Why Bad Things Happen to Bad Money Managers

Most investors are reluctant to change their approach even when it clearly isn't working. And the reasons for this are often profound. And profoundly unprofitable.

Yesterday, one of my oldest clients e-mailed me out of the blue and said what a wonderful job I had done with her account over the past four years. I smiled, thanked her and, since she’s a friend, I wrote in response: “Please tell all your rich friends about me.”

Her reply: “I have, but getting people to change what they’re doing financially is almost impossible -- no matter how badly they’re doing.”

I know from experience that she’s right. Getting humans to acknowledge that there might be a better way to manage their money is like gently suggesting to a loved one that he or she should drink less. They may listen to you the first time, but I wouldn’t bet on it. You need a full-scale familial intervention to make the point -- and even then it may not work.

I’m writing this entry to explain what I confront every week of my working life and to encourage you to change what you’re doing if what you’re doing is not working.

Here are some of the reasons people cling to a losing strategy:

1) They don’t really know how their portfolios are performing. Almost no one I know can tell you with any degree of accuracy how they’re investments have performed over time. “I’ve done alright, about in line with the market,” people will say. And then, when I look at their portfolio, I gasp, because the carnage looks like something out of Baghdad. If you don’t know exactly how you’ve done, I promise you this: Your performance is worse than you think. Why? Because that’s how the human brain works. We go through contortions to protect our self-esteem. We focus on the good months and put the bad years out of mind. We fixate on our Google (GOOG) winnings rather than recalling that loss in JDS Uniphase (JDSU), which happened to have been four times as large as the Google win, but no matter.

If you don’t know how you’re really performing, you can’t possibly know that it might be time for a change. So, I implore, keep very clear records of how you’re doing -- and don’t eliminate those wacky fliers you took on stocks that sought to bring nanotechnology to the bowling alley.

2) People console themselves with fact that no one they know is really doing any better than they are. In this regard, misery really does love company. To salve his wounds, one of my favorite clients repeatedly says that everyone got killed in the tech bubble. I’ve subtly suggested that I didn’t -- and that other value investors didn’t either -- but I don’t have the heart to confront him directly.

3) It’s painful to make a change. It’s not pleasant to acknowledge that the investment approach you’ve taken for 10 years is sub-par. It feels as if you’re confessing to a failure. I mean, imagine how much more money you’d have had if you’d done better. People hate acknowledging that they’ve been wrong. What’s really unfortunate -- and almost comical -- about this reason for staying with a bad approach is that 85% of mutual fund managers underperform the market. So there’s no shame in admitting that you can’t beat the averages. Some people can, but the vast majority cannot. Not beating the market is the human condition -- for most humans. My advice for most people would be to find some humans who do beat the market over time or to abandon the quest altogether and simply index.

4) People feel enormous -- and enormously misguided -- loyalty toward the financial professionals who’ve let them down for five, 10, 15 or 20 years. It’s very, very hard to dump a financial adviser, no matter how bad he is. I’ve seen this again and again. One 50-year-old I know was so phobic about telling her financial consultant at a major brokerage that she was leaving that she put off the call for years. My three-and-a-half-year-old daughter often behaves more maturely, but this is by no means unusual. First, lots of people genuinely like their brokers as human beings. (And why not? Being likable is one of a broker’s primary skills, after all. Sometimes it’s his only skill.) So they don’t want to hurt their feelings or their wallets. (They’ve seen those pictures of the kids with crooked teeth on his desk.) Second, once you entrust someone with a significant portion of your life savings, you often end up endowing them with substantial powers. You puff them up. Hey, they’re handling your loot, they better be good. And, if you’ve been with them a while, you know that they had a good year or two. That they nearly disemboweled your portfolio, however, is a fact that you prefer not to look at.

I have a friend who’s very bright, and her cousin, a broker, has done a lousy job with her money. I manage her husband’s money, and it’s taken her four and a half years to even consider giving me a little piece of her portfolio. We’ve talked about it over the years. “What can I do, he’s family?” she says. That’s like, “What can I do, I’m in a lousy marriage?” Well, you can try to make it better, and if that doesn’t work you can leave. But people’s inertia and their desire to protect the feelings of someone who has done a poor job of managing their assets are very powerful.

5) People feel that the next joker might be even worse. Giving someone your money to manage is like giving them your heart. It takes a leap of faith, a particularly huge leap when you’ve already been hurt. If, say, you’ve had two bad brokers, how confident could you possibly be that a third money manager would really be the charm? To some people, that sounds too much like a fairy tale.

6) For some people -- presumably not those of you reading this blog -- dealing with money is so unpleasant, so thoroughly uncomfortable and painful that it’s simply better to ignore the situation altogether. Obviously, this makes no financial sense but, to some people, it makes great emotional sense. To them, out of sight is out of mind.

So, yeah, I understand a lot of the reasons why people don’t take steps to improve their financial fate, but I don’t really understand. Because I’m wired differently. Twenty-five years ago I was an average investor. I got tired of just being average, and I completely overhauled my investment approach. It worked. But I’m enormously competitive and I hate losing. I have no talent for deceiving myself about my financial performance.

So, if you recognize yourself or any of your loved ones in this piece, just remember: There really is a better way. And it doesn’t have to be very painful at all.

By Andrew Feinberg
February 07, 2006

*Article taken from Kiplinger's Personal Finance

Please feel free to share 1 link with us if you choose to comment on this article.