Working with, and now also writing about, investing stuff necessarily exposed me to things that I do not understand. Not because they are complicated (there are but they are not the topic of this post) but because they are stupid. At least for me.
As Matt Sperling would say, “I am sick of it“.
So here is my, definitely not comprehensive, list of dumb things investors do.
Investing in Dumb Indexes like the Nasdaq-100 ($QQQ)
I was in my early 20s when the dot.com bubble peaked. Internet was…well, obviously…spreading but it wasn’t yet mainstream so the main source for news was the old-fashion TV. And they were in love with this new “tech index”, the Nasdaq. Soon enough, every national stock exchange in Europe had their own version of the Nasdaq, an ad-hoc exchange, under the main exchange umbrella, where tech companies could list with reduced requirements compared to the standard listing.
Yes, here comes the boring part. The one 99% of retail investors (and 98% of professional ones) do not pay attention to because…investing is supposed to be fun and exciting. Who wants to deal with boring shit? Can you point me to the moment in the Wolf of Wall Street movie where Leo DiCaprio is reading a contract (no, not the fine print, just A contract)?
Companies do IPOs (list their shares on a stock exchange) to get funds; funding through selling shares is very cheap, because there is no fixed interest attached to shares and the capital firms raise is permanent, no fixed maturity to repay it. Well, it is cheap based on these elements, let’s put it like this and do not get over-complicated.
Exchanges like the Nasdaq are for-profit entities, they provide a service to make a profit. That’s it. The business of publishing an index is also very lucrative. Some index providers like Standard and Poor’s are not in the exchange business, and others are, like the Nasdaq.
The fact that the Nasdaq index, particularly the Nasdaq 100, became the World’s shortcut to “tech stocks” is great for the Nasdaq, the for-profit entity, because it is free marketing, and free advertising. Companies want to list on the Nasdaq exchange because the Nasdaq index is popular and therefore liquid, so the cost of funding for companies listed on the Nasdaq is cheaper.
Nasdaq-the-exchange does not care if the company which wants to use its exchange services is a tech company or not, the fee they get for their exchange services is the same. The more, the merrier. Non-tech companies can profit from Nasdaq liquidity as tech companies do, especially if they are added to the main index, the Nasdaq 100. Indeed, the Nasdaq prevents OLNY financials to be included in their Nasdaq 100 index; all the rest is legit.
As of today, c40% of the Nasdaq 100 is non-tech: this percentage depends on how you define things. For example, Amazon and AirBnb are considered Consumer Discretionary, according to the company-I-do-not-want-to-check that provides this classification; but I think no one would consider Baker Hughes or Dollar Tree as tech companies for sure.
There are also many, many, big tech companies that are not included in the Nasdaq 100: Spotify, Shopify, Alibaba, Tencent…you name it. Why? Because you can be part of Nasdaq-the-index only if you do business with Nasdaq-the-exchange.
I hope by now you understand where I am going: investors buy the $QQQ because they want to have exposure to the tech sector, and they believe they do, while what they get is driven by a very different logic, and a little bit by chance, a little bit by design, what they get is closer to what they want to have.
At this point you might expect me to suggest you a better alternative to $QQQ but…what the fu&* is tech anyway? If Amazon spin-off AWS tomorrow, would be Amazon still tech? What if this AWS-less Amazon incubates the next AWS? What if Coca-Cola will, with its venture arm?
There are plenty of tech indexes out there, with their related ETFs, pick the one that you like but be sure to read their rules before you do it. And be mindful that what you consider tech today might change tomorrow, as the index provider idea. I would definitely suggest a pure index play rather than the Nasdaq concoction of an index provider that is also an exchange.
At least, there is no big ETF that follows the DOW (innit?!?).
Investing in National Indexes
This one is a close relative to the Nasdaq example.
I would not spend much time on the home country bias, you probably already know why it is bad and you would still do it anyway. The aspect that is at least equally puzzling for me is investors that pick their home country index because they want a…link? to the place where they live and, as an added benefit?, to avoid currency exposure, the FX risk.
This practice is so ingrained that even the smart guys at Monevator.com run their Slow-And-Steady model portfolio with a 20% exposure to UK equities whereas the MSCI World Index only allocates 4.24% to the crazy island & occupied territories.
As the FT put it some weeks ago about companies that are avoiding listing in London, the reason to choose an exchange (or a country) over another are: deeper capital pools, a more engaged investor base and a government that is building infrastructure rather than imploding periodically. ARM, the chip design giant that is headquartered in Cambridge, is the latest example of a firm that decided to do its IPO on the NYSE and not on LSE (hint, SE means Stock Exchange, you can figure out the rest ;)). If you prefer another case “closer to home” Prada, a company so linked to Milan that has the bloody name as an integral part of its brand, in 2011 choose Hong Kong to do its IPO. Why? Because Asia is where demand was for Prada. It is just a matter of cheap financing.
If you think that investing in the FTSE-100 would provide you a sort of a hedge for you planned or current retirement in the UK, brace yourself for a surprise. The theory, at least the way I understood it, is that you want to anchor your portfolio returns to the ‘economic growth’ of your ‘surroundings’. If the UK economy grows, you want to participate in that growth so that your wealth stays more or less in line relative to the people around you. It makes sense, from a behavioural point of view…you want to keep up with the Joneses, innit?
In reality, the relationship between GDP and stock market growth is a mess:
You would expect those points to hover around one diagonal, from bottom-left to top-right, but they are all over the place. This is because too many factors influence the relationship between a country’s economy and its stock market: how open is the local economy, how interconnected is the global economy and, as I already said, where companies decide to list. And all those factors can change tomorrow. The graph I attached also highlights how much of a difference a single year can make, given that stock prices are way more volatile than GDP figures (remember, it might be more stable in the long-term…but you will be dead in the long-term).
I agree that investing in a global index built on market-cap is not the best but I consider it better than spinning the wheel and choosing a random correlation between your national index and its GDP.
For a similar reason, I think is dumb choosing to invest in the FTSE instead of a global index to avoid currency volatility. The biggest companies in any national index are multinationals (except maybe in China), and their profit exposure to currencies other than the one of the place where they are listed is affected by: the currency mix of their revenues, the currency mix of their costs and their FX hedging policy. It is not uncommon for multinationals, even when they are HQed and listed outside the US, to use the USD as their functional currency.
In short, you think you are avoiding currency exposure whereas you might get a ton of it anyway. The FTSE gains in the last few years were driven by the post-Brexit weak GBP and the fact that its main components have revenues in EUR and USD. If they hedged those revenues, as FX volatility-averse investors would have preferred, FTSE performance would have been different (worse).
Investing in High Dividend stocks
This is so bad I do not even know where to begin. Probably the sad part is that investors’ dividend obsession started for a good reason: as a shortcut to select sound investments. But:
- High dividend-paying companies are simply a bad proxy for the value factor. It is 2023, if you want to focus on value, there are plenty of products designed for that, use them.
- Dividends are very tax inefficient. To pay a dividend, a firm has to first make a profit, on which it pays taxes. Then it might pay taxes on the dividend payment (withholding tax) and then the investor pay taxes on the dividend as income. Market participants realised that stocks’ buyback programs (the one where stocks are cancelled, not when they are used as an alternative remuneration for employees) are EXACTLY the same as dividend payments but save at least one round of taxes. As a signal, investors should focus on Shareholder Yield, dividend plus buyback flows.
- Investors can create their own dividends by simply selling shares of the firm that would have otherwise initiated the cash flow. This way, they might be liable for a capital gain tax but usually CGs are taxed at a lower level compared to income. In a world of 0-fee brokers, investors do not even have a reason to complain that selling shares would generate transaction costs.
The most egregiously stupid dividend stans are the ones that take the dividend and immediately reinvest it in the same instrument that paid it, being a single stock or an ETF. I mean, grow up and find a different hobby than reading your broker statement.
Buying shares in the company you work for
Some employees have the opportunity to buy shares of the company they work for at a discount. Like the Resistance approaching the ‘new’ Death Star in Star Wars VI, what looks like a great opportunity is instead a trap. But in this case, instead of a bunch of funny furry creatures, there is me coming to help you.
99% of those employees have already their financial future linked to their employer’s fate: it pays their salaries and the participation in the company upside is granted with bonuses (ok, only for those who get them). Why should anyone do a double-up and risk as well their savings on the same horse?
Obviously if the employee could immediately sell those shares and realise a gain, I would not see any issue. But these programs come with substantial lock-up periods, three or more years. Think in terms of risk and returns. If things go well for your employer, you would have plenty of chances to profit: salary increases, bonuses, internal job opportunities. The rising tide will bring up everyone (and if it does not, it is simply time to change boat, you will have a great name on your cv to show around). Your stock gains would be icing on the cake…but I bet the under on the fact that you will be the next Microsoft secretary-like newly minted millionaire. The only life changing event is the reverse, if shit hits the fan. In that case you will lose your salary AND your savings…but with a 30% or whatever discount.
Once I tried to build an option strategy overlay to monetise immediately the discount on those shares, only to be immediately stop by the Compliance Office: as an insider, I could not touch any financial instrument related to my employer at the time. Talking about insiders, if you think that you can make money because you know from the inside how your employer is doing…you probably do not. But if you are really convinced so, consider how many things happened in the last three years that affected your employer without being about your employer.
I know I am in the minority here. I cannot count how many times I was surrounded by colleagues gloating about how many shares they were holding..or even worse, cheering like the company dividend payment date was their second birthday.
Judging an asset class/investment by its own and not in the context of a portfolio
I wrote a lengthy post about this more than a year ago, in case you want to dig deeper. This practice is common among retail AND professional investors, something that constantly amazes me.
“If you do not have something in your portfolio that makes you puke, you are not diversified enough”. I do not know who said it but it is true. If you want to build a resilient portfolio of financial assets, you have to include assets that are, in the best scenario, inversely correlated: this means you will always have something that is down and/or underperforming BY DESIGN.
While it is pretty easy to assemble a bunch of investments that are up together sometimes, the hard part is to find assets that are up when the rest of the world is in a meltdown…and do not cost you an arm and a leg in any other scenario.
Since financial markets spend most of the time in an uptrend (“take the stairs up and the elevator down“), the above assets relentlessly, or it feels like it, challenge your decision-making process: why are you allocating part of your capital to this shit when that growth stock/crypto was obviously a winner? Why are you losing money on purpose?
I spent the last five years designing Strategic Asset Allocation portfolios and I still have to meet someone that did not ask me, on a quarterly basis, “ok, let’s look at the portfolio on a line-by-line basis”. The next, almost inevitable step, is the finger-pointing at the worst performing asset and a request for explanations. A few considerations about the portfolio in its entirety might follow. I never heard the most appropriate question: is the portfolio performing as expected, given the current circumstances?
This is a known phenomenon in the industry. An increasingly number of asset managers are bundling assets together into a single fund so that clients have only one line to look at; lower tracking error compared to the assets the client’s golf club friends hold. This is not great because it forces expert trend following managers, for example, to add stock-beta allocations that would be better managed by someone that does that as their primary job, like Vanguard. It forces them to design strategies optimised to lower the risk that the client would fire them instead of maximising risk-adjusted returns or the Sharpe ratio.
It is the forest and the trees all the way down. “Resulting” is a powerful force, it is hard to mentally reconstruct the relationships and the roles of the assets in a portfolio, it is even harder to evaluate them in the context of what could have been and did not happen. But that’s what you should look at, the portfolio and how it is performing relative to your initial goals.
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