerful effects that manifest quickly.

To treat finance studies the way they would be handled in medicine one would have to test NEW results for, say, a small value strategy. Getting the data would take many years, since the noise and variability of market returns tell us that 3 months or 3 years worth of data would be meaningless.

This means that most finance studies go over the same data sets, changing the analysis, but not the underlying data. Thus, if you have a decades long data set in which, on average, small value produced higher Sharpe ratios, then you can test different ways of defining "small" or "value", but you cannot get new data on whether these premiums exist.

It would make sense to run a current definition small value study for 20 years and look at the results from out of sample data. But no one is willing to wait that long.

I have long thought that financial advisors should charge an hourly rate, which would not scale with assets under management. If an established client needs half an hour a year of checking for rebalancing, considering but rarely doing tax loss harvesting and making sure the plan suits any changes in life circumstances, then this should be billed at half or a reasonable hourly rate- $100/ half hour? $250/half hour? Hard to imagine the hourly rate should be more than $500. But I doubt the financial planning model works unless one can collect far higher effective hourly rates.

Physicians effectively have their hourly rates set by insurance companies. Successful financial planners probably are not interested in going that route.
We don't know how to beat the market on a risk-adjusted basis, and we don't know anyone that does know either | --Swedroe | We assume that markets are efficient, that prices are right | --Fama
Topic Author
larryswedroe
Posts: 16022
Joined: Thu Feb 22, 2007 7:28 am
Location: St Louis MO

Re: your advisor should act like a good doctor

Post by larryswedroe »

Afan
As good example, FF paper on small and value published 92, covering period beginning in 63. But then they did out of sample tests after "data mining" accusations. They found same results basically going back to 1926. Then we have basically the same results since 92. And then they did tests in developed and EM countries and they have basically the same results. So there are plenty of out of sample tests.
Same can be said about other factors such as MOM.
While the criticism is SOMETIMES valid it isn't always so

Larry
Topic Author
larryswedroe
Posts: 16022
Joined: Thu Feb 22, 2007 7:28 am
Location: St Louis MO

Re: your advisor should act like a good doctor

Post by larryswedroe »

Nisiprius
As promised I asked our compliance guy who is top notch. Here is his answer to my questions

There are many different definitions of the term (Google comes up with plenty), but the one I liked the most comes from Wikipedia:

A fiduciary is a legal or ethical relationship of trust between two or more parties. Typically, a fiduciary prudently takes care of money for another person. One party, for example a corporate trust company or the trust department of a bank, acts in a fiduciary capacity to the other one, who for example has entrusted funds to the fiduciary for safekeeping or investment. Likewise, asset managers—including managers of pension plans, endowments and other tax-exempt assets—are considered fiduciaries under applicable statutes and laws.[1] In a fiduciary relationship, one person, in a position of vulnerability, justifiably vests confidence, good faith, reliance, and trust in another whose aid, advice or protection is sought in some matter. In such a relation good conscience requires the fiduciary to act at all times for the sole benefit and interest of the one who trusts.


The SEC (or specific state if the advisor is state-registered) has the power to enforce the fiduciary standard of care based upon a Supreme Court Case that states the nature of the relationship between an advisor and client is of a fiduciary manner. In the case, the Court says:

The Advisers Act: “reflects a congressional recognition of the delicate fiduciary nature of an investment advisory relationship, as well as a congressional intent to eliminate, or at least to expose, all conflicts of interest which might incline an investment adviser - consciously or unconsciously - to render advice which was not disinterested.”

And
Investment advisors are fiduciaries with "an affirmative duty of 'utmost good faith and full and fair disclosure of all material facts,' as well as an affirmative obligation 'to employ reasonable care to avoid misleading' … clients”.

Based upon my research, it appears as if most of the cases are settled and thus not exactly “won” by the SEC. Here are a few examples:
http://www.secactions.com/adviser-co-fo ... roceeding/

https://www.lexology.com/library/detail ... 9db8e16d2b

http://www.financial-planning.com/news/ ... 6842-1.htm

I hope that is helpful
Best wishes
Larry
Tamales
Posts: 1644
Joined: Sat Jul 05, 2014 10:47 am

Re: your advisor should act like a good doctor

Post by Tamales »

Hi Larry, here’s what I’ve found about Registered Investment Advisors:

RIA is not a professional designation and according to most regulators, should not be used in advertising to clients since it can be a misleading representation. RIA just means the registration process was completed. There are many exclusions to the requirement to register (see document below). There are significant differences between registering as an investment advisor with the SEC and individual state securities regulators. More than $3 Billion was recovered by the SEC in both 2012 and 2013 from RIA penalties.

I also found this 2013 document about the regulation of investment advisors by the SEC: http://www.sec.gov/about/offices/oia/oi ... 042012.pdf
which seems to give pages of ways out of the requirements.

This snip is interesting:

"The Advisers Act does not provide a comprehensive regulatory regime for advisers, but
rather imposes on them a broad fiduciary duty to act in the best interest of their clients.

As the Commission explained:
Unlike the laws of many other countries, the U.S. federal securities laws do not
prescribe minimum experience or qualification requirements for persons providing
investment advice. They do not establish maximum fees that advisers may
charge. Nor do they preclude advisers from having substantial conflicts of interest
that might adversely affect the objectivity of the advice they provide. Rather,
investors have the responsibility, based on disclosure they receive, for selecting
their own advisers, negotiating their own fee arrangements, and evaluating their
advisers’ conflicts."


Note especially the last sentence, which seems to neuter the intent and puts the responsibility on the individual. Beyond extremes like fraud, the obligations on a RIA seem minimal. I'm sure there are some who practice above and beyond the minimum requirements, but from where I sit it seems you are overselling the significance of an RIA. It insures very little beyond extreme behaviors like fraud. (This isn't a commentary on your practices Larry, which I'm sure are top notch; I'm just opining on what the regs say (or don't say))

As far as the Supreme Court case you mention, I assume you mean SEC v. Capital Gains Research Bureau, Inc., et. al. (1963). I came across that yesterday, skimmed it, and it didn't give me any great clarity on the matter. The language is too vague to have any clear meaning except in extreme cases. It mainly deals with the self-enrichment (scalping) of an RIA and the Court decided it had to be disclosed by the RIA.
Topic Author
larryswedroe
Posts: 16022
Joined: Thu Feb 22, 2007 7:28 am
Location: St Louis MO

Re: your advisor should act like a good doctor

Post by larryswedroe »

Tamales
First, the issue of RIA being the firm not the advisor has been repeated over and over again. You hire a firm, your agreement, you sign an advisory agreement, is with a firm, not an advisor.
Second, Yes the term fiduciary is broad, but I simply ask why anyone would choose to not work with someone who isn't willing to be held to the standard? What benefit do you derive by not having that standard applied?
FWIW-you are starting to see more court cases related to selling high cost products--we are seeing these in 401k plans for example
Larry
Leeraar
Posts: 4109
Joined: Tue Dec 10, 2013 7:41 pm
Location: Nowhere

Re: your advisor should act like a good doctor

Post by Leeraar »

I am with Victoria on this one.

Economics and finance are not subject to the Scientific Method.

http://en.wikipedia.org/wiki/Scientific_method

Ergo, they are not science in the strict definition of the term. Neither are politics or religion.

I actually feel quite strongly about this. Finance is not science, and there is no bedrock of provable and accepted theory. Therein lies the danger. That's what people should be told.

Coincidentally, I made exactly this point in a lecture at an Ivy League school on Monday. I was lobbying that engineering students should explicitly be taught the Scientific Method, and where it applies and where not.

L.
You can get what you want, or you can just get old. (Billy Joel, "Vienna")
User avatar
nisiprius
Advisory Board
Posts: 52219
Joined: Thu Jul 26, 2007 9:33 am
Location: The terrestrial, globular, planetary hunk of matter, flattened at the poles, is my abode.--O. Henry

Re: your advisor should act like a good doctor

Post by nisiprius »

Sensible people can disagree about the range of meanings of the word "science." Oceanography is one of "the earth sciences," many universities have a department of "political science," the FBI has a "behavioral science unit," etc.

However, the word "science" should not be used to cast an unjustified aura of certainty around investing. If we are to consider it to be a science, it belongs, like economics, among the social sciences, such as anthropology, geography, or linguistics.

Medicine is in a different category. In the 1950s in elementary school, there were kids in wheelchairs and walking around with crutches because of polio. I personally received an injection during the field trials of the Salk vaccine, and we all got notices later saying whether we'd been in the experimental group or the control group. I remember the celebratory mood when the newspapers came out with the news that the vaccine had been 90% effective. Medicine may not be totally scientific but by golly they try.

I've never gotten a notice telling me whether I was in the experimental group or the control group for an investment strategy.

If we must come down with a firm yes-or-no statement on whether investing is a "science," then I agree with John C. Bogle, who wrote, in chapter 1 of Clash of the Cultures, "investing is not a science."

Image
Last edited by nisiprius on Thu Oct 30, 2014 2:53 pm, edited 4 times in total.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.
Topic Author
larryswedroe
Posts: 16022
Joined: Thu Feb 22, 2007 7:28 am
Location: St Louis MO

Re: your advisor should act like a good doctor

Post by larryswedroe »

FWIW
Clearly investing/finance isn't a hard science like physics. Having said that it doesn't mean that one cannot apply the scientific method. I know many world class scientists who have turned into financial economists and I think they would all say they apply the scientific methods they learned as top physicists, aerospace engineers, and so on. In fact I have co-authored a paper with a scientist that will appear in the Journal of Investing addressing the issue of Is Investing a Science.
Larry
User avatar
speedbump101
Posts: 999
Joined: Thu Oct 18, 2007 10:54 pm
Location: Alberta Canada

Re: your advisor should act like a good doctor

Post by speedbump101 »

"A better strategy is to learn from history, so you don't repeat the mistakes past generations made. Scientific investing, at its best, is about engaging the data honestly, with the intention of learning something new, hopefully something discordant with previously held beliefs. Science as it's currently practiced has plenty of flaws, but it's still the most reliable method of acquiring the truth that I know of."

http://news.morningstar.com/articlenet/ ... ?id=608389

SB...
"Man is not a rational animal, he is a rationalizing animal" -Robert A. Heinlein
Leeraar
Posts: 4109
Joined: Tue Dec 10, 2013 7:41 pm
Location: Nowhere

Re: your advisor should act like a good doctor

Post by Leeraar »

History is useful for learning. It is not science.

L.
You can get what you want, or you can just get old. (Billy Joel, "Vienna")
scone
Posts: 1457
Joined: Wed Jul 11, 2012 4:46 pm

Re: your advisor should act like a good doctor

Post by scone »

It would be great if investing had a stronger intellectual foundation. But trying to make it "look and feel" like a hard science is jumping way ahead of the game, in my view. Just for example, science helps us predict in great detail the behavior of the world around us, but investors and economists can't even predict interest rates! I'm not even sure investing really ought to mimic hard science, because it's not studying nature, it's studying human nature.

That doesn't mean you don't use the data you have as well as you can-- of course you do. But gathering and using evidence in investing is much more like writing a history paper than doing a physics or biology experiment. It's like history in that you take the data and create a rhetorical case, you construct a narrative that attempts to "explain" the data. The methods you use making arguments in a history paper are more like the methods of a legal trial than hard science, e.g. preponderance of evidence, reasonable man, beyond a reasonable doubt, etc. We use these methods, and this type of evidence, to make some pretty important decisions, such as whether a man will be condemned to death for murder, so obviously as a society we think they are "fit for purpose" in some sense.

So you might do any number of studies and experiments about investing, and these studies might be pretty "scientific" by any reasonable definition. But in actually applying the results to practical investing, I think you're essentially constructing a plausible narrative that a reasonable man might accept as likely. So for example, we have a good amount of evidence that slicing and dicing works, but the evidence isn't as iron-clad as that supporting, say, Newton's laws or the germ theory of disease. In fact we may never have iron-clad evidence for the big issues in finance, partly because we can't use all the methods of hard science-- e.g., we can't do double blind placebo controlled experiments to determine the causes of the Great Depression.

But that's not necessarily a bad thing. If you put investing on a firm foundation in the social sciences, borrowing from sociology, psychology, statistics, history, economics, etc., then you've got something solid and intellectually respectable that "covers the ground" better than a narrow hard science viewpoint could ever do, because the social sciences deal directly with human nature, which is really what you are studying in finance. And you still have lots of room for number crunching and ethical experimentation. That should be good enough, and it's certainly a long way from speculating on tulip bulbs or gambling in bucket shops.
"My bond allocation is the amount of money that I cannot afford to lose." -- Taylor Larimore
Topic Author
larryswedroe
Posts: 16022
Joined: Thu Feb 22, 2007 7:28 am
Location: St Louis MO

Re: your advisor should act like a good doctor

Post by larryswedroe »

Scone
I basically agree. If you could make these predictions like in science with say gravity, then there would be no risk. But investing isn't like that. There are always unpredictable events that occur, so all we can do is understand the nature of risks and expected returns, the sources of returns and what is likely to happen, putting the odds in our favor.
I think we can all agree that weather forecasting or climate is a science and yet the forecasts aren't all that much better than what we get with investing. Just think how far off the climate change forecasts have been since 1998, as just one example
While not a science one can use scientific methods to better understand the world of finance/investing.
Larry
User avatar
arcticpineapplecorp.
Posts: 15081
Joined: Tue Mar 06, 2012 8:22 pm

Re: your advisor should act like a good doctor

Post by arcticpineapplecorp. »

Larry, thanks for the article.

One correction--while you can take a blood test to screen for prostate cancer, my understanding of the literature is that digital exams are still more accurate and still performed by doctors who know that (like mine). In addition, the blood test (PSA or prostate specific antigen) does lead to both false positives and negatives. see http://www.cancer.gov/cancertopics/fact ... ection/PSA

Secondly, was the phrase "In the end, he had the test done" an intended pun? :D

Finally, I agree with Nisi, Leeraar, Victoria and of course Jack Bogle that investing is not a science (mostly for the reasons they mentioned). Russ Roberts likes to say on his podcast (Econtalk) that economics for that matter is also not a science, despite many in the field claiming otherwise. Running regressions may be statistics, but that's not necessarily science.

thanks again. interesting discussion everyone.
It's hard to accept the truth when the lies were exactly what you wanted to hear. Investing is simple, but not easy. Buy, hold & rebalance low cost index funds & manage taxable events. Asking Portfolio Questions | Wiki
Leeraar
Posts: 4109
Joined: Tue Dec 10, 2013 7:41 pm
Location: Nowhere

Re: your advisor should act like a good doctor

Post by Leeraar »

larryswedroe wrote:Scone
I basically agree. If you could make these predictions like in science with say gravity, then there would be no risk. But investing isn't like that. There are always unpredictable events that occur, so all we can do is understand the nature of risks and expected returns, the sources of returns and what is likely to happen, putting the odds in our favor.
I think we can all agree that weather forecasting or climate is a science and yet the forecasts aren't all that much better than what we get with investing. Just think how far off the climate change forecasts have been since 1998, as just one example
While not a science one can use scientific methods to better understand the world of finance/investing.
Larry
Larry,

Please stop throwing red herrings and analogies.

On Sunday, my wife cuts out the 7-day weather forecast from the paper and posts it on the fridge. It is pretty good, down to whether the rain on Friday will be in the morning or the afternoon.

For some curious reason, there is not a similar reliable prediction of the market.
While not a science one can use scientific methods to better understand the world of finance/investing.
Exactly. Logical reasoning applies in the social sciences as well as the natural sciences.

At the risk of incurring the wrath of Lady Geek, this has indeed been a great week for science and the scientific method. First, the Pope acknowledged religion as a belief and physics (the "big bang") as not a contradictory fact, and the President came out on the side of using scientific evidence to deal with Ebola.

L.
You can get what you want, or you can just get old. (Billy Joel, "Vienna")
Topic Author
larryswedroe
Posts: 16022
Joined: Thu Feb 22, 2007 7:28 am
Location: St Louis MO

Re: your advisor should act like a good doctor

Post by larryswedroe »

Leerar
You and others keep missing the point IMO hanging on science as a hard science, as opposed to using scientific methods
And btw there is plenty of random tracking error in weather forecasts, they aren't all that accurate, just more accurate than most other forecasts
As I said, I know many scientists who have become financial economists and they all believe they use scientific methods while agreeing that finance isn't hard science, like physics
No one is claiming it is hard science, but that isn't the point.
Larry
Tamales
Posts: 1644
Joined: Sat Jul 05, 2014 10:47 am

Re: your advisor should act like a good doctor

Post by Tamales »

larryswedroe wrote:Tamales
Yes the term fiduciary is broad, but I simply ask why anyone would choose to not work with someone who isn't willing to be held to the standard? What benefit do you derive by not having that standard applied?
Larry...OK...you asked...
Much of this is a rehash of what I already posted but here goes...

What you're missing is there is no standard (or perhaps there are a thousand different "standards," and multiple standards is an oxymoron). Therefore what benefit do you lose by not having an advisor who practices a nonexistent (or essentially arbitrary, and unenforceable except at the extremes of fraud) standard?

I have in front of me a document from a large investment management company regarding their managed portfolios and their advisory services. They and their subsidiaries involved in the program are Registered Investment Advisors. I'm not going to mention company names, but the document discloses the various conflicts of interest, such as:

The compensation they may receive for directing clients to particular broker-dealers; they may recommend clients buy or sell securities in which XYZ has financial interest in. XYZ may take positions on the opposite side of the transaction which a client may be engaged in...(the document goes on and on for several pages with similar disclosures)

This is from the actual document that the elderly person I mentioned earlier in this thread has their managed account with. So they already have their money managed by RIAs.

I believe the problem is that RIAs don't have an obligation to hold themselves to the high standard you practice. I presume you have no disclosures of these sorts of conflicts of interest, and I also presume that these sorts of conflicts of interest are not that uncommon among RIAs, because it's allowed (even blessed by the Supreme Court so long as there is disclosure). The documents and info I posted above reinforce this. So I'm just not on board with a generic recommendation that an RIA is a good thing, or even any better than a non-RIA. It would be a big mistake for people to believe that those 3 letters imply some automatic safety or high ethical behavior towards clients. They don't. A non-RIA could choose to operate with high integrity from the client perspective as well.

There is something more required of this process of choosing a RIA. It's absolutely not the case than any old RIA will do. Some will legally do things not in the best interest of their clients, but that is in their own best interest or their parent company best interest.

I want to emphasize again that any irritation apparent in my reply is not directed at you Larry. It's directed at this "system" which should have been set up to provide some guarantees, and some written, clear integrity standards. Instead, the system is compromised by all these fully legal self-enrichment clauses--as long as they are disclosed in a long legal document I am quite certain few clients ever read. It ruins any pedestal of integrity the RIA designation might otherwise have. I do appreciate your replies, since that's what got me looking into this further, but I come away unconvinced that using an RIA necessarily means much. So I'm back at square one.
scone
Posts: 1457
Joined: Wed Jul 11, 2012 4:46 pm

Re: your advisor should act like a good doctor

Post by scone »

larryswedroe wrote:Scone
I basically agree. If you could make these predictions like in science with say gravity, then there would be no risk. But investing isn't like that. There are always unpredictable events that occur, so all we can do is understand the nature of risks and expected returns, the sources of returns and what is likely to happen, putting the odds in our favor.
I think we can all agree that weather forecasting or climate is a science and yet the forecasts aren't all that much better than what we get with investing. Just think how far off the climate change forecasts have been since 1998, as just one example
While not a science one can use scientific methods to better understand the world of finance/investing.
Larry
There is a basic, fundamental difference between a weather system, however complex, and investing. Human investors are conscious, weather is not. If you wanted to study investor behavior by comparison or analogy to the natural world, then IMO you would look at the behavior of mammals in large groups which use complex signaling behavior, such as wildebeests, or maybe flocks of birds, or fish. The mathematics of herding behavior is pretty interesting.

If you liked, you could see all human history as the story of very large herds, using extremely complicated signaling, over very large distances, over very large time periods. Only history and allied sciences even attempt to come to grips with this level of complexity. Thousands of years of culture, and all of that history, all that narrative, from hundreds of different cultural traditions, feeds into human behavior as it plays out in investing around the world, minute by minute, every day. If investing is essentially communication, we have never talked to each other so much as we do today.

On another level, it's possible that we are making the problem too complex. Let's say investing is a game that can be "won" only by a very small number of people who are not "normal," people who can shut down their limbic brains and go against the signaling of the herd. There have been studies that suggest people who are psychopaths, or have brain damage, or perhaps Aspies, make better investors than average. In that case, maybe it's not a problem of inadequate science, or inadequate humans, but an investing "game" that is largely unwinnable by normal people. Maybe blaming people for their poor investing is like a scientist blaming fish for not being able to breathe in air. Perhaps we have made a communication system that we have not evolved to cope with.

So maybe the average investor is o.k., but the game is perverse. In fact, if we really wanted good outcomes for most people in society, why have we rigged up a game which goes against 3.5 million years of evolution, and arguably rewards anti-social behavior? No logical, rational scientist would have set up a system as destructive and wasteful as this.

In any case, improving the investing world, as hard as that might be, is a lot easier than improving Homo Sapiens.
"My bond allocation is the amount of money that I cannot afford to lose." -- Taylor Larimore
Leeraar
Posts: 4109
Joined: Tue Dec 10, 2013 7:41 pm
Location: Nowhere

Re: your advisor should act like a good doctor

Post by Leeraar »

larryswedroe wrote:Leerar
You and others keep missing the point IMO hanging on science as a hard science, as opposed to using scientific methods
And btw there is plenty of random tracking error in weather forecasts, they aren't all that accurate, just more accurate than most other forecasts
As I said, I know many scientists who have become financial economists and they all believe they use scientific methods while agreeing that finance isn't hard science, like physics
No one is claiming it is hard science, but that isn't the point.
Larry
Larry,

That is exactly the point. In this thread
http://www.bogleheads.org/forum/viewtop ... 0&t=149777
you "illustrate" expected return as a normal distribution about some expected value.

This is not true, you know that, and it is very dangerous to look at the issue with this degree of presumed precision. The "Black Swan" or your oft-quoted "Fat Tails" are exactly deviations from the scientific norms you wish to apply when convenient.

Investing is not physics, so look out!

It is what it is. That it (investing) is not a natural science subject to the scientific method is not to demean it at all.

L.
You can get what you want, or you can just get old. (Billy Joel, "Vienna")
User avatar
speedbump101
Posts: 999
Joined: Thu Oct 18, 2007 10:54 pm
Location: Alberta Canada

Re: your advisor should act like a good doctor

Post by speedbump101 »

Science or what?

Isn't the author using scientific methodologies? Someone must think so b/c he won the Nobel prize for "Economic Sciences" in 1990 (option pricing).

On a topic we all hold dear to our hearts. Is this science or what?

"The best way to measure a manager's performance is to compare his or her return with that of a comparable passive alternative. The latter -- often termed a "benchmark" or "normal portfolio" -- should be a feasible alternative identified in advance of the period over which performance is measured. Only when this type of measurement is in place can an active manager (or one who hires active managers) know whether he or she is in the minority of those who have beaten viable passive alternatives."

http://web.stanford.edu/~wfsharpe/art/active/active.htm

SB...
"Man is not a rational animal, he is a rationalizing animal" -Robert A. Heinlein
Alex Frakt
Founder
Posts: 11589
Joined: Fri Feb 23, 2007 12:06 pm
Location: Chicago
Contact:

Re: your advisor should act like a good doctor

Post by Alex Frakt »

Leeraar wrote:
larryswedroe wrote:As I said, I know many scientists who have become financial economists and they all believe they use scientific methods while agreeing that finance isn't hard science, like physics
No one is claiming it is hard science, but that isn't the point.
Larry
Larry,

That is exactly the point.
Leeraar,

This is a simple semantics issue. All we need to do is define our terms - in this case science.

If you define science to exclude any class of questions which are not theoretically solvable from an application of physical laws, then economics and other social sciences are not science.

So the question becomes, do you accept any of the social sciences as science?

IMO, they are. But you have to go into it with the understanding that, unlike natural phenomena, human behavior has no absolutes, there is nothing analogous to physical laws. What we do have are stronger or weaker tendencies. You also have to realize that human behavior is malleable to an extent, thus these tendencies can change over time and that even the process of documenting these tendencies can result in such changes. That said, you can use the scientific method and scientific tools, primarily statistical analyses, to attempt to define these tendencies, including their practical applications and limitations.
Topic Author
larryswedroe
Posts: 16022
Joined: Thu Feb 22, 2007 7:28 am
Location: St Louis MO

Re: your advisor should act like a good doctor

Post by larryswedroe »

Leerar
All I will say is I know many scientists who very much disagree with you
Larry
Leeraar
Posts: 4109
Joined: Tue Dec 10, 2013 7:41 pm
Location: Nowhere

Re: your advisor should act like a good doctor

Post by Leeraar »

larryswedroe wrote:Leerar
All I will say is I know many scientists who very much disagree with you
Larry
Larry,

Yes, I agree with that.

There really is not much point in arguing this further and, to be quite honest, on reflection, I am disappointed in myself with having taken it this far in this forum.

L.
You can get what you want, or you can just get old. (Billy Joel, "Vienna")
User avatar
nedsaid
Posts: 19275
Joined: Fri Nov 23, 2012 11:33 am

Re: your advisor should act like a good doctor

Post by nedsaid »

I am glad to see discussion of the behavioral aspects of investing. There is nothing wrong with people taking what they have learned from science and mathematics and applying these principles to investing. It is just that these things have their limits because of the wildcard of human behavior. People are not always rational and human emotion affects even the best of us. As much as some of us would like to reduce investing to hard math and hard science, human emotion fouls things up, and thus successful investing can be as much an art as a science.

I certainly haven't been willy-nilly in my investments just picking investments according to whim. I did things that made sense to me at the time. I have learned and as a result attempted to improve myself as an investor and improve my portfolio. I have incorporated portfolio theory, academic research about performance factors, model portfolios, efficient frontiers, monte carlo simulations, and other tools into my thinking realizing that even the best tools have their limits. There is so much that we don't know. So I do the best I can.

A good advisor will guide us through the storms of market turbulence and of our own emotions. Hopefully give us perspective when things look dark. I don't know about anyone else, but I have found a bit of hand holding in tough times to be very helpful. I have sought advice and I am very glad that I did.
A fool and his money are good for business.
afan
Posts: 8195
Joined: Sun Jul 25, 2010 4:01 pm

Re: your advisor should act like a good doctor

Post by afan »

Back to the topic of out of sample testing:

If someone writes a paper in 1993 about small and value, then the entire market history up to that point is in sample. One might consider only results back to 1963 in the paper, but the idea of looking at small and value was hardly novel in '93. People looked at these strategies because of their observed performance over the entire time period. One could formally evaluate only a subset of the data available at the time, but that does not render the other results that existed at that time out of sample.

NEW data, which did not exist in '93, would be out of sample. So one could ask how the small and value strategies performed AFTER the '93 paper. Of course, there is nothing special about this particular study. People had been noting these factors for a long time.

This is why one has to be careful about "better" ways of reaching these factors. They are declared to be better based on retrospective looks at data. The second step of this process, the scientific step, would be to run the "new improved" value and size methods on data that did not exist when the approaches were designed. Then see whether they are really better going forward or just a better fit to the old data. Unfortunately, this takes another 10, 20 or whatever years to see whether the new methods really work out of sample.

It is a hard problem in finance.
We don't know how to beat the market on a risk-adjusted basis, and we don't know anyone that does know either | --Swedroe | We assume that markets are efficient, that prices are right | --Fama
Post Reply