Introduction
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
Car
Buying
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.
College
Selection
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.
Investment
Choices
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.
Conclusion
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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