Did you know that when US Airways Flight 1549 struck a flock of Canadian geese on takeoff Captain Chesley (Sully) Sullenberger was not flying the plane? It was then he said:
“My aircraft,” and took the controls, not because he thought [co-pilot] Skiles couldn’t handle the job but because he was responsible for the airplane as the pilot in command.
(Quoted from the story of Flight 1549, “Anatomy of a Miracle” by William Langewiesche in the June 2009 Vanity Fair.)
Whether you like it or not you are the pilot in command of investment portfolio. You are responsible for its performance. The question is: who is your investment co-pilot?
Investors these days have a number of ways to get assistance with their portfolios. You could delegate the management of your portfolio to others like an investment adviser. You could follow the recommendations of any number of newsletter writers. (A misnomer since they all now provide their reports via the Internet). Or you could take on the task yourself and manage your portfolio.
The investment of choice for many individual investors is the exchange traded fund or ETF. Even then we must recognize that this constitutes farming out your investment in that asset class. This decision is not without risk because some ETFs are not exactly well designed.
Absent a few rugged individualists, we all rely on the results of other providers in some form or fashion. The question is how much weight should we put on the track record of these investment advisers?
Recent research shows that in the face of “expert advice” parts of our brains involving “valuation and probability weighting” actually turns off. In short we gave over our decision making ability to others providing “credible” advice. (See this piece by Dan Ariely at Predictably Irrational.)
There is no shortage of recent examples where so-called experts led investors astray. The Bernie Madoff scandal is one where investors ignored any number of red flags due in part to the impressive returns he was supposedly generating. On a smaller scale one need only look at the notion that Lenny Dykstra was “110-0” in his picks for his TheStreet.com premium options newsletter. (We would recommend any one interested in the Lenny saga peruse the Lenny archives of the Daily Options Report by Adam Warner.)
Even in the regulated world of mutual funds it is easy to see how it is that we can get lead astray by a gaudy track record. Bill Miller of Legg Mason Value was heralded for years for his streak of beating the S&P 500. But the fact of the matter is that we should expect to see streaks like this arise out of chance. We really can’t say with any sort of certainty whether Miller was lucky or good. What we can say is that holding his fund for the past five years has been a disaster. (See this piece by Jim Bianco at the Big Picture.)
The simple fact is that there are no guarantees in the financial world. For years the concept of asset allocation was pitched as a way to smooth out portfolio returns while sacrificing little in terms of returns. The recent economic crisis has put that notion into doubt. (See our piece on the state of asset allocation these days.)
There are no promises in the financial world. Track records are records of the past.
Which raises a sticky point. All we have in the investment world are track records. If we can’t rely on those, what can we rely on? A question for which there is no easy answer.
Once we dismiss the obvious frauds and blowhards the difficult work begins. Due diligence involves getter a better sense for the inner workings of an investment operation. For newsletter and mutual funds this is relatively straightforward. For something more opaque like a hedge fund the work is far more labor intensive. The bottom-line being that investors need to have some sense that the investment process being pursued is legitimate, replicable and reliable.
Thankfully in the vast majority of cases we need worry less about fraud and more about simple poor performance. It is not a fluke that the majority of actively managed mutual funds underperform their benchmarks on a regular basis. The fact of the matter is that investing is a tough game.
In the end no matter how much managing we actually do, we are all responsible and accountable for piloting our own portfolio. However, nearly every investor has some sort of help in managing his or her portfolio. The question is: how well do you know your investment co-pilot(s)?