INVESTING WITH CLARITY® BLOG
Ignorance is Not Bliss
July 27, 2020 2:18:38 PM
The old saying “Ignorance is Bliss” may be good for the ostrich sticking his head in the sand, but it certainly should never apply to investors. When asked what their number one holding is, many investors mention the name of a fund or ETF. After doing so, when pressed on the individual holdings within that respective fund, they unfortunately have no clue. Furthermore, they also have very little idea on the construction process of the fund and who actually chooses those holdings.
Many investors have been incorrectly told that removing the human element of selection eliminates emotion from the process and that so-called Passive Investing reduces risk and enhances diversification. We believe neither to be true. Additionally, we believe it is incorrect to assign the label of passive investing to index funds, as each one has a separate unique methodology developed by an investment committee chaired by human beings, as they design and construct the constituents in each fund and control how they are reconfigured. In the case of the most famous index, the S&P 500, the Investment Committee, with actual human beings on it, is prohibited from granting access to their selection process.
We believe that the biggest risk taken by many investors is their inability to fully understand the investment process used by their advisor or money manager. Client portfolios built of individual stocks based upon a stated investment philosophy and strategy provide investors a greater level of clarity than an ambiguous index construction methodology process. This was confirmed by the most recent Dalbar QAIB Study released in 2020. The report cited as one of its top suggestions to advisors in how to deliver a calming message to their clients is to make them aware of their own behavioral biases. This awareness includes knowing what holdings they own in their own in their portfolio and the process by which they are chosen. In times of market stress and turmoil, clarity is paramount in battling fear and unrest.
Advisors who have a structured investment selection strategy and philosophy are better equipped to counsel their clients by relying on sound judgment and eliminating emotion in the decision-making process.
In closing, the ostrich may find solace in sticking its neck in the sand to appease its feelings of fear; however, advisors should counsel their clients to do just the opposite. Using awareness of process and a keen understanding of the actual companies they hold and why they hold them is a very strong tool in combating destructive behavior that is often seen in times of peril.
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