Don’t Become Shark Bait
Do you have what it takes to be Wall Street’s next victim? If you consider yourself to be smarter than the next investor due to your social status, education or success in an unrelated career, then watch out because you’re going to be eaten by sharks.
How do you avoid becoming shark bait? Recognize the weakness that you’re prone to and overcome it. I believe a diehard trust in low-cost Index fund investing helps keep the sharks away.
Hubris is an over-confident attitude that attracts the sellers of high-cost investment products the same way blood attracts sharks. Wall Street’s finest circle to feast on high-net-worth investors who believe their elevated social status, elite college education, or extraordinary career success somehow entitles them to extraordinary returns in the financial markets.
Unfortunately, this attitude is easily spotted by experienced Wall Street salespeople and is taken full advantage of. Remember Bernie Madoff? He was a master at selling to people who suffered from the “entitlement effect.”
I define the “entitlement effect” as the belief that obtaining superiority in one aspect of life entitles a person to superior investment returns in the public markets. This belief could have been formed from having extraordinary success in business, graduating summa cum laude from an Ivy League college, completing medical school early, hitting a baseball better than anyone else, or just being born into the right family. Whatever the reason for the belief, the “entitlement effect” is an attitude that often leads people into shark-infested waters where they are sold the wrong investments for the wrong reason.
Most of the supposedly superior investments that are sold to the elite are no better — and often much worse — than buying a portfolio of index funds. Carl Richards, writing for the NY Times, attempted to isolate why this occurs. In The Appeal of Investments That Cost More and Return Less, Richard observes that once an investor has a big pile of money, the way they invest becomes complicated, and the more complicated, secretive and exclusive it is, the better it is (at least according to Wall Street).
The entitlement effect isn’t confined to individuals; institutional investors suffer also. Hundreds of college endowments attempt to follow the Yale Model because they believe their investment committees are every bit as smart as the Yale investment committee. Yet, most college endowments perform well below that of a simple portfolio of index funds. See my 2012 analysis, The Curse of the Yale Model, and a 2013 follow-up article, More Unconventional Failure.
A simple portfolio of low-cost index funds often provides better results than what the “entitlement effect” generates. Thus, I ask the same question that Richards asked in his article, “Why, despite this body of evidence and our experience to the contrary, do people think that once you have a bunch of money you’ve somehow outgrown the simple, low-cost investment tools that most academics think you should use, like broadly diversified index funds and basic, safe fixed-income instruments?”
The answer is this – it’s a character flaw. So, if you believe that you are entitled to earn higher returns because you’re______(fill in the blank), then you need to be extra careful not to fall into the trap of entitlement thinking. The markets don’t care where you went to college or how much you sold your business for. You’re not special even though people selling you investments tell you (repeatedly) that you are – and then they laugh all the way to the bank with your money.
Success in one field does not entitle anyone to success in the financial markets, regardless of what Wall Street wants you to believe. If you are truly a superior investor, you’ll get out of the shark tank and put your money in a simple portfolio of index funds and get the returns that you are entitled to.