The perils of trading are understated.
Internet technology has transformed much of the financial world, so that it barely resembles any scenario from 10 years ago. This makes comparisons difficult – but not impossible. And comparisons should be made because there are trends that have emerged post the Global Financial Crisis, that are copies of trends that followed previous large market falls. One of those trends is a higher level of do-it-yourself trading.
Many people were lured into opening their own trading accounts owing to the view that professionals had botched the job in the 2007-2009 market crash – so why not just do it yourself? A very large number of analysts, commentators and professional traders sought to take advantage of this move and increased the level of information and trading services available to retail investors who wanted to take that step into do-it-yourself.
All of which is fine, and quite ‘normal’ for a post crash period. Except that the trading mentality has taken hold of much of the media, to the point that the buy-and-hold investment strategy has been crushed by naysayers.
“That’s fine”, i hear you say, “except that now i can obtain expert opinion on a raft of complex issues, and i have trading platforms and news services and risk-cutting measures that allow me to do what only professional investors could do not very long ago. Why should i adopt a buy-and-hold strategy when that just loses money, and means that i hold a less-than-optimal portfolio of losing securities at any given point in time.”
To discuss this further, let’s talk about ‘bias’.
i am a financial planner, who is a part owner of a financial planning business that makes money from helping people through giving advice on financial matters. So it could be said that i am biased against any strategy that does not involve a financial planner. It can also be said that i have a financial bias against direct investments because financial planners always recommend managed funds. And it can be said that i have a financial bias because any strategies or products or services i recommend are going to make me money in some way or another.
OK. Let’s just say for the moment that all of this is true. It’s not – but i’m not going to argue any of the points here, so we’ll just assume it is true.
Now i would ask you to ask yourself where the commentators favouring do-it-yourself strategies might have a financial bias – because i assure you that they do.
Firstly, there is the obvious bias that they will make more money if more people adopt a do-it-yourself strategy, as they will end up with more newsletter/email/website subscribers who will pay to access their trading knowledge, data and information.
Secondly, there is the financial bias of ‘platform’. Now this may sound a little silly to you but from my position in the money world, i find it quite ironic. Financial advisers and financial planning groups and banks and institutions make money from all sorts of areas. One of the least obvious but most profitable is “platform”. That is, a system that holds other people’s money and charges a fee for that service. In one way or another, that platform will earn fees for its owners, which obviously will encourage its owners to keep promoting the service. Do-it-yourself groups have platforms – it’s just not seen in that light. An example would be a newsletter or email list or website. Subscribers are worth money, and in the current world – a lot of money. Very high profile “do-it-yourself” commentators / analysts / experts have earned a lot of millions of dollars by selling their ownership in such ‘platforms’. The argument is that people willingly choose to join these ‘platforms’ and they don’t charge percentage fees – so that means there is no bias. Put on a thinking hat for a moment though, and you will realise that this is a straw man argument, and not a very strong one at that.
Thirdly, there is the financial bias caused by past knowledge, experience and training. This is something that i have covered in Musings articles in the past. A person who develops their skills in a particular area will naturally feel better equipped to deal in that area. They will naturally have less faith in areas that they have not worked in or studied in or have experience in.
Yet none of these forms of security or asset or strategy selection bias or financial bias are ever noted in do-it-yourself articles. The do-it-yourself-is-better mantra has become so entrenched that it now permeates even as far as standard national financial news outlet – which now actively promote strategies of one kind or another. The bias towards “industry super funds” is one form. The bias towards “self managed super funds” is another. The bias towards “active management” is another.
What i find strange, is that none of this bias is acknowledged and i frankly believe that a large number of people involved aren’t even aware of the perspectives that they have adopted.
A Financial Planner’s point of view
As a financial planner, it is an ironic view. Financial planners have been actively highlighted for ridicule and interrogation, with well-funded campaigns by national groups seeking to reduce confidence in financial planner activities. Independence, bias and fees have been issued raised in a negative light where planners are concerned. There is the occasional “not all planners are like this”-style comment but it is usually a tag-along or throwaway line, and is usually in such a context as to suggest that most planners ARE like this and are best avoided.
As an old man of the financial planning industry, i can see why the financial planning industry annoys some people. However, most of those reasons are quite limited in their scope, and there have always been ways of avoiding excesses or inequities or bias or lack of independence.
So, i can forgive a bit of angst but i really cannot forgive hypocrisy – especially what i would term “cynical hypocrisy”, whereby a knowledgeable person just follows the crowd simply because it is easier or they make more money or more friends or receive more authoritative status.
If you have been patient enough to read all of this then i truly do thank you. There is no great reward that i can offer but i can at least help you out by pointing to the reason for my breaking a little personal rule, by being very blunt about something that could really be seen as “professional jealousy” or some such thing…
This post was sparked by an article in the Australian Financial Review (“Dark underworld of FX broking”, p15 AFR Wednesday 21 January 2014). Here’s the text of a highlighted breakout paragraph from the article..
“An estimated 95 per cent of retail traders are pre-programmed to fail, which means the brokers will win.”
Why has, and does, this statement rankle me so much?
Because it is not a secret. It’s a well known fact that retail trading of securities (listed or forex or derivatives – it doesn’t really matter which) will generally lead to less-than-market returns for the average investor. Retail traders will encounter a wide range of outcomes – from the stunningly high to the horribly low. Do-it-yourself proponents would suggest that this is no different to what will be encountered from financial planner recommendations. While this may (MAY) be true, it’s highly unlikely to be correct. The reason is that individual traders are taking highly selective risks when operating in a given market. Financial planners will usually be required by their dealer or compliance system, to recommend highly diversified products, strategies or platforms. Even a rudimentary knowledge of mathematics would suggest that this will be less risky than the do-it-yourself process.
My experience suggests most trading strategies will fail
Over the years, i have watched many, many, many people move in and out of active trading strategies. In fact, it is an active policy of our business that we try to allow for the desire for do-it-yourself activity in any broad recommendation, so we are definitely not against such strategies. But everything has its place, and in the world of money, an active trading strategy has a very high chance of resulting in an outcome lower than that obtainable from a simple buy-and-hold strategy that is easily accessed via an “index” type fund.
In a “smartinvestor” section of the same issue of the Australian Financial Review (p 19 – “Panning for gold has never been this easy”), is an article that suggests…
“Sock-picking Powerful new platforms allow ordinary investors to play fund manager.”
The wording is appropriate. The news is about listed securities trading platforms that include “filters” that can help you sort out listed companies in terms of their past performance or current financial make-up or projected earnings/expenses (the last under a few different guises, from single research source right through to major broker/analyst consensus). There is a fund manager in the article who points out that there is more to the job than just applying basic analytic filters but again, such commentary is negated simply by the choice of title for the article. Fortunately, there is also an article on page 21 (“What use are forecasts to anyone?) which gives the portfolio construction thoughts of fund manager Steve Johnson of Forager Funds Management that helps provide some sort of balance – but it is later in the section and doesn’t have anything like the “punch” of that lead article on very clever software.
i have seen many people lose a lot of money trading. Some were always going to lose money, while others seemed to have what it might take to be successful but in the end, most simply failed to earn a market rate of return over multiple cycles. And that’s the trick. Virtually anyone can win in a few trades – simple luck can do that for you. Anyone buying during a low point in a particular share or sector or market can look very clever when the position changes and that share or sector or market regains favour and momentum. The real skill is maintaining a winning margin over a larger number of trades over multiple cycles in multiple markets. Even well researched, well resourced and well connected professionals rarely get that right, so it is time that more retail investors were made aware of the just how unlikely it is that a do-it-yourself strategy will result in above-market or even market, levels of returns.
A little aside on Do-It-Yourself financial planning
You may be interested to know that i’m not as “anti” DIY financial planning, as in many cases that is what the bulk of Australians are doing anyway. It’s just that i think it’s a good idea to get someone with a broader insight into some of the broader issues to look over your shoulder every now and then. But i’m biased on that one, aren’t i?