Thursday, 6 January 2011

Investing Success: More is Less, Less is More

Do you have nagging doubts whether you've made the right investing choices? Do you feel over-whelmed and confused by the huge number and variety of investment options? The reason for these feelings may not be anything you have done or failed to do at all.

The Tyranny of Choice: You Choose published in the December 18th edition of The Economist magazine, describes many ways in which the proliferation of choice in modern society can go too far. Whether it is a decision facing a person to buy a shampoo or an ETF, the benefit of a wider range of products to suit the circumstances and desires of individuals eventually reaches the point of diminishing returns and value. To understand the potential for investor over-load, consider that the main Toronto Stock Exchange lists 1498 securities according to Wikipedia and GlobeInvestor Fund Filter tells us that there are 13069 ETFs, mutual funds and closed-end funds in Canada alone.

Too wide a choice manifests its negative effect two ways. First, more choices often means less and less technical difference between products so that expending a lot of effort to see the differences may not be worth it.

But there are also a harmful effects on the consumer through psychological influences. A multitude of choices often causes people to avoid making any choice at all, an effect explained in such studies as When Choice is Demotivating: Can One Desire Too Much of a Good Thing? by Sheena Iyengar and Mark Lepper. With investments, a pertinent example is that people do not start saving if they cannot figure out the right way to invest, or if they do make a contribution to a TFSA or RRSP, the money simply sits as cash gathering dust. As has been shown and discussed many times, the sooner one starts saving for retirement, the less one needs to contribute in total to achieve goals as the effect of compounding has more time to work.

Another harmful effect is that people faced with too many choices will simply pick the first one at hand instead of taking time to choose using proper criteria. The potential time and effort required to weed through so many choices is so daunting that spinning the wheel or picking a nice sounding name becomes the decision method. Despite professional management, funds are not all the same! A variant of this effect is that people pick the fund that did best in the past on the erroneous supposition that fund success will be repeated, despite even the mandatory warnings imposed by regulatory authorities that past performance is no guide to future performance.

What to do - A (Very) Few Ways to Reduce Investing Choice Problems
We'll try to avoid the fault by keeping our list ultra-short.
  1. Keep your portfolio small, no more than 10 holdings - In our previous post Simple Portfolios Compared we looked at eight (that's still a manageable number to choose from, right?) portfolios with a balance and mix of types of assets. None of these portfolios contain more than five holdings. As we noted in the post, they perform quite acceptably.
  2. Look for low fees amongst funds and ETFs - Funnily enough, low fees reliably equal good performance for the investor. As recounted by McMaster University finance professor Richard Deaves in his book What Kind of Investor Are You? (see review here by CanadianFinancialDIY) and recently again re-confirmed in a Morningstar report various studies concluded that investors get the best net results from mutual funds with low fees, even amongst actively managed funds where the portfolio managers supposedly aim to justify higher fees with better results.
  3. Seek out a trustworthy advisor - When the investing world gets to be too much consider going to a professional who can guide and narrow choices by having worked through it before. Of course, you need to choose the advisor too! The key is to be able to satisfactorily answer this question - "Is this potential advisor worth listening to?" In other words, does he or she know what they are talking about and will he/she be guiding me for my benefit, not his or hers to my detriment? Your head / logic and your heart / instinctive feeling should both be saying the same thing to make a good decision. See this Globe and Mail article or Blue Collar Financial Planning for more detail on how to choose an advisor. Though not on a personal, formal basis, the aim of this blog is to offer impartial information and trustworthy practical analysis to individual Canadian investors.
Best wishes to blog readers for health, happiness and investing success in 2011.

Disclaimer: this post is my opinion only and should not be construed as investment advice. Readers should be aware that the above comments are not an investment recommendation. They rest on other sources, whose accuracy is not guaranteed and the article may not interpret such results correctly. Do your homework before making any decisions and consider consulting a professional advisor.

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