When Intuition Fails

According to Warren Buffett, most investors would be better served by acquiring an index fund with their money. If we ignore all the variables other than rate of return, based on experience that seems difficult to argue about.  Management does not add value. That experience and the resulting intuition fail.

As it turns out, Scott Adams’ Dilbert Mutual Fund launched in  October 1997 would be better.

There was a time when I would have assumed that Scott Adams was making a joke, but it now seems that he is, as usual, quite perceptive.

Monkeys really would beat a capital weighted index.

Robin Powell wrote an interesting piece earlier this month. It is worth the time to read it. I especially liked the Scrabble index idea.  You can see it here, and you should.

Why do randomly generated funds beat human managed ones and especially why do they beat index funds? According to Powell’s research source, monkeys would beat the index two thirds of the time.  That result is based on a BILLION randomly generated portfolios. Probably a significant sample.

The answer is, of course, we don’t know. That suggests monkeys running a fund may not be a suitable predictor of future performance. The key is randomness and randomness is not a prediction tool.

When you think about it, you learn that a passive capital weighted index fund is not random as required. It is a formula and the formula relies on prices that may be influenced by its activities. Logically a flawed idea. It worked very well when few people used the idea and their affect on randomness was negligible.

So what to do for we humans that cannot outperform the monkeys?

Develop three factors that are suitable for your particular situation.

  1. Sufficiency. How much money do you need and when do you need it?
  2. Your projected savings between now and the time you need the money.
  3. The Goldilocks yield. What yield is “just right” to have the savings stream plus the yield accumulate to the amount you need?

If you get the right answer with the Goldilocks yield and your reasonable savings, how much risk would you take to get extra. Probably not much.  In that case a reasonably predictable investment portfolio held for a long time works well enough.

If the time is long enough, you will be able to adjust any of the factors to get what it turns out you really want or need.

Can you do it alone?  Maybe, but it will require skills that many of us do not possess.

  • Emotional stability
  • Discipline
  • Time competence
  • Self motivated
  • Objective reporting and analysis
  • Tax efficiency
  • Investment selection skill

Delegation ten becomes a useful tool.

Hiring a third party advisor who can help manage you and your expectations is often money well spent. That management of you, not the management  of the money, is ultimately what will create the wealth you need.

Always understand the meaning.  Never forget that you cannot eat rate of return, you can only buy food with money. Advisors  help you make sure there is some.

Don Shaughnessy arranges life insurance for people who understand the value of a life insured estate. He can be reached at The Protectors Group, a large insurance, employee benefits, and investment agency in Peterborough, Ontario.  In previous careers, he has been a partner in a large international public accounting firm, CEO of a software start-up, a partner in an energy management system importer, and briefly in the restaurant business.

Please be in touch if I can help you.  don@moneyfyi.com  866-285-7772




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