A cynic is described as knowing the price of everything and the value of nothing. In a society supposedly led by the intelligent there is a great tendency for the top-down thinkers to be a source of guidelines that a cynic would produce. Experts pandering the supposed short attention span of the populace produce mathematically accurate measures for comparisons to aid or direct decision making. These “experts” are found in government, media, universities, and private practices.
Three examples of this approach and their results illustrate this cynical attitude are as follows:
- Car buying by gas mileage delivered
- College selection by test scores and future income
- Investment choices vs. securities indices
The US government in its desire to foster climate management requires auto manufacturers to place on the price stickers the estimated average gas mileage of each car being considered with the intention to lead the buyer to purchase the most fuel efficient vehicle. Early after these requirements were promulgated some of the manufacturers advertised their high number of miles per gallon. While initially there were some market share shifts in that direction, but recently the relatively low gas mileage SUV and light truck models market shares have risen dramatically.
Why didn’t the guidance work? There are two main reasons. The first is that in buying a new car the buyer is interested in other values. Many buyers either consciously or not want their purchases to say something about them either to themselves or others. This is the basis of most successful advertising. The second reason is that the number set of just city and highway driving consumption is inadequate on two levels. First, in the early years of car ownership the cost of fuel is among the smallest amount spent on the car, where normal repairs and servicing (plus in certain locations garage and insurance) are higher than gas. Second, none of us are average in many things that we do or consume. If the data showed the range of consumption, it may become very clear that our own driving habits have a great deal to do with the results.
For many people the single or the next most important purchase is their school education. As with any purchase it is useful to examine the transaction from both sides of the trade. From the student and/or the student’s family viewpoint early on in the decision process there is a series of statistical arrays to sort through. These include test scores, acceptance ratios, and average income expectations. Again these pinpoint numbers do not show the ranges of outcomes or even in most cases the difference between averages and medians.
I have had the privilege of sitting on two Boards of Trustees of universities that I didn’t attend. I have watched in each case the admissions staff create a model of the desired incoming class. The importance of test scores is only in the absence of other indicators. For some universities class ranking is more important combined with an overall grade point average and trend. The incoming class should augment the other students in terms of academic, sports, and social skills to produce the best universe for the school over the next few years. From their point of view, the yield of the accepted applicants to those who attend is an important measure. The odds are that an application without a visit particularly from a distant home raises the probability of attendance question. I suspect, but have no confirmation, an eye should be placed on the odds of future financial or public success of the student. In these lights, awards and work progress either for pay or organized charities is important.
In my opinion, one of the tragedies of the American college scene is the level of student debt being assumed. Too many students and their families believe just graduating from college is the ticket to a successful career. They don’t try to determine the percent of the starting class that graduates on time, the range of income earned immediately after graduation and over the working lifetime, and an all-in estimate of the costs to attend a college including a reasonable estimate of spending. A non-statistical measure that can be probed through interviews is whether the prospective college student is ready for this level of commitment and responsibility. As with many things in life, the selection of schools should not be solely or perhaps even importantly, a “by the numbers” exercise.
Making investment choices can be intellectually and emotionally difficult. No wonder many people including professional investors seek quick, simple decision tools. Often they are serviced by media or salespeople that have been trained under the mantra of “keep it simple, stupid.” While the summation of a planned course of action can, and often should be, transmitted simply, most simple thinking is simply wrong. Any one sided decision that does not consider both the rewards and the risks of each decision is unwise.
The most grievous mistake is to make a comparison of two unequal subjects. Securities indices were developed as a sales method to describe the movement of a market as if it was a single force, not a collection of many. Pooled investment vehicles, including mutual funds, are more than a collection of individual securities. Mutual funds are a legal entity that are required to follow specific federal and state regulations. Funds have expenses involved with gathering and redeeming assets, expenses of managing assets, including transaction costs. In may cases, through some marketing activity the ability is provided to discuss immediate concerns of an investor that is troubled due to personal or market concerns. Historically, a wise steadying hand has prevented many investors from selling out at the bottom. None of these functions and constraints are on the publisher of indices. (I was one a number of years ago.)
Recently, I have noticed a number of brokerage houses and other wealth management organizations are attempting to hire qualified analysts in their fund selection efforts. I wish them well as that is part of the process of what we do. It is not easy once you no longer rely solely on “The Big Mo” or momentum as spoken by a former US President. One of the great dangers of following momentum is that it can’t go on forever in recognition that once everyone is dancing to the same tune, there will be no new followers. Momentum often ends abruptly with sharp reversals.
Fund selectors should be focusing first on comparisons with other mutual funds that are actually doing what the fund under scrutiny does, also other funds that could do those things but don’t. As someone who learned basic analysis at the racetrack, in every decision there are odds that one can be wrong. Each manager, active or passive could be wrong. The critical skill set is mixing funds with different potential risks into a portfolio that on average can sustain it itself under varying circumstances.
In each of the three decisions discussed the single most critical variable is the individual involved. How you drive will determine your gas mileage and satisfaction with your car. The student will for the most part determine his/her success at college and beyond. The owner of the securities or funds will be the biggest single determinator of the investment. In addition the people that manage the funds will drive their investment vehicle within the range of available choices and they are more important than their records.
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A. Michael Lipper, CFA
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