I am sure everyone knows K.I.S.S. by now. Probably one of the best acronyms ever created and yet it still remains a mystery to me, why investors tend to ignore it.
Keep It Simple Stupid. For as long as I have been in the business, I have tried to live by these four words. Do not create confusion, make it simple, and get to the point.
Over the decades, one thing has become abundantly clear to me. The more complicated the investment scenario, the more chances for things to go wrong. With the possibility of failure increasing (with the level of complexity), why put your hard earned money to work there. I do understand that if these complex strategies work, the rewards are substantially higher but still, how do you explain, to the people that count on you, what happened if they fail?
My general rule of thumb is if that a reasonably intelligent college junior can understand it, then you can go ahead and invest. The reasoning is this, no one cares how you got rich when you hit it. They just want to share in the spoils. It’s when things fail that you need to give a good explanation and hopefully, everyone involved will learn something from this failure.
Keeping it simple is just that, invest in things you understand. Stepping out of your comfort zone for a portion of your assets is ok but even when you do that, I believe it’s safer to learn about this new, riskier investment.
You don’t have to tell me how boring this sounds. Risk takers are what has made this country great. I get that and I think there are places for that risk but your investment future is not one of them.
A prime example of taking risks and not truly understanding the risks involved was this past Gamestop rally and fall. I am pretty sure that most of the investors in that little scenario really had no clue about all of the underpinnings of that story. They heard on some Sub-Reddit about the run on Gamestop’s stock and wanted a piece of that move. Some made money, some lost money but I am pretty sure neither knew much about the causation. Dumb luck and fast fingers may have helped but at the end of the day, it turned into a fiasco.
Another example, let’s look at the financial crisis in 2008. Without Michael Lewis doing an extraordinary job of explaining it, I doubt there were 100 people in this country who truly understood the complexities and dangers of this CMO market. Lots of people knew a little, but few knew the full scope. When the Chairman of one of the largest banks in the World comes out and says that he really did not understand the risk his bank was taking, that tells you something.
Financial history is littered with stories like this and they always seem to end up in disaster because these products and ideas only take in certain scenarios and ignore scenarios they deem statistically improbable. Instead of planning for “Whatever could go wrong, will go wrong”, they create investments that work best under ideal conditions. And as we have painfully learned, “Ideal conditions” are not permanent and things always fall apart when there is poor preparation for “poor conditions”.
I do understand that taking a more simplistic approach to investing leads to lower returns and there are models that show having riskier assets as part of an overall investment portfolio may produce better results over the long term. My point is that understanding where your money is going to work is fundamental to being successful. Doing a deep dive into potential investments and learning about those investments is critical to success and peace of mind. If after doing that deep dive, you still don’t understand it, stay away. Critical failure is mostly from lack of understanding.