We do not generally respond as well to carefully constructed and nuanced arguments as we do to big and brassy truth claims. We crave certainty. Hyperbole sells, especially when it is coupled with real passion. That might explain why political candidates, for example, seem more focused upon conviction and commitment than upon accuracy and fairness. But that does not make it good practice, particularly when it comes to money management.
Last week-end I read Dan Solin’s new book, The Smartest Portfolio You’ll Ever Own. Solin’s suggested portfolio (and its variants) is predicated upon the assertions that active management is a failed notion, that all practitioners of active management are either rubes or charlatans and that all proper investment should be passive and based upon indexing. You may be surprised to learn that I am not at all unsympathetic to a fair number of Solin’s points (see here for some general overview), including the idea that costs and taxes matter a lot. But the book is still very disappointing.
Solin makes a number of very helpful suggestions, especially for the do-it-yourself investor. For example, he argues that our brains tend to push us toward the thrill of short-term decisions, when our real focus should be on longer term ones. He also emphasizes that one’s knowledge of risk, rebalancing, and the effects of taxation are critical to investing successfully.
Solin also has a helpful discussion of how an advisor can provide important services, particularly with regard to issues like personal discipline and comprehensive planning. Perhaps best of all, Solin provides a useful explanation of how an individual investor might take advantage of the Fama-French three-factor model, which posits that exposure to small cap and value stocks, together with the portion of one’s portfolio invested in stocks, explains 90% of the variability of returns in diversified portfolios.
Unfortunately, Solin diminishes his credibility by egregious oversimplification, overstatement and data mining. His exceedingly short chapters make his arguments little more than general soundbites, despite some supporting documentation provided late in the book. For example, he claims that “[t]his is an industry infected by systemic greed and the absence of an ethical or moral code of conduct.” While I can agree that ethical standards are well less than they ought to be, I know many advisors who are passionately committed to serving their clients’ best interests. To the extent that advisors are wrong, I suspect that most do not have venal intent; they simply do not know any better. Investing is much more difficult than Solin allows, as evidenced by the problems experienced by recent retirees (even indexers), for example.
He also claims (without qualification) that markets are efficient, seeing the judgments of all investors worldwide as wise in the aggregate. However, most objective observers need only look at the tech bubble near the turn of the century and the more recent real estate bubble to conclude that some markets are much less efficient than others. Markets are not rational weighing machines, as Solin would have it. They are voting machines – often reflecting emotional and irrational responses to some “shiny object” (what Keynes quaintly called “animal spirits”).
Solin also insists that the small and value stocks that the Fama-French model suggest should be emphasized are riskier than other stocks. That case is plausible with respect to small stocks, at least in part, but even so, volatility and risk are not synonymous.
Solin also has a data mining problem. In making the case that gold has not been a great investment historically, as it generally tracks inflation – a case with which I agree – Solin charts gold’s performance from 1802-2001 as indicative of very long-term performance and notes that $1 invested in gold in 1802 would be worth $0.98 in 2001 (inflation adjusted). That’s colorful and accurate, as far as it goes, but by avoiding the most recent decade (which has been a great one for gold overall even though its overall historical investment performance remains spotty at best), Solin puts his credibility into question.
Similarly, Solin criticizes “lost decade” advocates (as I have), but supports his case by pointing to attractive returns of portfolios during the period from June 1998 through June 2008, avoiding some major market difficulties and upheavals in the years between June 2008 and the September 2011 publication of his book. There is no way to sugarcoat it. That’s data mining at its most obvious.
Finally, Solin suggests (and stronger) that financial professionals who disagree with him aren’t just wrong – they are essentially evil and out to steal from and damage the general public. And, consistent with his background as an attorney, he seems to think that every advisor who refuses to bow to his approach in toto ought to be sued for malfeasance. That position is extremely disappointing. The evidence is not nearly as one-sided as Solin pretends.
We are all prone to overstatement. By nature we are subject to confirmation bias, which means that we are likely to look for evidence to confirm our pre-conceived notions and to examine evidence in a light most favorable to our existing points of view than to analyze all the data objectively and come to a reasoned conclusion. As a consequence, we hold our own opinions too tightly and are generally too quick and too negative in our disparagement of opposing points of view.
These tendencies provide a pretty good basis for what Aristotle called the “golden mean,” what Confucius called the “doctrine of the mean” and what Buddhists call the “middle way,” which is the desirable middle between two extremes. Thus courage is the golden mean between irresponsible recklessness and cowardice. As Aquinas observed (in Summa Theologica), “evil consists in discordance from their rule or measure. Now this may happen either by their exceeding the measure or by their falling short of it;…Therefore it is evident that moral virtue observes the mean.” Truth often resides between extremes.
All of which is not to say that truth can always be found on some “middle ground.” The argumentum ad temperantiam is a logical fallacy which wrongly asserts that between two extremes there must be a correct compromise between them. In practice, this fallacy often leads to false equivalencies and an overarching relativism, even when one side is clearly and demonstrably right and other wrong. As the great abolitionist William Lloyd Garrison wrote in the inaugural editorial of The Liberator in 1831:
I am aware that many object to the severity of my language; but is there not cause for severity? I will be as harsh as truth, and as uncompromising as justice. On this subject, I do not wish to think, or to speak, or write, with moderation. No! No! Tell a man whose house is on fire to give a moderate alarm; tell him to moderately rescue his wife from the hands of the ravisher; tell the mother to gradually extricate her babe from the fire into which it has fallen; — but urge me not to use moderation in a cause like the present. I am in earnest — I will not equivocate — I will not excuse — I will not retreat a single inch — AND I WILL BE HEARD.
The tendency to equivocate is particularly acute in our media culture, which tends to rely upon a simple he said/she said motif instead of doing comprehensive reporting and the pithy soundbite over careful analysis.
We cannot avoid our certainty bias altogether, but we can mitigate its effects by becoming aware of how our minds work. Our feelings of conviction are sensations and not logical conclusions. Only in the absence of certainty can we have mental flexibility and the willingness to contemplate alternative – perhaps better – ideas. However, it probably will not sell as many books.
Solin has a plausible case to make, even if it is ultimately unsatisfying. His book would have been much more helpful and more persuasive had he made his case fairly rather than relying upon so much unfounded hyperbole.