The Sunday Times 29 April 2018
A famous quote often attributed to Albert Einstein, “Not everything that counts can be counted and not everything that can be counted counts” has particular relevance to the financial services sector.
I’ve often used this as a metaphor for the spurious use of quantitative modelling techniques in financial services, which is in thrall to hard sciences like physics where one is able to use models to predict to several decimal places of accuracy. In financial services, decimal places are mostly used to show a sense of humour.
Some things we can measure. Some things we can't. And just because we can measure something doesn't make it more real or significant.
I was reminded of Einstein’s observation at a conference in London I attended a few weeks ago. Several speakers bamboozled us with charts and tables on the most effective income drawdown strategy for clients in retirement.
There were numerous spreadsheets, copious data and plenty of citations for financial heavyweights. The presentations were technically skilled and as engagingly presented as is possible on such a dull topic.
Yet in the space of five minutes, without a single chart or presentation slide, the key note speaker destroyed each of their arguments. And his message was brutally simple. It matters not whether you use a ratchet, guardrails or Bengen approach to income drawdown (trust me you don’t want to know what these are); what matters is that your income outlives you, and not vice versa. And the only asset that has historically come close to assuring retires of this, is equities. His advice was simply to invest in the stock market the risk of which he argued is widely misinterpreted.
We tend to think about money in nominal terms – euros and cents in our bank account. In the long run, the only rational definition of money is purchasing power. If my living costs double and my capital and interest thereon remain the same, I have effectively lost half my money. If money is purchasing power, risk becomes that which threatens it and safety, that which preserves or enhances it.
And what has protected purchasing power best over the average retirement time horizon? The stock market, he argued. Hence, low risk in this context. And what has threatened purchasing power most over the average retirement time horizon? Cash and bonds. High risk in this context.
If this seems terribly straight forward, it’s because it is. But that doesn’t make it easy counsel to follow nor indeed provide.
I should concede at this point, that as an adviser to financial advisers, I have spent most of my career advocating the benefits of diversification – spreading your investments across multiple asset classes.
Notwithstanding the long term evidence that equities have frequently delivered the best returns, this approach seemed sensible in recognising that investors do not react well to dramatic price swings and capital losses.
However, I see that it’s possible that following a diversified approach is less a hedge against investor loss aversion, and more a hedge against the inability (or unwillingness) of financial advisers to educate investors properly. This may be a little harsh. I have worked in financial markets for over twenty years and still find stock market gyrations to be incredibly unnerving. So it’s expecting a lot for those with little experience to remain steadfast during inevitable fears and fads. This is where I think advisers earn their corn.
I didn’t learn anything at the conference I didn’t already know. But I now accept a responsibility, as should the investment advisory community, to deliver the unvarnished truth about long term returns, accepting that for many, it will be telling them what they don’t want to hear.
Arguably the most important aspect of what it means to invest successfully is getting investors to stay the course through the inevitable ups and downs along the journey. In the main, investors do not like volatility and are averse in the extreme to multiple periods of negative returns.
By betting against the powerful force of human fallibility the all-equity approach to investing may be setting investors up for expensive failure. But maybe the failure should be registered as one for the adviser and not the client.
Guaranteed, absolute or target returns are offered to you as a solution to your behavioural shortcomings. Know that there is a price to pay for this, though it may not be that obvious.
It’s hard to put a value on good advice. But as Einstein once counselled, not everything that counts, can be counted.
Gary Connolly is Managing Director of iCubed, an investment consulting company providing investment support to financial advisors. He can be contacted at firstname.lastname@example.org or on twitter @gconno1. iCubed Training, Research and Consulting, trading as iCubed, is regulated by the Central Bank of Ireland.