Uncovering the Mysteries of the Money Management Field

When I started my financial career, I was in awe of the people who managed money professionally. I thought that these people had the secret sauce to creating wealth. I wanted to know what set them apart and learn what made them so special! I craved their knowledge – and I wanted it fast! I was impressed with these high achievers and their prestigious backgrounds. Many came from the best colleges and had advanced degrees in engineering, mathematics and finance. Some had MBA’s and other impressive designations like CFA’s and PhD’s. They also had histories of success, meaning that they had done something very special in previous years that set them apart. During the typical work day, it was not unusual to be working with an Ivy League quarterback, a professional hockey player or a world famous tennis player. Some had extraordinary resumes such as running a well-known family business, designing a computer system, doing high level medical research, or even working as a rock band promoter – I mean you’re talking about some serious cocktail party bragging here!

As time went on, however, I realized that shear education and previous accomplishments did not always guarantee money management success. I learned that investing money is an art as well as a science and that only a select few are blessed with the golden touch. I began to understand that time tended to shake out the less capable and that the best money managers were few and far between. The reality is that human beings tend to make mistakes and even the most capable are brought to their knees from time to time.  Just read the classic book, Extraordinary Popular Delusion and The Madness of Crowds by Charles MacKay – an early study of crowd psychology. The book highlights how even the smartest of the smart can get bamboozled from time to time.  Google Long Term Capital Management, Bear Stearns, and Barings, etc. and well, you will get the picture.

Over the years, I have witnessed many so-called investment geniuses fail because of process failures. As time went on, I concluded that good portfolio managers (and reliable investment approaches) are hard to find. Here are several real life examples of failed approaches by those that I had admired so much early on in my career. In each case, investors were severely damaged:

  • A Genius with Overconfidence Bias: Superstar portfolio manager trades excessively and captures excellent short term results. Trading turnover typically exceeds 400% per year. Their managed fund swells with new assets. Two good years of performance is followed by severe underperformance. Manager is fired and the person opens a store on Newbury Street.
  • A Genius Straying from the Process and the Plan: Famous Sector Fund Portfolio Manager believes that oil prices will recover so he “averages down” on his oil positions (which continue to fall). The losses grow larger and the redemptions increase. Eventually the manager averages himself out of a job.
  • A Genius Overwhelmed by Worry Bias: Top-ranked manager specializing in NASDAQ stocks leaves a major Boston investment firm to start his own hedge fund. Becomes perpetually fearful of the economy and the markets and loads up on gold stocks. Long term performance begins to deteriorate, and the hedge fund eventually closes.
  • A Genius with Short Term Random Success: A popular conservative Fidelity 5-Star mutual fund manager retires in the late 1990s and is replaced with an up-and-coming “superstar.” The new person quickly invests nearly half of the “conservative” fund into high-flying technology stocks, which occurs just three months before the infamous Tech Wreck of 2000. Manager is fired shortly thereafter.
  • A Genius with Confirmation Bias: Director of Research at one of the country’s oldest mutual funds recommends that I buy Digital Equipment because “there is no way this stock can go down.” Stock drops by more than one-half in just over a year.

At the end of the day, I learned that the investment business is not so mysterious after all and that the people in it, no matter how smart, are human beings subject to making mistakes just like the mechanic working on your car. I can say with a reasonable amount of confidence that the best and most successful in this business are the ones who are humble and patient and tend to take a skeptical view of the world. I like when I hear managers admit that they don’t know something – because nothing is certain in this profession. Those who say otherwise (like they know where interest rates are headed) are either lying to you or have distorted views of their capabilities. The best seem to have reasonable return expectations and have in place a process and a plan that they follow and stick to religiously. Envy the manager whose goal is to protect you and not subject you to too much risk. Avoid the manager with the gold watch and year-round tan, because they may be lacking the things that are more important – like taking care of you! No one is in possession of the investment Holy Grail out there! Instead, seek out those who not only have the necessary investment skills, but those with reasonable expectations who will serve you well.