Why is so much financial advice bullshit
Lets start this article off with a generic disclosure:
This commentary is being provided to you as general information only and should not be taken as investment advice. The opinions expressed in these materials represent the personal views of the author. It is not investment research or a research recommendation, as it does not constitute substantive research or analysis. Any action that you take as a result of information contained in this document is ultimately your responsibility. I will not accept liability for any loss or damage, including without limitation to any loss of profit, which may arise directly or indirectly from use of or reliance on such information. Consult your investment advisor before making any investment decisions. It must be noted, that no one can accurately predict the future of the market with certainty or guarantee future investment performance. Past performance is not a guarantee of future results.
Now that I have this legalese out of the way... I started writing this post a while ago because for many years I was rather annoyed by the financial "advisor" that my mother had employed. In fairness this particular financial advisor was foisted on her due to her work somehow going with this firm back in the day, but she stuck with them longer than needed when the option became available to leave. Much of the "advice" he gives is shit or just non existent. But because he's a participant in the in the system he's legally allowed to give this "advice" for his own profit. For years my mother was getting crap returns and frankly had a shit portfolio with respect to the investments in it. Given the multi-year war on savers now being waged via suppressed interest rates (in real terms) this was a big problem for her if she were wanting to ever retire.
But here's the thing, this guy is great at his job. His job, like many in retail finance, is really a sales job and the quality of any financial advice is secondary to this. As long as he brings money into the firm and keeps these assets under the management of the firm his job is done. If that can be done without any sort of quality financial advice it doesn't really matter because the firm itself might invest differently to the positions they advertise to their clients. I have to say I am in awe of this skill since people aren't easy to sway with financial decisions1, even if advice is clearly in their best interests resistance is common. The goal for many in retail finance is to get the largest amount of assets under the firms management as possible then to extract as much in fees for themselves as possible, preferably without customers realizing how much they are paying in fees. The incentive structures here often have nothing to do with giving good financial advice from the perspective of the client2. Further there are many situations where if you were to offer the sort of financial advice that was in the best interests of the client you'd actually get fired since the firm would lose money in these cases.
When you create incentive structures employees respond to those incentives. In retail finance the incentive structures revolve around sales to the general public. Unfortunately because most of the general public is not financially literate a lot of the sales process revolves around trying to convince people to be confident in the funds manager rather than actually educating the clients. Because educating people on a complex topic is really hard from the perspective of a funds manager just convincing them to blindly follow along can be a much easier path. But when people are blindly following along there's a lot of situations where they are getting wildly taken advantage of. When you understand how the sales process game is played it can be extremely frustrating and painful to see family and friends falling for these confidence tricks. If people buy into this sort of confidence or personality based deception then trying to show people the truth can get even harder. If people don't try to look for the truth then they tend to go based on other factors like how much confidence they have in the people and the people telling the truth may end up being seen to be less credible than the charlatans, because the charlatans have the fancy offices and cars and titles and "just look the part of a proper financial advisor". Breaking past this isn't easy and often it takes people losing everything to reevaluate.
Working as a retail financial advisor is a very different job to being a financial advisor that is internal to trading firms and banks. The incentives are very different for selling financial products compared to managing an internal position. If you have say multiple billions of dollars under management for a big firm then incentives tend to line up with making money for the firm, at least in the short term. Spinning a bunch of bullshit about an investment platform that has high fees and poor performance is highly likely to get you fired for cause rather than promoted, as it might if you did in retail.
Lately I've been struck by the tremendously low quality of financial information that the public gets. I think a classic example of this was recently where a guest on TV was pumping up a stock but didn't even know what industry the company he was investing in was at all: https://www.youtube.com/watch?v=j7imfdyi-C4
I can't help but feel that when people look back at this in the future it will be viewed as one of the iconic moments in the history of the 2021 stock market. Call me old fashioned or out of touch but if I was managing an investment fund and I went onto national television I'd make sure I had prepared some notes about what the positions I was about to talk about were, even if that wasn't information I was actually using for those trades. I first saw this clip shared in the financial crowd on Twitter, but I couldn't exactly remember where. When I tried to find this via a keyword search for inclusion in this article I found a wall of unrelated crap that had gone to efforts to have good SEO on these same keywords, but more about SEO later. All of this sort of non-news is getting far more common but yet people still retain a lot of confidence in the mainstream financial media because they assume that they are doing more journalistic work before publishing than they really are. There's an article that discusses the differences between deliberately misleading "fake-news" and this "non-news" that we see: https://www.epsilontheory.com/fiat-money-fiat-news/ even if you aren't an investor I'd highly recommend that you read this post as it has a good explanation of one of the most crucial issues of our times. While outright fake news is without a doubt a big problem people tend to be at least somewhat aware of it and they talk about it. This practice of non-news being passed off as real news is far less often recognized and therefore talked about less often. Even when people do realize this they tend to conflate the issues of fiat news with fake news but they are actually very different as they have very different causes and intentions. Specifically this non-journalism where information is passed on without any analysis or rigor is on the rise and the impacts this is having on society are likely larger than anyone realizes at the moment. A specific way in which I think this is underestimated is how much this skews peoples sense of history of events. This is very obvious when looking back at the historical state of the economy because people quote unreliable sources so much and spend so little time going back to study the more complete data when that data becomes available to them. People tend to write and publish articles hastily based on this poor quality information but rarely do people go back to edit their posts when better information becomes available later. When you search back you see a snapshot in time mostly biased towards whatever information was most easily available rather than what was the best information. As a result if you go back and search through news items you can get a very biased view of what happened at the time. More about this in a future article.
In much of the financial media some information is correct and some of it is just outright wrong, but very little is explained in terms of how it actually works with narratives being the main thing peddled rather than a deeper understanding. In any case people seem to engage with it because "correct sounding" stuff is talked about and at least to anyone without a deeper understanding of how it all really works can be passable. This brings me back to the clip from before, it's easy to get caught up on the fact that the fund manager was investing in Upstart Holdings without knowing what they did but asking the question "why would someone invest in companies without knowing what they are doing?" is a much deeper and more important question. This deeper discussion won't happen in the framework of the mainstream media and the hot-takes class of comments that we will typically see in reaction to a video clip like this. In this particular case I think what's happening is that this particular fund manager has a trading strategy based almost entirely on technical analysis and with little to no focus on analyzing the fundamentals of each stock. The talk of different factors like the 200 day moving average is a nod to this technical analysis based approach to trading these current markets. Given the downright absurd state of the markets with companies trading at insane price to earnings and price to sales ratios there's probably far more value in this fundamentals-free technical analysis approach in these current market conditions than most people would be comfortable admitting.
As much as I think having such a low focus on fundamentals to the point you don't even know what industry the stocks in your portfolio is a bad decision (for a number of reasons that would take an entire post of it's own to do justice) at least there's probably some sort of strategy going on here. But what worries me far more than the spreading of wrong info is what Wolfgang Pauli would have called "not even wrong". There are a lot of people in the finance industry for which the truthfulness of statements is simply not a concern. This sort of professional bullshitting hurts individuals but the broader impact on the general public is what concerns me most. This has created an environment that's normalized sticking with low-conviction positions and statements that can be weaseled out of later. People can create completely unfalsifiable positions and not get called out on them, worse some of these people seem to have attained "guru like status" with large followings on social media. Perhaps a large number of those accounts following them have been purchased but there's still real people who fall for this bullshit.
Much of the retail finance space likes to sell varieties of index funds. This is a great way to create an enormous number of hidden fees without the client knowing it. If the client goes and searches things up they might see some of the details but unless they run the numbers themselves they won't have any idea just how bad a deal they are actually getting. You might be wondering why people don't go run the numbers themselves and get informed? I think there's a lot of reasons for this but it's a hard slog to actually get to understand the modern financial systems since they are deliberately complex. On top of this a lot of people don't have a lot of numeracy skills and forget a lot of what they were taught at school. Sadly a lot of people who have the capacity to understand are just lazy or disinterested.
But what really concerns me is not so much that index funds are a suboptimal manner of investing but what the prevalence of these products has done to the markets. The rise of passive investing has led to a number of rather big distortions in the markets that actually hurts real economic growth and has caused major systematic risks to arise.
Fund management incentives
Fund managers typically like to structure things such that they get paid as much as they possibly can to manage other people's money. This is of course something that is subject to both market pressures and regulatory oversight. Some time ago hedge funds often had this incentive structure known as 20 and 2, which referred to fees which were 20% of profits and 2% of the assets under management. In an environment of monetary inflation this was more feasible than it is now. Before the global financial crisis, at least over a longer time window, markets were growing when priced in dollars. Since then we have had a long era where the global monetary system has been in a broken state. This has made the 20 and 2 model increasingly infeasible and market forces have meant that this has fallen greatly out of favor. We see this manifested in the enormous, and enormously dangerous, growth in passive investing where people have put their money into index trackers and ETFs directly instead of taking a more active approach to investing.
As the number of people who have had investments has grown the amount of focus from lawmakers to introduce regulations around investments has also grown. As real yields were more and more suppressed people attempting to save their money were increasingly forced to move their money into more risky investment classes. With high inflation relative to the interest rates offered on bank accounts leaving your money in the bank was a sure way to see wealth get destroyed. This has driven a surge in the retail finance industry in the last few decades. Because as the introduction of this article talked about there's a lot of people in the retail finance industry who don't actually care about getting the best outcomes for their clients. This principle agent problem is an issue in all finance but it's particularly acute in retail finance since there is a large asymmetry of knowledge between the firms and individuals when individuals are just the average member of the populace.
And this is a difficult part of the dynamic, building up an understanding of the modern financial system is a hard undertaking. The financial system is deliberately kept complex such that people can profit off that complexity. To be clear in some cases these more complex financial products are a good thing but in others they most certainly are not. In any case one part of this dynamic is that adding more complexity creates a class of professionals who exist to navigate this complexity.
Because of this principle agent problem there's regulations that have come into place to try to protect individuals from the excesses that are possible from unscrupulous asset managers. One of the difficult things about this from a legislative point of view is that these rules and regulations are reactionary, by the time the regulations are drafted up then put into force they are often responding to events and the market conditions of the past. There's a lot of assumptions that have become first accepted as reasonable then ossified into laws and regulations. Some things tend to be great rules that have stayed in place for a long time, these I sometimes thing of as timeless regulations, like rules against fraudulent company reporting are a good thing, people cooking the numbers like Enron did leads to all sort of bad outcomes and there's very good reasons to make this level of egregious behavior a criminal offense. Where things get less obvious is trying to encode some notion of what a prudent asset management strategy needs to be since the best asset management strategies from the perspective of the client and the asset manager depend directly on the current market and economic conditions. So while there is in theory a potential benefit to regulations that attempt to constrain the risk that the asset managers can take on there is in practice a lot of difficulty in making such legislation effective. Put simply almost all legislators lack the financial and game theoretic knowledge that is a requisite to have any chance of making such legislation in such a way that it is effective and works in the interests of all involved. As such much of the regulation that passes in this risk management space is dubious at best and typically encodes extreme backwards looking biases as legislators tend to ask "how can we avoid these things that were risky in the past?" when in reality the question that needs to be answered by such regulations and standards is "how can we avoid risk in the present and in the future?".
An especially common example of this is to say that a "prudent" asset portfolio has a split of 60% equities and 40% bonds. This may have been a reasonable split for quite some time, after all we had a multi decade long bond market rally in there and similarly with equities. Over time this 60/40 split assumption has become ossified and has even become the subject of some regulations. Looking at just how unsafe the bond market is right now makes this 60/40 split look a whole lot less reasonable. The trouble of course is that as market conditions change stationary advice like this can start to get very out of date to the point where it is downright imprudent to continue to invest in this way. However if there's regulations that have ossified around this you get a strange situation emerging whereby people start to require things to be true about the markets rather than following what's happening and responding to it by changing course. In the case of the bond markets we have definitely seen this happen after seeing such a long rally there. People investing in bonds at the moment are at extreme risk of getting crushed due to the rising inflation and rising yields that are starting to be seen worldwide. Looking at this from the perspective of an investment fund this is a difficult situation, you want to have as much customer assets under management as possible (as that will make you more money) but in 2021 investing in bonds is getting more and more risky (and losses will reduce your assets under management). If you have some regulations that force you to invest a portion of your portfolio in bonds then this is a difficult situation as you are now being forced to act against the best interests of your customers and potentially of your firm. But if you want to keep the assets under management growing you have a dilemma, if you were to tell your customers the truth about the bond market people would take their capital out of the firm. But changing the ratio might be hard due to regulations. As a fund manager you are put in a no-win situation if you are legally obligated to invest in a bad investment class.
Trying to figure out the incentive structures of funds as an outsider to the system is very hard
So why isn't financial education taught at schools?
I think there's a lot of reasons that financial education isn't taught at schools. The first reason is that the modern financial systems are so complex that it takes years of study to start to get a useful understanding of what's going on. This complexity in the system is entirely deliberate because it creates a caste of people who wield power over other people. It would be possible to simplify things but people with vested interests will fight against that. Frankly the truth is ugly in this space and educating people requires facing ugly truths.
“It is well enough that people of the nation do not understand our banking and money system, for if they did, I believe there would be a revolution before tomorrow morning” — Henry Ford
I think Henry Ford's quote remains as true now as when he first said this many decades ago. This forms a difficulty for the educator and more broadly the educational system as to educate more fully would be to create short term societal instability.
If people actually understood the system they would realize that a lot of things are set up in a way that don't really benefit everyone. We see this for example with the principle agent problems that are so severe with retail finance. When people understand the system they start to get highly invested in changing it. Such a change would represent a huge transfer of power and hence would have very deep political impacts. If everyone was highly financially literate the current debt based monetary system would implode quickly.
Reflecting on the financial adviser situation from earlier, something I've noticed is popular in retail finance is to give people a simplified version of the situation that sounds right so people feel confident. Unfortunately the actual financial system is quite complex and learning how it works is a substantial undertaking. I'm reminded of the following quote:
"For every complex problem there is an answer that is clear, simple, and wrong." -- H. L. Mencken
The financial system has deliberately added complexity over time to make it less easy for outsiders to understand. Informational asymmetry is a source of great profits for some and as such very real incentives exist for people to create arbitrary barriers to information flow.
In a broader sense I think there's ebbs and flows in education, at the moment it seems that numeracy and logic are very much not fashionable, at least in the west, and finance frankly needs these skills as a foundation.
How can I learn better?
In many areas searching around on the internet isn't a bad way to get started on a journey to understand topics. Unfortunately as search engines are getting worse at giving results due to their shift to mostly serving advertising this has got harder. There's still value in internet searches in many topics, especially the ones not dominated by commercial interests, but the value is mostly in areas not destroyed by search engine optimization and advertising results. However this is definitely not so in finance, since many of the people running the most sophisticated Search Engine Optimization (SEO) schemes are in the business of getting you to buy their financial products and are not interested in actually educating you. In the most egregious examples people will willingly mislead people under the guise of educational content as a strategy to get more people to put their assets under their firms management.
Finance companies were very early to the content marketing game, perhaps because marketing has always been such a core part of the business. This predates the existence of the internet and many in the finance space were the early adopters of SEO practices when the search engine era finally did come around. What we see as a result is that many articles that claim to be financial education are really just marketing pieces. Sometimes this lack of impartiality impacts the contents of those articles in a big way. Getting yourself to a level of understanding where you can start to judge the quality of content for yourself is an extremely important goal to have. In finance you need to be able to come to your own conclusions and have the knowledge to do so in a way that's accurate and reliable. You won't be able to rely on other people doing that for you.
Everything starts from a solid base of numeracy and the ability to apply logic. If you lack basic numeracy then you need to start there. For example can you calculate what 10 years of 7% interest does to an investment of $100? If the answer is no then you should first start by going to somewhere like Kahn Academy or similar so you can learn about things like algebra, compounding interest and the other aspects of mathematics that are foundational to business and finance. Without these nothing else will really make sense, I say this with not a shred of exaggeration. You NEED this foundation of basic financial numeracy in place. The next step is to spend a bit of time looking at formal logics, many things in the markets are quite logical, there are aspects that really do directly follow on from other aspects and you need the mental frameworks to be able to really think clearly about these things. If you feel uncomfortable with this then there's some courses out there that are good.
The foundation for any ability to understand finance requires basic numeracy, you need to have this as a solid building block. It's also very important to understand some basics of psychology, the markets are heavily driven by this. There's many books that talk about how mass psychology impacts the markets and there's even books like "The mental game of trading" that talk about how psychology impacts individuals who are trading. There's a few suggestions I have with regards to better understanding what's going on:
- Learn to look at the data directly, paying less attention to pundits and more attention to the data is crucial. This will involve learning where to find the right data in the first place. Many pundits and commentators don't give you the full picture with regards to what's going on. For example if pundits talk about how a stock moved go check the charts yourself directly, seeing the real data is much better than the narratives. Go look at a place like tradingview, sometimes someone will say "the stock went up massively" and it's just a small blip on the chart or sometimes it's a massive move but a sentence just can't tell you want you really need to know with enough accuracy. The charts are far more accurate than the narratives can ever be. Then there's all the things about company reporting, some talking head shill might say "oh profits have been strong last quarter" but the actual financial reporting might tell an entirely different story. If you are going to invest in something you should know where to look for company financial reports so that you can read them for yourself and decide if everything is above board. Keep in mind an especially well paid and skilled industry of "Public relations" professionals exist to sell spin for companies, digging into the data yourself is a great way to get past some of this damaging influence.
- Learn what money itself is. This is not straightforward in the modern world and many people have very flawed ideas about how the modern monetary system works. If you don't have a solid understanding of what money is then you literally have no hope of understanding how things work on a deeper level. I have a series of posts on here about monetary policy where I try to get into some more detail about this, I've learned a lot in the process of studying these things and 10 years ago I think it would be safe to say I had not just an uninformed idea about money I had an outright incorrect mental model of some of the details of how the modern monetary system worked.
- Learn the basics of game theory, this is crucial to having a deeper understanding of how the markets really work.
- Learn about the structures and rules of the various markets, the details matter a lot3. Have you ever bought a product and then read the terms and conditions to realize that you actually got a shit deal? Financial products are just like many other products, read the product disclosure statements and terms and conditions carefully. Things are not always as they seem on the surface and the details can literally make or break an investment position.
- Learn about the incentive structures of market participants. Why are people making trades? What is advantageous for different groups with different positions? What do people stand to gain and lose? What options are available to market participants?4
- Learn the basics of technical analysis, remember that clip from earlier where there was that fund manger who didn't know what the stock was he was putting clients money into? He's making a technical analysis based trade here and even though he might look like an idiot/charlatan there's more to this trade than most people realize. It's easy to get caught up on how much of an idiot this guy looks like but if he's making money anyway with this little knowledge of the stock you should start asking "why?", technical analysis is very powerful when applied in the right circumstances.
- Have an open mind and intellectual curiosity, ask "why?" a lot. Don't fall into the trap of accepting simplistic narratives at face value, there's usually a lot more going on than is obvious on the surface.
- Look at things from the perspective of the other side of a trade, this practice can reveal a surprising number of insights and biases. For example, if you are looking to take on a loan or a leveraged position have a think about it from the perspective of the other party offering these loans, why are they offering a loan? What needs to be true in order for them to profitably offer this? What do they get out of it? What are the risks and benefits to the counter-party? Who even is the counter-party?
- Get a good grip on the mental game of trading while it's much easier to accept that the markets have a large number of participants that act irrationally it's harder to accept that in some circumstances you too will act irrationally. Understanding the psychology of why this happens is a crucial part of understanding the markets. The saying goes that markets can stay irrational longer than you can stay solvent, but if you stay irrational it doesn't really matter what the markets do as you'll likely not stay solvent for long.
- Have intellectual integrity. I know a lot of people at the moment are cooking the books and engaging in massive fraud but you have to avoid the temptations to be intellectually dishonest with yourself. This is an especially easy trap to fall into in a climate filled with such dishonesty but it's a very hard one to recover from. You must maintain integrity to yourself as delusion puts you on the express train to financial ruin and worse.
- Find people who you can have quality discussions of various topics with, and make sure that not everyone agrees with you. Much like the rest of life landing in a bubble of thought in finance is incredibly dangerous. If concepts are controversial you still need to be able to talk about them, consider things like the Chatam House rule to facilitate uncomfortable but crucially important discussions. For example I saw a huge bubble around certain areas of cryptocurrencies lately and a lot of people entirely wiped themselves out on Dogecoin because they lived in a hype bubble around it, people who get trapped in hype bubbles are likely going to lose large amounts of money in this most recent wave of shitcoins too. Don't fall into this trap. Echo chambers are lethal to good investing.
I suspect there's some historical cultural factors for this, since so many people involved in the industries that involve convincing people to hand their cash over to them are not the most upstanding people there's a natural aversion that people have built to talking about money. There's a default level of distrust towards people who work with money and I think this distrust is entirely warranted since without a very heavy regulatory system and constant oversight the wheels tend to always fall off in this industry. ↩
I am aware that there's laws and regulatory compliance issues that attempt to force the actions of the firm to align with some of the interests of the clients. But to say that firms are acting in the best interests of their clients because they don't fall afoul of laws related to fraud is quite the statement. ↩
The terms and conditions from various markets and brokers are huge. People got a massive slap in the face with the Gamestop situation when they logged into their brokerage accounts and found they were only allowed to sell shares and not buy them. As I was saying earlier the terms and conditions can matter a lot, and people get caught out all the time by this. We also saw this when the Hunt brothers tried to corner the silver futures market. The exchange itself, in this case the COMEX, changed the rules overnight explicitly to screw them. ↩
Say you have a hedge fund position with multiple billions of dollars under management and you are looking for investments that you can make for the firm. Perhaps you spot a company that's offers a really great ROI and the stock is majorly underpriced but the market cap is small. You can't easily invest in that position because pushing a large amount into that stock will move the price of that stock a lot. You can invest a smaller amount or try to build a position over time but that's about all you can do. By contrast the returns on something like the SPY might be a lot lot worse but you can establish the entire position in something like this a whole lot easier. This factor is a big one for any firms that have a large amount of assets under management. This then also tends to shift the narratives about why people invest in things, you'll notice a lot of fund managers (especially large ones) talking about how the big ETFs are such a great vehicle for investments when in reality they are saying "the ETFs are a great vehicle for us to invest in". While this is subtle it's a major point, you have vastly different options based on the assets under management size you are dealing with. There are positions a smaller fund can take that bigger funds cannot and vice versa. ↩
This post is part 6 of the "MonetaryPolicy" series:
- Finally getting around to publishing some monetary policy articles
- Fast things happen slowly then quickly
- Politics of unproductive debt
- Futures markets lower prices, both in good and bad ways
- Why do stable coins matter
- Why is so much financial advice bullshit *
- Bank bail ins
- Where is money created
- Bastiat on legal systems and morality
- Transitory inflation means permanent purchasing power reduction
- Problems with Celsius
- Crypto's Lehman moment
- Crypto crash update May 2022
- The myth of the unbalanced government budget
- The 2006 debasement of NZ coinage
- Demand destruction anecdotes
- Central bank interventions and price discovery
- Luna a modern case of hyperinflation
- Collateral crisis psychology