"I would never join a club that would have me as a member." - Groucho Marx

When we pay for an expensive item or service, we usually do so because it will help us perform a task more efficiently, last longer, or allow us to utilize our time better by paying someone else to do it. In normal life, this usually benefits us.

However, it's tough to defeat this frame of mind that higher price equals better results when evaluating an investment strategy. We think that the more complicated the ecosystem, the more complicated the solution should be to solve it. Therefore, it is easier to convince someone that a sophisticated strategy will be better for them versus a vanilla investment plan. A lot of the asset management business justifies their high-fee investments due to their complex strategies. The notion is that only the best can afford to hire the brightest minds and most up-to-date strategies, and don't you want to be the best? However, a simple strategy, while not being a catchy sales pitch, is what investors really need.

 

Investor's Appetite for Complexity

Financial markets are vast and convoluted with many players and variables interacting at the same time. It stands to reason that a complex market needs a complex solution and that anything less than a 20-factor-currency-hedged-triple-reverse-quantitative-income strategy won't do you any good. I'd argue that while complex solutions may sound great they are not what investors need. Complex solutions justify high fees and work to move money from investors pockets into the pockets of the fund managers.

What complex solutions are you talking about? There's a few that are all the rage in the institutional space:  hedge funds and private equity ("institutional" stands for the upper-class echelon of investors where hundreds of millions or billions of dollars are available to be invested over a long time frame. Examples: university endowments, state employees' retirement funds, and large private foundations).

These investments are only available for institutional and "sophisticated" investors. Both of these are illiquid, meaning you can't access them quickly like you could a stock or a bond by selling it on the market. Most "lock-up" periods range from 3-7 years until investors have access to their money back. Hedge funds have the ability to skirt under normal filing requirements, which allow them to be more flexible in their selection of investments. They can borrow (leverage), short (sell a security with the hope of buying it back at a lower price), and use derivatives (options and futures). The private equity space involves buying smaller private businesses, helping make them more efficient and profitable, and then selling them in a few years at a large return.

Complex, right? These types of investments pitch uncorrelated returns with a lower risk of losing all your marbles (or more diversification with lower risk). But more importantly, they market the allure of "being in the club." These investments prey on investors' emotions of wanting to be seen as sophisticated. Their expensive fees trigger feelings in us that they must be higher quality.

This is natural because we do this all the time. It's why people buy a Ermenegildo Zegna t-shirt that costs $295 instead of a t-shirt from Target that costs $6. Sure the thread count might be a bit higher but is it worth the 5,000% price difference? No! The reason we buy it is that we want everyone to know we're wearing an Ermenegildo Zegna (Who the heck is that anyway?). Turns out for all the flair, hedge funds on average aren't really good for anything besides delivering poor performance to their investors and making themselves rich.

Be careful when you read, hear about, or are pitched a strategy that you don't understand. It's easy for us to be impressed by presentations especially when done by people with Ph.D.'s or other fancy business titles. We reason that since these guys are so smart, they have got to have an edge or a greater understanding. We're biased toward complexity. But the downside to complexity is fees and poor decision making due to lack of understanding. 

"It is far easier for people to sell you what you think you need rather than spending more time trying to educate you on how investing really works." - Ben Carlson

And here's how it really works on a personal finance level. It's truly simple: spend less, save more, and get out of your own way when choosing and sticking with investments.