Simonelle is on leave and Mark LaMonica is filling in with the editor’s note this week.
He wears a mask and his face grows to fit it
There are few better lines in literature.
And while there are several ways to interpret Orwell’s poignant observation is his essay Shooting an Elephant, its meaning to me is clear. The constructs that guide the roles we play in life eventually become who we are.
I was thinking about this line when I was reading an interview with a portfolio manager for a dividend fund in the US. The second largest position in the dividend fund she manages is Amazon – a share that has never paid a dividend.
The rationale for this seeming deviation from common sense is illustrative of a type of thinking that bedevils professional and individual investors.
As the portfolio manager explained, her dividend fund is benchmarked against the Russell 1000 Value Index. The index currently has a 20% weighting to technology shares.
The technology allocation has doubled in the last year as more tech shares have joined the index – shares like Amazon.
In an investment world where performance against an index is paramount this means that even a dividend fund manager believes she needs to hold non-dividend paying shares to keep up with the benchmark.
Does it matter that nobody invests in a dividend fund to own non-dividend paying shares?
Apparently not.
Does the benchmark return align with the goals of any of the investors in the fund?
Unlikely.
The constructs that guide the thinking in the investment world can bear little resemblance to the whole point of investing in the first place.
The problem…is us
Before mocking the structurally influenced decision-making of professional investors it is worth examining why they behave this way.
French philosopher Joseph de Maistre wrote that every nation gets the government it deserves. And we are getting the professional investors we deserve.
Fund managers are fixated on keeping up with indexes because individual investors chase short-term performance and punish any shortfall.
The downside of underperforming in the short-term is much greater than the upside from outperforming over the long-term.
This perverse incentive structure is our fault.
We can’t seem to help ourselves. We don’t bother to define our goals but somehow think we will reach them. We quote Buffett while attempting to day trade our way to riches.
The personal investment decisions each of us make can do little to change the overall industry – but we can improve our own outcomes. A reminder of three ways investors often self-sabotage.
Defining success by someone else’s terms
Orwell was a minor colonial official in Burma. And what set Orwell apart from many of the other cogs in the imperialistic system was his self-awareness.
Orwell could see the downside to colonialism extended far beyond the people being colonised. He could see the ‘success’ of the system was backfiring against those imposing it.
As Orwell put it, when the white man turns tyrant, it is his own freedom he destroys.
Throughout life the way success is defined matters. And professionals aren’t the only investors fixated on indexes.
Just like the dividend fund the indexes many individuals use to measure success often have little relation to what we want out of life.
There are several ways comparing returns to an index can push investors in the wrong direction.
It could be comparing a diversified portfolio to a narrow index. The comparisons might be over short – and therefore meaningless - time periods. Survivorship or hindsight bias may distort the relevance of these so-called benchmarks.
Despite the constant feedback loop of prices and the numerous ways to judge performance, investing isn’t a competition. The purpose of investing is to help you get what you want out of life.
For some investors that may be the peace of mind that comes from holding more cash than advisable for a portfolio optimised for the highest possible returns.
For some it is generating steady and stable income by holding shares that pay dividends even if they fall behind in a bull market.
For others it is accepting the simple truth that the more money you have in relation to your needs the less risk you need to take.
None of this is easy. I’ve struggled to separate avarice from ambition and to stop viewing any departure from wealth maximisation as a character flaw.
Yet as I’ve grown older I’ve come to accept the only way to get satisfaction out of life is to define success in your own way. Don’t forget that investing is simply a means to an end.
Your portfolio and your life are linked
A crazed elephant showed up in the Burmese village Orwell oversaw.
Orwell was a sub-divisional police officer. It was his job to investigate but what seemed clear at the outset became muddled as he got closer.
A story always sounds clear enough at a distance, but the nearer you get to the scene of events the vaguer it becomes.
Most professional investors know little about the end investors. This asymmetrical relationship enables risk to be defined in peculiar ways. It enables a detached view of investing – afterall, it isn’t their money.
A dizzying array of metrics are bandied about – the Sharpe Ratio, standard deviation, beta, the Sortino Ratio. Portfolios are minutely adjusted to stay perched on the precipice of the mythical efficient frontier.
These risk measures have a role to play but they are often disconnected from how most individuals experience risk in their lives. The risk we face is measured in trips not taken, loved ones not helped, anxiety not relieved - our risk is missing out on our hopes and dreams for the future.
Trying to live up to a false narrative of sophistication
When it was clear the elephant was a danger Orwell knew he had to do what was expected of him by the villagers. They were all playing roles in the farcical colonial system.
As he wrote, to be a sahib, you have to act like a sahib. Orwell didn’t want to shoot the elephant. But he knew his role was to shoot the elephant.
Many individual investors follow a false narrative of what it means to be a successful investor.
Investors are conditioned to believe each market environment can be exploited. There is a natural inclination to follow sophisticated sounding professionals.
Combine this with our natural action bias and you have a formula for overtrading and poor outcomes.
Some do this out of ignorance. But many people know that most professional investors underperform – yet still copy their approach.
There are no extra points for having the most complex portfolio. To sound sophisticated requires constantly having an opinion on the best course of action.
But building long-term wealth often means doing nothing.
I don’t rotate my portfolio. I don’t look for catalysts. I’m not making tactical asset allocation decisions. At best I rebalance when things get extreme while trying to keep my investment strategy as simple as possible.
Maybe I’m not the most sophisticated investor. I’ve made peace with that but I do have occasional moments of self-doubt and question my choices. Should I make more of a concerted effort to capitalise on every potential opportunity? Should I take on more risk?
These thoughts are generally fleeting and I go back and focus on the little things like growing my passive income, minimising taxes and fees, and saving money. That is what ultimately pays off.
Final thoughts
The constraints on individual investors are self-applied. The benchmarks are artificial. Many individual investors end up wearing a mask that isn’t meant for them.
Our biggest advantage is we don’t face the same challenges as professional investors.
We have no fickle investors to worry about.
We don’t have to explain each of our positions to our boss during an annual review.
We have no incentives to index hug, participate in group think or focus on the short-term.
Everyone internalises incentives and norms. Gradually they shape our behaviour and identity. For many professional investors the influence is structural and difficult to resist. Individuals have far greater freedom which we often surrender willingly.
Think clearly about what is important to you and the best way to get it.
Mark LaMonica
Also in this week's edition...
UniSuper CIO John Pearce shares his perspective on FY26 and what is ahead for investors.
Many investors are still suffering from the post budget blues. Joshua Derrington argues that the response from many wealthy people isn't the right one.
Value investing has fallen out of favour but Anton Tagliaferro and Simon Conn argue that the current market is ripe with opportunities.
Most of us are aware global diversification is needed given the concentration in our local market. Jarrad Stuart opines on the right way to do it
Saokai Fan outlines how macro forces are shaping the market for gold.
We could all use some positivity and Anthony Doyle outlines why you shouldn't count Australia out.
Curated by Simonelle Mody and Leisa Bell
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