To be or not to be complex, that is the question

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Mike Scott
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Re: To be or not to be complex, that is the question

Post by Mike Scott » Fri Jun 01, 2018 12:52 pm

Our portfolio is simple enough but we don't have control over the number of different accounts that are required through employers and individual accounts. The number of accounts keeps creeping up rather than down.

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Re: To be or not to be complex, that is the question

Post by abuss368 » Fri Jun 01, 2018 1:18 pm

This is a good post. Over time we have simplified and are always looking for more simplicity both in our financial lives and non financial lives.
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Re: To be or not to be complex, that is the question

Post by MikeG62 » Sat Jun 02, 2018 5:32 am

TheTimeLord wrote:
Wed May 30, 2018 8:23 am
The older I get the more appealing simplicity is because I want to spend time living my life not managing my portfolio.
^This

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AtlasShrugged?
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Re: To be or not to be complex, that is the question

Post by AtlasShrugged? » Sat Jun 02, 2018 5:52 am

Bogleheads...One strong factor to consider on the question of simplification: Who you leave behind when you die. Over the last year, I have been whittling down funds. I now have a three fund portfolio in my Roth, and a four fund portfolio in my primary 401K. All are low cost index funds through Fidelity. Why? My beloved wife. She has oceans of common sense; she does the bills. But very little understanding of ER, contango, fund placement strategies, etc. When I thought about it in those terms, I simplified it in a major way.

One other side note. On 5/31, I maxed my Roth IRA for 2018. It is the earliest I have ever done this. I am pleased as punch. :D
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Re: To be or not to be complex, that is the question

Post by livesoft » Sat Jun 02, 2018 7:38 am

I don't think the number of funds in an account is a sign of complexity. I have one fund in my Roth IRA, 3 in my taxable account. I don't even have a traditional IRA anymore.

Based on widows that I know, a sign of complexity is the number of cars and other vehicles that one has parked in the driveway or on the street because the garage is full of crap.
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1210sda
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Re: To be or not to be complex, that is the question

Post by 1210sda » Sat Jun 02, 2018 10:08 am

We are currently in the 3 fund portfolio. If I predecease my spouse, she will exchange all (taxable and tax advantaged) into Lifestrategy.

As we determine our future tax brackets (as best we can), due to RMD and single filing status for the survivor, we may change to the Tax Managed Balanced fund for Taxable. If we do make that change, our AA would then be 50/50 for taxable and 60/40 for tax advantaged. Total portfolio would average 55/45. Never higher than 60/40 or lower than 50/50. (for the survivor)

Livesoft, may I ask how you and your spouse are planning in case you predecease her?

1210

billthecat
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Re: To be or not to be complex, that is the question

Post by billthecat » Sun Jun 03, 2018 11:46 am

So...what is the benefit of holding some international stock, instead of all US stock?

Bogle seems to say have zero. Vanguard seems to say have 40% (of stock) in international (up from 20% then 30%).

Edit: this is the benefit
Last edited by billthecat on Sun Jun 03, 2018 1:09 pm, edited 2 times in total.

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Re: To be or not to be complex, that is the question

Post by randomizer » Sun Jun 03, 2018 11:53 am

I am a big believer in the virtue of simplicity. No tilts here but still more funds than I would really like (spread across multiple institutions for various reasons). I hope to consolidate in the future.
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Re: To be or not to be complex, that is the question

Post by RamblinDoc » Sun Jun 03, 2018 12:45 pm

To some extent, ‘simplicity’ and ‘complexity’ are relative.

For example, I have a 3-fund core portfolio with SCV and REIT tilts. I consider this “simple” since my tilts will always be weighted according to my IPS. I won’t deviate from that and only rebalance when my pre-defined thresholds are met (according to the 5/25 rule). I don’t worry about market noise in the interim.

Others could argue that this type of portfolio is ‘complex’. However, if mine was ‘simpiler’, I would pay more attention to it and be more likely to erroneously tweak it for fear of missing out. To each their own...

In my opinion, the ‘complex’ part for me was creating an IPS that I could live with for the long haul.

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Re: To be or not to be complex, that is the question

Post by Fallible » Sun Jun 03, 2018 1:38 pm

RamblinDoc wrote:
Sun Jun 03, 2018 12:45 pm
To some extent, ‘simplicity’ and ‘complexity’ are relative.

For example, I have a 3-fund core portfolio with SCV and REIT tilts. I consider this “simple” since my tilts will always be weighted according to my IPS. I won’t deviate from that and only rebalance when my pre-defined thresholds are met (according to the 5/25 rule). I don’t worry about market noise in the interim.

Others could argue that this type of portfolio is ‘complex’. However, if mine was ‘simpiler’, I would pay more attention to it and be more likely to erroneously tweak it for fear of missing out. To each their own...

In my opinion, the ‘complex’ part for me was creating an IPS that I could live with for the long haul.
I might also consider my IPS at least leaning toward the complex even though my portfolio is basically a three-funder. This is because I include detailed explanations for my asset allocation and even my whole approach to and reasons for investing, plus a list of the BH principles to occasionally check against. It's all really about maintaining the emotional discipline to stay the course during market downturns, and that's not simple. In fact, you could say it's the "not easy" part of the Buffett quote, "Investing is simple, but it's not easy."
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Re: To be or not to be complex, that is the question

Post by friar1610 » Sun Jun 03, 2018 5:39 pm

1210sda wrote:
Sat Jun 02, 2018 10:08 am
We are currently in the 3 fund portfolio. If I predecease my spouse, she will exchange all (taxable and tax advantaged) into Lifestrategy.
1210,

In a perfect world, I would like to leave a similar plan in place for my spouse to execute after my demise. But I can't get past reducing what's left for her so much because of the CG hit involved in selling individual equity funds (one TSM and one TISM) and buying an LS fund. Just curious if you have a relatively small percentage of your assets in taxable? (Not the case for me). Or have you run numbers and come up with a rationale for taking the hit?

Thank you for any thoughts you'd care to share.
Friar1610

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1210sda
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Re: To be or not to be complex, that is the question

Post by 1210sda » Sun Jun 03, 2018 6:13 pm

friar1610 wrote:
Sun Jun 03, 2018 5:39 pm
1210sda wrote:
Sat Jun 02, 2018 10:08 am
We are currently in the 3 fund portfolio. If I predecease my spouse, she will exchange all (taxable and tax advantaged) into Lifestrategy.
1210,

In a perfect world, I would like to leave a similar plan in place for my spouse to execute after my demise. But I can't get past reducing what's left for her so much because of the CG hit involved in selling individual equity funds (one TSM and one TISM) and buying an LS fund. Just curious if you have a relatively small percentage of your assets in taxable? (Not the case for me). Or have you run numbers and come up with a rationale for taking the hit?

Thank you for any thoughts you'd care to share.
We have a large percent of our assets in taxable. We live in a community property state, so at the first death (presumably me), the basis of all our assets would be stepped up to current market value at the time of that death.

So we are anticipating either no, or very small, CG tax upon exchanging our 3 FP to the LS fund. My wife would, of course have to contact Vanguard and tell them her wishes. (which we both have committed to in writing)

I'll share a couple of points from another BH thread. My hesitation point has been that many/most BH's say that a LS (or Target Retirement, or Balanced Index, etc.) in a taxable account is in-efficient because of bonds in taxable. However, fellow BH Longinvest found a study that indicated that the benefits from tax efficient asset location doesn't matter much.

Before this, it didn't matter much to me either. The benefit of not having to re balance or having to decide which mutual fund to use for withdrawals or additions is very important to us/her. Now that folks smarter than I are saying it doesn't matter much, that's all I need.

There is a possibility that for Taxable we would use the Tax Managed Balanced Fund (50/50) if in the near future we determine that because of RMD's and having to file as a single taxpayer it would be better.

In case my wife predeceases me, I will continue with the 3 FP.

My final worry, which hasn't been resolved yet, is that of my incapacity. If I don't die, the step up in basis would not take place and exchanging the 3 FP to LS would be tax costly.

Hope I didn't ramble on for too long. :) Any thoughts you have on this would be appreciated.

1210

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Re: To be or not to be complex, that is the question

Post by tomd37 » Sun Jun 03, 2018 7:26 pm

Question about joint ownership in a taxable retirement account. With such ownership how is the valuation of the account handled for tax purposes on the passing of one of the owners? Would it have been better to have the account registered in the name of only one of the spouses? Only five percent of total investments is held in this manner right now. but it is subject to a slight increase in future unless changed. This whole post has been very interesting to me.
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TimeRunner
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Re: To be or not to be complex, that is the question

Post by TimeRunner » Sun Jun 03, 2018 7:31 pm

lostdog wrote:
Thu May 31, 2018 9:35 am
Well said. Total World Equity Index is all I need for now. I'll add Total World Bond as I get older.

A very simple two fund portfolio.

Vanguard Total World Index Fund
Vanguard Total World Bond Index Fund(ETF for now).

Thanks!
I have the Federal Retiree version of this as my endpoint: Vanguard Total World ETF (VT), and Thrift Savings Plan G (Bond) fund. Not there yet, but getting there. :beer
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Re: To be or not to be complex, that is the question

Post by FIREchief » Sun Jun 03, 2018 8:02 pm

Random Walker wrote:
Wed May 30, 2018 10:12 am

CAPM explains about 70% of equity returns.

Fama-French factors increase explanatory power to greater than 90%.

Adding momentum and profitability increases explanatory behavior beyond 95%.
Please explain what "explain" means in this context. The fact that somebody can use historical inputs to mathematically produce (nominal) results that come close to matching historical outputs has no value in predicting the future (especially in an ever changing world with ever changing variables). When it comes to investing, the only thing that matters is the future (unless we can take a Sports Almanac back to the 1950's in a time machine).
I am not a lawyer, accountant or financial advisor. Any advice or suggestions that I may provide shall be considered for entertainment purposes only.

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FIREchief
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Re: To be or not to be complex, that is the question

Post by FIREchief » Sun Jun 03, 2018 8:05 pm

Rick Ferri wrote:
Wed May 30, 2018 6:42 am

My goal IS NOT to endlessly debate whether complex beats simple in theory or vice versa. Rather, my intention is to discuss the practicality of the two strategies in real life. Is there any actual advantage to being complex? I’ll admit my thinking has shifted over the years. I was a complex advocate for many years, but now I believe that was more about stroking my own ego than anything else.
Outstanding post Rick. Especially the part about "stroking your own ego." I' spent a career in a technical Megacorp and the biggest weaknesses i observed in some very smart people was that they just couldn't accept that they couldn't out-think and out-smart the next guy in every situation.
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Re: To be or not to be complex, that is the question

Post by FIREchief » Sun Jun 03, 2018 8:07 pm

dbr wrote:
Wed May 30, 2018 7:30 am
I guess that is why I have such disdain for buckets, LMP, and other schemes, even VPW, which does have some rationale.
One of these things is not like the others. A simple TIPS ladder based LMP can be the absolute simplest fixed income "portfolio" that a person can hold.
I am not a lawyer, accountant or financial advisor. Any advice or suggestions that I may provide shall be considered for entertainment purposes only.

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Re: To be or not to be complex, that is the question

Post by RamblinDoc » Sun Jun 03, 2018 8:28 pm

Fallible wrote:
Sun Jun 03, 2018 1:38 pm
RamblinDoc wrote:
Sun Jun 03, 2018 12:45 pm
To some extent, ‘simplicity’ and ‘complexity’ are relative.

For example, I have a 3-fund core portfolio with SCV and REIT tilts. I consider this “simple” since my tilts will always be weighted according to my IPS. I won’t deviate from that and only rebalance when my pre-defined thresholds are met (according to the 5/25 rule). I don’t worry about market noise in the interim.

Others could argue that this type of portfolio is ‘complex’. However, if mine was ‘simpiler’, I would pay more attention to it and be more likely to erroneously tweak it for fear of missing out. To each their own...

In my opinion, the ‘complex’ part for me was creating an IPS that I could live with for the long haul.
I might also consider my IPS at least leaning toward the complex even though my portfolio is basically a three-funder. This is because I include detailed explanations for my asset allocation and even my whole approach to and reasons for investing, plus a list of the BH principles to occasionally check against. It's all really about maintaining the emotional discipline to stay the course during market downturns, and that's not simple. In fact, you could say it's the "not easy" part of the Buffett quote, "Investing is simple, but it's not easy."
Agreed!

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Re: To be or not to be complex, that is the question

Post by friar1610 » Sun Jun 03, 2018 8:49 pm

1210sda wrote:
Sun Jun 03, 2018 6:13 pm
friar1610 wrote:
Sun Jun 03, 2018 5:39 pm
1210sda wrote:
Sat Jun 02, 2018 10:08 am
We are currently in the 3 fund portfolio. If I predecease my spouse, she will exchange all (taxable and tax advantaged) into Lifestrategy.
1210,

In a perfect world, I would like to leave a similar plan in place for my spouse to execute after my demise. But I can't get past reducing what's left for her so much because of the CG hit involved in selling individual equity funds (one TSM and one TISM) and buying an LS fund. Just curious if you have a relatively small percentage of your assets in taxable? (Not the case for me). Or have you run numbers and come up with a rationale for taking the hit?

Thank you for any thoughts you'd care to share.
We have a large percent of our assets in taxable. We live in a community property state, so at the first death (presumably me), the basis of all our assets would be stepped up to current market value at the time of that death.

So we are anticipating either no, or very small, CG tax upon exchanging our 3 FP to the LS fund. My wife would, of course have to contact Vanguard and tell them her wishes. (which we both have committed to in writing)

I'll share a couple of points from another BH thread. My hesitation point has been that many/most BH's say that a LS (or Target Retirement, or Balanced Index, etc.) in a taxable account is in-efficient because of bonds in taxable. However, fellow BH Longinvest found a study that indicated that the benefits from tax efficient asset location doesn't matter much.

Before this, it didn't matter much to me either. The benefit of not having to re balance or having to decide which mutual fund to use for withdrawals or additions is very important to us/her. Now that folks smarter than I are saying it doesn't matter much, that's all I need.

There is a possibility that for Taxable we would use the Tax Managed Balanced Fund (50/50) if in the near future we determine that because of RMD's and having to file as a single taxpayer it would be better.

In case my wife predeceases me, I will continue with the 3 FP.

My final worry, which hasn't been resolved yet, is that of my incapacity. If I don't die, the step up in basis would not take place and exchanging the 3 FP to LS would be tax costly.

Hope I didn't ramble on for too long. :) Any thoughts you have on this would be appreciated.

1210
Thank you very much for your detailed answer. I completely understand why your approach makes perfect sense. Alas - Mass is not a community property state so the same approach won't work in our case. I just did a quick Google search re: Mass and a cursory glance makes me think we would get a step-up on half our jointly held taxable financial assets. But I need to dig much deeper and also see how bad the hit would be if CG taxes have to be paid on half our taxable appreciated assets.

If I come up with any deep insights :? I'll pass them on. Thanks again.
Friar1610

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Re: To be or not to be complex, that is the question

Post by Random Walker » Sun Jun 03, 2018 8:52 pm

FIREchief,
Not sure I’m qualified to answer your challenge. My statistics is pretty basic. That being said, I’m sure youll agree that what I stated about the factors is true for past data such as original Fama French study which looked at something like 1962-1990ish. Obviously data mining and data torturing are potential huge problem. So one can test the hypothesis generated from one data set by subjecting the hypothesis to other data sets. In investing , these out of sample tests are in other time periods, other geographic markets, and in some cases even other asset classes. I don’t know specific data, but I do believe these factors have been shown to explain the performance of portfolios in these out of sample tests, both looking retrospectively and prospectively.
I totally agree that we invest looking forward. In fact, I’ve stated before the importance I believe should be attributed to Larry’s intuitive criteria. “Intuitive” is not ESP. Rather it is Larry’s requirement that a factor have a rational risk based or behavior based rationale to expect the factor to persist in the future. This is in addition to the other 4 criteria (persistent, pervasive, robust, investable) which I agree with you look more backwards than forwards.

Dave

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FIREchief
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Re: To be or not to be complex, that is the question

Post by FIREchief » Mon Jun 04, 2018 12:36 am

Random Walker wrote:
Sun Jun 03, 2018 8:52 pm
FIREchief,
Not sure I’m qualified to answer your challenge. My statistics is pretty basic. That being said, I’m sure youll agree that what I stated about the factors is true for past data such as original Fama French study which looked at something like 1962-1990ish. Obviously data mining and data torturing are potential huge problem. So one can test the hypothesis generated from one data set by subjecting the hypothesis to other data sets. In investing , these out of sample tests are in other time periods, other geographic markets, and in some cases even other asset classes. I don’t know specific data, but I do believe these factors have been shown to explain the performance of portfolios in these out of sample tests, both looking retrospectively and prospectively.
I totally agree that we invest looking forward. In fact, I’ve stated before the importance I believe should be attributed to Larry’s intuitive criteria. “Intuitive” is not ESP. Rather it is Larry’s requirement that a factor have a rational risk based or behavior based rationale to expect the factor to persist in the future. This is in addition to the other 4 criteria (persistent, pervasive, robust, investable) which I agree with you look more backwards than forwards.

Dave
Thanks for the response Dave. I (and many) have enough formal training in statistics to understand that in the absence of extensive, independent, statistically significant input data; the results are highly suspect. In common terminology, "garbage in, garbage out." The fact that people who a) need material for their graduate theses, b) need to get cited in prestigious publications for whatever reasons there may be, c) need to sell books and/or d) are selling "financial management services", advance these academic approaches adds no credibility to the "academic research." Every market is different. Every country is different. Every time period is different. The future will not be the same as the past (I will personally guarantee this). You simply can't use data (incomplete and unreliable as it may be) from any of these to reliably predict future outcomes in any other. "Explain" historical outcomes? I see no value in that. If others do, then more power to them. To Rick's original post (highly paraphrased), complex approaches may just be a bunch of ego driven (or profit motivated) baloney (sorry Rick).

If you see that a company's, sector's, economy's balance sheets are producing value; then invest and, if you are right and the world doesn't go down the toilet, you will be rewarded! Last I checked, US companies are generating strong earnings, running healthy margins, have healthy balance sheets and are operating in an improving global economy. Why should I care about what happened ten years ago?
I am not a lawyer, accountant or financial advisor. Any advice or suggestions that I may provide shall be considered for entertainment purposes only.

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Re: To be or not to be complex, that is the question

Post by vineviz » Mon Jun 04, 2018 2:23 am

FIREchief wrote:
Mon Jun 04, 2018 12:36 am
I (and many) have enough formal training in statistics to understand that in the absence of extensive, independent, statistically significant input data; the results are highly suspect. In common terminology, "garbage in, garbage out."
It’s not entirely clear what this is meant to imply, but if the suggestion is that modern asset pricing models have not been extensively and independently validated then that suggestion is clearly wrong.

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Re: To be or not to be complex, that is the question

Post by Random Walker » Mon Jun 04, 2018 9:26 am

FIREChief wrote “Every market is different. Every country is different. Every time period is different. The future will not be the same as the past (I will personally guarantee this).”

Certainly “history doesn’t repeat itself, but it certainly rhymes.” Not sure who said that but it’s a great quote. Don’t you think there are basic characteristics to all markets that are solid, universal, timeless? All markets will be ruthlessly efficient, price risk, have changing risk premiums. Companies will be subject to the same universal risks. Human behavior is quite universal and amazingly consistent. I think we can learn things from the past which will apply in the future. I also agree that alpha gets turned into beta in the blink of an eye.

Dave

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Re: To be or not to be complex, that is the question

Post by Alexa9 » Mon Jun 04, 2018 9:30 am

I agree to some degree. Tilting to small value is not complex though and I would recommend it over the three fund portfolio.

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Re: To be or not to be complex, that is the question

Post by FIREchief » Mon Jun 04, 2018 10:50 am

vineviz wrote:
Mon Jun 04, 2018 2:23 am
FIREchief wrote:
Mon Jun 04, 2018 12:36 am
I (and many) have enough formal training in statistics to understand that in the absence of extensive, independent, statistically significant input data; the results are highly suspect. In common terminology, "garbage in, garbage out."
It’s not entirely clear what this is meant to imply, but if the suggestion is that modern asset pricing models have not been extensively and independently validated then that suggestion is clearly wrong.
I would instead suggest that modern asset pricing models have been extensively and independently invalidated due to the simple fact that they are so poor at predicting future market performance. If analytical tools were superior at picking stocks, then the actively managed funds of those who use the best proprietary pricing models would be kicking butt year after year. This just isn't what we see.
I am not a lawyer, accountant or financial advisor. Any advice or suggestions that I may provide shall be considered for entertainment purposes only.

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Re: To be or not to be complex, that is the question

Post by Random Walker » Mon Jun 04, 2018 11:34 am

FIREchief,
The factors explain performance, not predict it. We know that a portfolio composed of certain investments, which are in turn composed of a collection of factors will behave as the factors do. No one is claiming we can predict how the factors will behave. And especially no one will say they can predict how any factor will behave over any given time frame. That’s why many of us promote diversifying across the factors.

Dave

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vineviz
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Re: To be or not to be complex, that is the question

Post by vineviz » Mon Jun 04, 2018 12:01 pm

FIREchief wrote:
Mon Jun 04, 2018 10:50 am
I would instead suggest that modern asset pricing models have been extensively and independently invalidated due to the simple fact that they are so poor at predicting future market performance. If analytical tools were superior at picking stocks, then the actively managed funds of those who use the best proprietary pricing models would be kicking butt year after year. This just isn't what we see.
Any contention that modern asset pricing models have been extensively invalidated is completely devoid of evidence that would support that conclusion. In fact, if it were true there'd be no basis for the second contention ( that active managers fail to outperform).

Asset pricing models do not accurately predict future market performance mostly because that's not at all what they are designed to do. The majority of stock market return variability is due to systematic risk (e.g. wars, natural disasters, recessions, political turmoil, etc.) which, absent a crystal ball, no pricing model could forecast. Instead, a single factor asset pricing model like CAPM or a muli-factor model like Fama-French has the purpose of explaining the unsystematic risk of an asset or asset class. They do this incredibly well.

Although it's true that most active funds fail to outperform the market, there's plenty of evidence that the managers of those funds actually do have some talent for modeling asset prices: many funds consistently outperform BEFORE fees and expenses are deducted. Those active fund managers are generally good at picking stocks, but the companies for which they work (and they advisors who sell those funds) are even better at picking your pockets. Don't let the latter fact obscure the former fact.

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Re: To be or not to be complex, that is the question

Post by 9-5 Suited » Mon Jun 04, 2018 12:26 pm

FOMO (fear of missing out) is a major driver of complexity. I know that I've fought against that demon many times. When you hear enough people calling out the risks or benefits of a particular choice, you start to wonder what if they are right? What would be the consequences?

The natural inclination as a response to FOMO is to hedge. Well maybe I'll 5% in REITs. Maybe I should split my investment between mortgage and taxable. Maybe I should have 10% in small-cap value just in case these pretty compelling arguments really are true. Etc, etc, etc. That way no matter what happens, you will be a little right and a little wrong, but not all wrong!

It's one thing to say one should be satisfied with simplicity and quite another to truly achieve a zen-like state where all of these things pass through your mind without feeling some desire to take action.

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Re: To be or not to be complex, that is the question

Post by galeno » Mon Jun 04, 2018 12:36 pm

I'm guilty of FOMO also.

Right now I'm debating if I should add a developed world small cap ETF to our FTSE all world ETF and "tilt smaller".

Also I'm debating if our FI allocation needs non-USD bonds hedged back to USD.
9-5 Suited wrote:
Mon Jun 04, 2018 12:26 pm
FOMO (fear of missing out) is a major driver of complexity. I know that I've fought against that demon many times. When you hear enough people calling out the risks or benefits of a particular choice, you start to wonder what if they are right? What would be the consequences?

The natural inclination as a response to FOMO is to hedge. Well maybe I'll 5% in REITs. Maybe I should split my investment between mortgage and taxable. Maybe I should have 10% in small-cap value just in case these pretty compelling arguments really are true. Etc, etc, etc. That way no matter what happens, you will be a little right and a little wrong, but not all wrong!

It's one thing to say one should be satisfied with simplicity and quite another to truly achieve a zen-like state where all of these things pass through your mind without feeling some desire to take action.
AA = 40/55/5. Expected CAGR = 3.8%. GSD (5y) = 6.2%. USD inflation (10 y) = 1.8%. AWR = 3.0%. TER = 0.4%. Port Yield = 2.0%. Term = 35 yr. FI Duration = 6.2 yr. Portfolio survival probability = 100%.

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Re: To be or not to be complex, that is the question

Post by FIREchief » Mon Jun 04, 2018 1:28 pm

vineviz wrote:
Mon Jun 04, 2018 12:01 pm
FIREchief wrote:
Mon Jun 04, 2018 10:50 am
I would instead suggest that modern asset pricing models have been extensively and independently invalidated due to the simple fact that they are so poor at predicting future market performance. If analytical tools were superior at picking stocks, then the actively managed funds of those who use the best proprietary pricing models would be kicking butt year after year. This just isn't what we see.
Asset pricing models do not accurately predict future market performance mostly because that's not at all what they are designed to do. The majority of stock market return variability is due to systematic risk (e.g. wars, natural disasters, recessions, political turmoil, etc.) which, absent a crystal ball, no pricing model could forecast. Instead, a single factor asset pricing model like CAPM or a muli-factor model like Fama-French has the purpose of explaining the unsystematic risk of an asset or asset class. They do this incredibly well.
I really don't know how you can separate the two. Are you just accepting the outputs of the pricing models as highly accurate and attributing all other variance to wars, disasters, recession, turmoil, etc? Are you assuming that all such factors impact each asset class equally? I would think future corporate earnings would be the largest factor, and estimating (or "modeling") those is more an act of faith or prediction of where are economy is headed (which is unknowable).
Although it's true that most active funds fail to outperform the market, there's plenty of evidence that the managers of those funds actually do have some talent for modeling asset prices: many funds consistently outperform BEFORE fees and expenses are deducted. Those active fund managers are generally good at picking stocks, but the companies for which they work (and they advisors who sell those funds) are even better at picking your pockets. Don't let the latter fact obscure the former fact.
Do you have a source for this? If this is true, a person could just mimic the composition of such a fund's assets in their own portfolio and consistently beat the market. Or, even better, the competition could mimic the smart guy's fund and charge only half the expense ratio. What am I missing here?
I am not a lawyer, accountant or financial advisor. Any advice or suggestions that I may provide shall be considered for entertainment purposes only.

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Re: To be or not to be complex, that is the question

Post by vineviz » Mon Jun 04, 2018 2:53 pm

FIREchief wrote:
Mon Jun 04, 2018 1:28 pm
vineviz wrote:
Mon Jun 04, 2018 12:01 pm
Asset pricing models do not accurately predict future market performance mostly because that's not at all what they are designed to do. The majority of stock market return variability is due to systematic risk (e.g. wars, natural disasters, recessions, political turmoil, etc.) which, absent a crystal ball, no pricing model could forecast. Instead, a single factor asset pricing model like CAPM or a muli-factor model like Fama-French has the purpose of explaining the unsystematic risk of an asset or asset class. They do this incredibly well.
I really don't know how you can separate the two.
And I don't really know how to help you understand it. Asset pricing models are designed to explain the cross-section of asset returns, and they do a good job of it.

As for the difference between systematic and unsystematic risk, that's a core concept in modern portfolio theory and any introductory finance text will explain it better than I could.

Finally John Cochrane has a great book on asset pricing, and even though it hasn't been updated since 2005 it's pretty relevant and written on a reasonably casual level: https://press.princeton.edu/titles/7836.html.
FIREchief wrote:
Mon Jun 04, 2018 1:28 pm
vineviz wrote:
Mon Jun 04, 2018 12:01 pm
Although it's true that most active funds fail to outperform the market, there's plenty of evidence that the managers of those funds actually do have some talent for modeling asset prices: many funds consistently outperform BEFORE fees and expenses are deducted. Those active fund managers are generally good at picking stocks, but the companies for which they work (and they advisors who sell those funds) are even better at picking your pockets. Don't let the latter fact obscure the former fact.
Do you have a source for this? If this is true, a person could just mimic the composition of such a fund's assets in their own portfolio and consistently beat the market. Or, even better, the competition could mimic the smart guy's fund and charge only half the expense ratio. What am I missing here?
The Carhart (1997) paper is the classic, and search of Google Scholar will lead you both PDF versions of it and links to the 13,374 subsequent papers that cite it.

Most relevant probably is the 2015 Berk et al. paper https://www.sec.gov/divisions/riskfin/s ... 020213.pdf (emphasis mine):
Our results are consistent with the main predictions of Berk and Green (2004). In­vestors appear to be able to identify skilled managers and determine their compensation through the flow–performance relation. That model also assumes that because rational investors compete in capital markets, the net alpha to investors is zero, that is, managers are able to capture all economic rents themselves. In this paper, we find that the average abnormal return to investors is close to zero. Further, we find little evidence that investors can generate a positive net alpha by investing with the best funds.
And competition mimicking the smart guy's fund and charging only half the expense ratio is exactly what the multi-billion dollar "smart beta" and factor ETF industry is doing.

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Re: To be or not to be complex, that is the question

Post by protagonist » Mon Jun 04, 2018 4:07 pm

Rick Ferri wrote:
Wed May 30, 2018 6:42 am
Bogleheads spend a lot of time talking about the benefits and drawbacks of simple portfolio strategies and “complex” strategies. Simple portfolios include Life-Strategy funds, 2-fund, 3-fund, Core-4 and other set and forget type strategies. Complex portfolios include factor tilts, commodity exposures, currencies and various other slice and dice strategies that need a lot of maintenance.

I wrote the following post in another conversation; however, after thinking about this a bit, I decided to start a new conversation about simple vs complex.

My goal IS NOT to endlessly debate whether complex beats simple in theory or vice versa. Rather, my intention is to discuss the practicality of the two strategies in real life. Is there any actual advantage to being complex? I’ll admit my thinking has shifted over the years. I was a complex advocate for many years, but now I believe that was more about stroking my own ego than anything else.

++++

On paper, a more complex strategy should outperform a simple one, but I don't believe it does in real life for most people. The outcome of simplicity is actually greater in real life than the outcome for complexity, even if in theory complexity outperforms.

We know complexity will cost more and that it takes up more of our time. But that's not all. Complexity changes. What will be new that we'll have to include in a portfolio 5 or 10 years from now?

There's also tracking error in any portfolio that's not a market portfolio, but we can't know how negative tracking error will affect us if it goes on for a long time. I noticed the advocates for complex on this board never seem to be satisfied with what they have. They are seeking (or chasing) a perfect portfolio that can only be known in retrospect.

These issues lead to cognitive errors. How many times will we change a complex strategy? Probably several. How will these changes affect our long-term return? Probably not much. What's the next thing I'll have to add? Complexity will require adding the next "evidence-based" asset class, factor or strategy.

All of the above have lead to an advancement in my investment views. The more I know, the more I realized how little I know, and how little anyone knows. Yet we must invest. So, how do we do it?

Simpler is better. Less is more.

Rick Ferri
Very well stated, Rick. I agree completely. +1!

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Re: To be or not to be complex, that is the question

Post by Peppergrass » Mon Jun 04, 2018 4:28 pm

Rick,

the wise thing I've ever read from a book, and I cannot say the exact origin of it as I myself cannot fully say or understand...

"he" said : "the highest level things are simple" ... then goes on to say people cannot comprehend simplicity, because they believe something of high value has to be justified by being complex... ....



this is a good thought though, as I try to build what I want for a lifetime.. I someone's go back to Buffett's advice, buying 90% SP and 10% treasuries would yield greater then 95% of people's portfolios.. or if you just invested in Berkshire you would be mega rich....

I even say if you have the brass, just invest all in small cap value

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Re: To be or not to be complex, that is the question

Post by Fallible » Mon Jun 04, 2018 6:07 pm

9-5 Suited wrote:
Mon Jun 04, 2018 12:26 pm
FOMO (fear of missing out) is a major driver of complexity. I know that I've fought against that demon many times. When you hear enough people calling out the risks or benefits of a particular choice, you start to wonder what if they are right? What would be the consequences?

The natural inclination as a response to FOMO is to hedge. Well maybe I'll 5% in REITs. Maybe I should split my investment between mortgage and taxable. Maybe I should have 10% in small-cap value just in case these pretty compelling arguments really are true. Etc, etc, etc. That way no matter what happens, you will be a little right and a little wrong, but not all wrong! ...
And this fear of missing out - also similar to the cognitive error of herd instinct/behavior - is yet another example of what Rick Ferri is saying. From his original post here:
I noticed the advocates for complex on this board never seem to be satisfied with what they have. They are seeking (or chasing) a perfect portfolio that can only be known in retrospect.

These issues lead to cognitive errors. How many times will we change a complex strategy? Probably several. How will these changes affect our long-term return? Probably not much. What's the next thing I'll have to add? Complexity will require adding the next "evidence-based" asset class, factor or strategy.
if interested, here's a link to a Stanford study of FOMO, in which two researchers said that "what investors fear the most is not the risk of a loss per se, but the risk that they may do poorly relative to their peers. That means even though investments in areas such as new technology may be particularly risky, investors tend to cluster around such pie-in-the-sky opportunities to avoid being the only one in the neighborhood to miss out on the "next big thing."

https://www.gsb.stanford.edu/insights/r ... risk-blind
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Re: To be or not to be complex, that is the question

Post by JoMoney » Mon Jun 04, 2018 6:47 pm

Fallible wrote:
Mon Jun 04, 2018 6:07 pm
9-5 Suited wrote:
Mon Jun 04, 2018 12:26 pm
...
FOMO is real, so is the risk of sticking your head out and being truly 'contrarian' to the crowd. Animals that stick out from the herd are more likely to get hen-pecked or even slaughtered by predators, on rare occasion the difference turns out to be a positive adaptation that succeeds in nature, but before it's recognized as a success it's a risk.
There are interesting arguments for "risk" in markets as being more appropriately measured not just in terms of volatility relative to some "market beta" but it terms of deviating from the consensus standard.
Academics and quantitative types want some measurable "factors" between risk and return, but such variables if true would create too linear of a relationship and not be representative of a real "risk". It's not "risk" for a casino to take bets where they expect an advantage / higher return.

EDIT: I saw someone start a different thread with a blind link, that was then deleted, to this interesting blog post that I think has a great explanation of "contrarian", and I'm adding it here for my own future reference since I had mentioned being contrarian here and I think this context of it differs with some other that think of it as just being opposite or following a value style or something:
http://www.collaborativefund.com/blog/t ... -of-money/
Most attempts at contrarianism is just irrational cynicism in disguise – and cynicism can be popular and draw crowds. Real contrarianism is when your views are so uncomfortable and belittled that they cause you to second guess whether they’re right. Very few people can do that. But of course that’s the case. Most people can’t be contrarian, by definition. Embrace with both hands that, statistically, you are one of those people.
Last edited by JoMoney on Mon Jun 04, 2018 9:34 pm, edited 1 time in total.
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Re: To be or not to be complex, that is the question

Post by 9-5 Suited » Mon Jun 04, 2018 8:50 pm

Completely agree and that’s an interesting article. Seems logical to assess wealth on a relative scale. People who make $30K in the US usually aren’t giddy about being in the top 1% of global wage earners.

And people chasing high-flying tech stocks while leaving less interesting companies alone? Sounds like I need at least 10% in small cap value!! :P

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Re: To be or not to be complex, that is the question

Post by Fallible » Tue Jun 05, 2018 4:58 pm

JoMoney wrote:
Mon Jun 04, 2018 6:47 pm
Fallible wrote:
Mon Jun 04, 2018 6:07 pm
9-5 Suited wrote:
Mon Jun 04, 2018 12:26 pm
...
FOMO is real, so is the risk of sticking your head out and being truly 'contrarian' to the crowd. Animals that stick out from the herd are more likely to get hen-pecked or even slaughtered by predators, on rare occasion the difference turns out to be a positive adaptation that succeeds in nature, but before it's recognized as a success it's a risk.
There are interesting arguments for "risk" in markets as being more appropriately measured not just in terms of volatility relative to some "market beta" but it terms of deviating from the consensus standard.
Academics and quantitative types want some measurable "factors" between risk and return, but such variables if true would create too linear of a relationship and not be representative of a real "risk". It's not "risk" for a casino to take bets where they expect an advantage / higher return.

EDIT: I saw someone start a different thread with a blind link, that was then deleted, to this interesting blog post that I think has a great explanation of "contrarian", and I'm adding it here for my own future reference since I had mentioned being contrarian here and I think this context of it differs with some other that think of it as just being opposite or following a value style or something:
http://www.collaborativefund.com/blog/t ... -of-money/
Most attempts at contrarianism is just irrational cynicism in disguise – and cynicism can be popular and draw crowds. Real contrarianism is when your views are so uncomfortable and belittled that they cause you to second guess whether they’re right. Very few people can do that. But of course that’s the case. Most people can’t be contrarian, by definition. Embrace with both hands that, statistically, you are one of those people.
Yes, it's a good point on contrarianism. The entire blog by Morgan Housel, "The Psychology of Money," is excellent. He went all out on this one, describing 20 "flaws, biases, and causes of bad behavior" that he has often seen. "Good investing," he writes, "isn't necessarily about earning the highest returns, because the highest returns tend to be one-off hits that kill your confidence when they end. It's about earning pretty good returns that you can stick with for a long period of time. That's when the compounding runs wild."

I think that is in keeping with Rick's points in this thread.
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Re: To be or not to be complex, that is the question

Post by Random Walker » Tue Jun 05, 2018 5:24 pm

Fallible wrote:
Tue Jun 05, 2018 4:58 pm

"Good investing," he writes, "isn't necessarily about earning the highest returns, because the highest returns tend to be one-off hits that kill your confidence when they end. It's about earning pretty good returns that you can stick with for a long period of time. That's when the compounding runs wild."
Big losses kill compounding. That is why it is perhaps worthwhile to consider a more complex portfolio with a more narrow SD. This is why compounded portfolio returns are so dramatically negatively affected by volatility

Dave

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Lessons from a lifetime of investing

Post by Taylor Larimore » Tue Jun 05, 2018 6:45 pm

Bogleheads:

I started investing in 1950 at the age of 26.

The S&P stocks were priced about 20. Today the S&P 500 price is 2,748 (not including dividends).

Lessons learned:

* Invest regularly in simple, low-cost, broad market index funds.

* Stay the course.
Michael Edesess, author of The Big Investment Lie: "As a mathematician I know when mathematical-sounding analyses are little more than elaborate sales pitches, designed to thoroughly obscure the simple fact that smart investing is non-mathematical and accessible to everyone."
Best wishes.
Taylor
"Simplicity is the master key to financial success." -- Jack Bogle

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Re: To be or not to be complex, that is the question

Post by Fallible » Tue Jun 05, 2018 8:15 pm

Random Walker wrote:
Tue Jun 05, 2018 5:24 pm
Fallible wrote:
Tue Jun 05, 2018 4:58 pm

"Good investing," he writes, "isn't necessarily about earning the highest returns, because the highest returns tend to be one-off hits that kill your confidence when they end. It's about earning pretty good returns that you can stick with for a long period of time. That's when the compounding runs wild."
Big losses kill compounding. That is why it is perhaps worthwhile to consider a more complex portfolio with a more narrow SD. This is why compounded portfolio returns are so dramatically negatively affected by volatility

Dave
More complexity is perhaps worthwhile for some investors, but the overall points made by Rick Ferri and Morgan Housel (who is quoted above) are aimed at most investors better off keeping it simple for the long run. As I understood him, Rick's concern is complexity leading to cognitive errors. Housel uses simple and complex examples that he says "show that managing money isn't necessarily about what you know; it's how you behave."
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Re: To be or not to be complex, that is the question

Post by Random Walker » Tue Jun 05, 2018 9:13 pm

Fallible,
Completely agree that behavior dominates the perfect portfolio. The best portfolio is probably the one the investor sticks with.

Dave

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Re: To be or not to be complex, that is the question

Post by David Jay » Wed Jun 06, 2018 9:13 am

The article at that link has a great "Hierarchy of Investor Needs" pyramid that fits in nicely with Rick's topic. Most "complexity" tends to happen at levels 4 and 5, but for most people the focus should be getting levels 1, 2 and 3 right. If we don't get the foundational issues right, which sectors we choose or how well we implement MPT won't really matter:
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Re: To be or not to be complex, that is the question

Post by JohnDindex » Tue Jun 12, 2018 8:36 am

Rick Ferri wrote:
Wed May 30, 2018 10:18 am
David Jay wrote:
Wed May 30, 2018 9:51 am
A favorite quote: "In theory, theory and practice are the same; in practice, they're not."
True. But theory also sells complexity well. Consider the large number of advisers who put something like this in their marketing material:

We put Nobel-prize winning research into practice.

Theory could produce a higher return, but if an adviser is in the mix, the “alpha goes to the manager”, something I’ve said for years. I don’t think the net return to investors after adviser cost has been or will be any higher than a Life-Strategy Fund with the same stock-bond allocation.
In another post you mentioned you would be getting back into the business in the coming year, and you also shared the link to advice only website. Are you suggesting that individual investors would be better served under the advice only model with very simple portfolios versus an advisor lead DFA portfolio? Or do you think there is a place for both, which side of the fence will you be on?

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Re: To be or not to be complex, that is the question

Post by Finridge » Wed Jun 13, 2018 6:45 pm

I agree that the complications provided by complexity often outweigh their perceived advantages. Simpler is usually better. But I don't see simplicity as an end in itself.

If my portfolio was liquidated and I was able to rebuild it from scratch, it would all be in a simple 3-fund portfolio. But my non-tax advantaged accounts, I have holdings in Vanguard index funds that were invested before the core 3-fund portfolio mutual funds were created. These are still good funds with a low expense ratios. There would be a substantial tax hit if I liquidated these to move them over to a 3-fund portfolio. I calculated how long it would take to break even after making such a move, and effectively, I never would recoup the loss.

So I just let the existing appreciated holdings be--I don't add to them, but they continue to grow, and at the end of the day, the only inconvenience is another tax form to enter when preparing my tax returns.

Also, the 3-fund portfolio is nice, but the rewards from tax harvesting are rich enough to justify having a TLH shadow portfolio. Yes, you now have doubled the complexity--but it's still easy enough to track and manage, and it more than pays for the extra inconvenience. TLH is the closest we get to a free lunch when it comes to taxes.

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Re: To be or not to be complex, that is the question

Post by Yukon » Thu Jun 14, 2018 5:13 am

GAAP wrote:
Wed May 30, 2018 10:48 am
In my case, it's simplicity for my heirs, not just for me.

I'm naturally inclined toward the more complex sliced/diced/tilted portfolio -- but need to consider heirs that are not ready to manage such a portfolio. It would be irresponsible on my part to leave them with something that they don't understand, and that is more difficult to change to something they do understand.
Interesting. Perhaps my ego needs to be called out, too. We are mid 40s, healthy, and in the process of updating wills/trusts for our minor children so understand that our heirs may be less inclined toward the complex. We are hoping heirs won't be relevant for another 40+ years so maybe we are legitimizing the "irresponsibility" a bit by not keeping things ridiculously simple. My current plan was to have a "death book" describing the plan of simplifying our 7 funds into life strategy funds for the heirs. One step less irresponsible, perhaps? May I ask your approximate age and if your mentality has changed over the years? Have you "paid" to decrease the complexity of your portfolio and wished you had done it sooner?
Don't Work Forever.

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Re: To be or not to be complex, that is the question

Post by GAAP » Thu Jun 14, 2018 9:29 am

Yukon wrote:
Thu Jun 14, 2018 5:13 am
May I ask your approximate age and if your mentality has changed over the years? Have you "paid" to decrease the complexity of your portfolio and wished you had done it sooner?
Late 50's and certainly it's changed -- and gotten much simpler. I don't know that I've "paid", since I've been reasonably lucky with that process. As for wishing it was done sooner -- perhaps. Simplification would have reduced some of the time I spent managing a portfolio, but not by much. Even when the portfolio was more complicated, I didn't touch it much.

My most immediate heir is my wife. Her formative financial experiences are nearly opposite from my own. The reasonable choices based on her experience are notably different from those based upon my experience. We have managed to meet in a somewhat acceptable middle ground. Finding a simplified solution that meets both our needs is far easier than finding a complicated solution -- especially since essentially all of the choices for slice/dice are in opposition to her early experience...

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Re: To be or not to be complex, that is the question

Post by 2015 » Thu Jun 14, 2018 9:40 am

Yukon wrote:
Thu Jun 14, 2018 5:13 am
GAAP wrote:
Wed May 30, 2018 10:48 am
In my case, it's simplicity for my heirs, not just for me.

I'm naturally inclined toward the more complex sliced/diced/tilted portfolio -- but need to consider heirs that are not ready to manage such a portfolio. It would be irresponsible on my part to leave them with something that they don't understand, and that is more difficult to change to something they do understand.
Interesting. Perhaps my ego needs to be called out, too...
I believe many an overconfident ego needs to be called out, along with marketing and sales techniques of academics, bloggers, financial "publications" of all types, lest they mislead people. Barry Ritholz knocks it out of the park again with his ranking of factors that affect investment returns:

http://www.latimes.com/business/la-fi-r ... story.html
No. 1. Behavior and discipline: Nothing has a bigger impact than the behavior of investors under duress. I stumbled upon this observation early in my career as a trader; everything I have learned since has served to confirm it.

We see this again and again in the data — just look at DALBAR’s Quantitative Analysis of Investor Behavior. Investors continue to be their own worst enemies when it comes to investment performance — buying as stocks hit greed-driven highs and selling on panic-inducing lows. On average, their actions lower their returns significantly, but in the worst cases they demolish them. Even worse, behavior is (or at least should be) within their own control.

Bonus: Luck and random chance: There is a lot of random chance in investing. We often cannot tell the difference between skill and luck in stock selection. And the moment when we each realize this can also be somewhat random.

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