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Comment author: devas 17 September 2014 11:10:46AM 2 points [-]

One becomes vulnerable to Ind pretending to be Coo?

Comment author: V_V 17 September 2014 12:11:57PM 3 points [-]

Exactly.

Comment author: V_V 17 September 2014 09:19:46AM 1 point [-]

Pointing out the obvious failure mode of this strategy left as an exercise for the reader .

Comment author: ColbyDavis 16 September 2014 06:50:02PM 1 point [-]

There's nothing I strongly disagree with with what you just said, but I think you are probably underestimating the heterogeneity of peoples' financial lives and the degree to which many people enjoy a personal touch.

Things like medicine and legal assistence need to be personalized because different people have >significantly different medical and legal issues, but investment?

Since I have started working in my current role I have been impressed with just how complex and particular an individual's financial situation can be, especially when dealing with high net worth individuals well into their career. Multiple accounts with different tax treatment, employee stock grants and options, insurance, inheritance, real estate holdings, dependents, charitable giving, trusts, required minimum distributions, loans and other financial obligations, etc. are all things I regularly encounter and deal with in considering portfolio construction. Add to this the fact that most people are very emotionally invested in and/or have ugh fields about their money and are prone to making foolish mistakes like selling at the bottom of a bear market (I've seen it from people who I know understand the efficient markets hypothesis) and you can see why there is a market for financial professionals who personally know their client and can hold them responsible to their financial goals. Not that everybody needs this, but I think younger people who have never had (or lost) a lot of money underestimate this aspect.

That said, I more or less agree with your point, and I think in a more competitive market there would be larger scale corporate consolidation in this market, along with law and medicine as well. One thing law, medicine, and finance all have in common is a system of occupational licensing and other cartelization policies in place that protect incumbents.

Betterment and WealthFront are trying to push our industry in that direction and have so far been quite successful for themselves. I would not be surprised, however, if after the next bear market their reputations take a hit when investors panic and hit the sell button when there's nobody there to talk them off the cliff. Maybe that won't happen. Time will tell.

I don't mean to imply that that all financial advisers are charlatans.

Thanks! =)

Part of the reason I got in the business I am in is because there is so much bullshit in the financial industry. I would like to try to bring a little more sanity to it, because I do think it is so important for our economy. This paper is part of my efforts to do so. I hope you appreciate it.

Comment author: V_V 16 September 2014 10:07:14PM 1 point [-]

Multiple accounts with different tax treatment, employee stock grants and options, insurance, inheritance, real estate holdings, dependents, charitable giving, trusts, required minimum distributions, loans and other financial obligations, etc. are all things I regularly encounter and deal with in considering portfolio construction. Add to this the fact that most people are very emotionally invested in and/or have ugh fields about their money and are prone to making foolish mistakes like selling at the bottom of a bear market (I've seen it from people who I know understand the efficient markets hypothesis) and you can see why there is a market for financial professionals who personally know their client and can hold them responsible to their financial goals.

I see. It is certainly possible that I tend to underestimate the complexity of this industry due to my lack of expertise.

Part of the reason I got in the business I am in is because there is so much bullshit in the financial industry. I would like to try to bring a little more sanity to it, because I do think it is so important for our economy. This paper is part of my efforts to do so. I hope you appreciate it.

It is difficult for me to evaluate your paper. Anyway, good luck!

Comment author: ColbyDavis 16 September 2014 12:08:20AM 3 points [-]

The age of the advisor matters not because of the skills he is or is not able to transfer to employees but because it may effect whether he wants to bring you on as a client in the first place. Most wealth management practices are owned by a single advisor or a small number of partners who are more concerned about maintaining their lifestyle than ensuring that their firm remains competitive in perpetuity. If a 55 year old advisor has an established practice working mostly with clients about her age who she likes, she is unlikely to take on a 25 year old from a different culture with few current assets just because the client can be expected to have a sizable portfolio after the advisor has already retired, even if doing so may theoretically increase the NPV of her firm. This is fairly common of private practice type industries like dentistry and law. Business owners are humans who like to form tribes, even if it means not being maximally efficient.

Comment author: V_V 16 September 2014 09:59:08AM *  1 point [-]

his is fairly common of private practice type industries like dentistry and law.

Is it? I never heard of a dentist refusing to take a client because of age difference. Do you have any reference?

Anyway, I understand that while a dentist or a lawyer may be interested to short-term goals, a financial adviser should be interested more to long-term goals, which may cause an age effect. But then, why don't financial managment practices scale to large corporations, or become more like investment funds that provide standardized products?

Maybe I'm overestimating my understanding due of the Dunning–Kruger effect, but from the outside view, it looks like this industry should have substantial economies of scale, since large corporations don't have this age bias, and they can better reduce risk using asset diversification, while the benefits of having a personal financial adviser making a personalized investment plan seem small unless you are truly unusual.
I mean, even luxury items such as Rolex watches and Ferrari cars are more or less standardized products made by corporations. Even if you are very wealthy you are most likely not going to hire a personal engineering team to make and maintain your own fancy car.
Things like medicine and legal assistence need to be personalized because different people have significantly different medical and legal issues, but investment?

I can't help but notice that proven investment strategies (index investment) are usually provided by large corporations like Vanguard, while more speculative investment strategies that promise to outperform index investment are provided by small-scale firms operating according a business model which, will all due respect, reminds me of tarot readers.

I don't mean to imply that that all financial advisers are charlatans. There are obviously lots of incompetent investors and advisers who consistently underperform index funds and a few highly competent investors and advisers who consistently overperforms index funds, probably by taking value from these incompetent investors. Finding the latter while avoding the former looks like a non-trivial problem.

Comment author: ColbyDavis 15 September 2014 06:05:06PM 2 points [-]

That sounds like usual risk aversion. How is that a bias?

Loss aversion is different than risk aversion, though they are related concepts, the shape of an agent's utility function under loss aversion can lead to inconsistent preferences.

Why in recent years? Why aren't these funds more common? And since you are talking about "rebalancing" in the next >paragraph, are these funds really automatic, like index funds, or do they still require active portfolio managment?

I can only speculate as to what the average of all the millions of decisions that go into releasing an investment product and whether it gains popularity looks like. As to why in recent years, I think it mostly is a function of the rise of index strategies, the emergence of the ETF as a vehicle that is well-equipped to execute strategies like this, and the general fall in popularity of expensive, black-box, active management strategies.

Internally, these products rebalance according to some rules-based methodology. IMO the "active vs. passive" debate is a false dichotomy, the better scales to judge an investment by are "cheap" vs. "expensive" and "transparent/rules based" vs. "black box/dependent on skill." Some of the enhanced index funds are in fact cheaper than some of the "true" index funds on the market.

Externally, there is currently no such thing as target date retirement fund which tries to strategically target these factor premiums in a rules-based fashion, they are generally limited to single-asset classes and so will require some measure of asset allocation/portfolio management decision making.

I think there is a kind of "meta" risk you are not considering here: index funds are proven investment strategies, based >on empirical evidence and economic theory. The investment strategies you propose here are more uncertain. You link many studies in favor, but I don't have the expertise to evaluate their relevance, and I suppose this holds true >for pretty much anybody who isn't a professional investor. From the "outside view", the strategies you propose are inherently more risky than index fund investment.

I basically agree. And you may say the possible greater expected return from these strategies is compensation for this meta-risk. As I am quick to point out, these strategies do underperform from time to time, sometimes badly. It is during these periods that investors proclaim that "things are different now" and change course, often to their detriment. This epistemic factor can make the strategies more risky in practice.

I have laid out what I consider to be the best evidence to support my philosophy, much of it is Nobel-prize winning research (not that having Nobel laureates on your side is always profitable...) But how comfortable you feel evaluating that evidence or trusting me to present it in a fair manner is a question I can't answer for you. If you are doubtful, and I do not find that an unreasonable proposition, you would do well to use index funds and be done with it. More intrepid investors may have a different attitude.

Comment author: V_V 15 September 2014 11:02:38PM *  2 points [-]

Thanks for your extensive reply.

The message I take away is that most "normal" people, that is, financial non-experts with an average risk aversion, would probably benefit from investing in index funds.
Unusual people outside this demographic may benefit from knowing that there are some investment strategies which are claimed to yield higher risk-neutral expected returns.

Comment author: ColbyDavis 15 September 2014 08:32:30PM 2 points [-]

Vanguard may very well be better for you, and I am happy to tell people to take advantage of Vanguard if their fortunes are small or they don't want to spend a lot of time on their portfolio or hire an FA.

I want to quell the notion, however, that you're only worthwhile to a financial advisor if you have millions of dollars. The average FA is 50+ years old and so is generally more interested in how your portfolio looks right now than what it will look like in 20-30 years, but younger advisors are much more interested in the trajectory of your wealth. My firm has, and I have known other FAs who have, taken on younger clients with trivial amounts of current assets because they were dedicated to an aggressive savings plan.

Comment author: V_V 15 September 2014 10:55:04PM *  1 point [-]

The average FA is 50+ years old and so is generally more interested in how your portfolio looks right now than what it will look like in 20-30 years, but younger advisors are much more interested in the trajectory of your wealth.

Why does the age of the financial adviser matter?

A firm can be expected to professionally outlive its employees and keep providing its services to its customers after any specific employee retires or quits, provided that employees operate according to known principles and their expertise if generally transferable. That's how engineering and medicine are done, for instance.
Is financial advising some kind of non-transferable "dark art" such that advisers aren't easily replaceable? This rings some alarm bells...

Comment author: V_V 15 September 2014 03:36:42PM 1 point [-]

that losses feel bad to a greater extent than equivalent gains feel good

That sounds like usual risk aversion. How is that a bias?

The only sense in which e.g. value and momentum stocks seem genuinely “riskier” is in career risk ... but if he chooses Ol’Timer and it underperforms he is a fool and a laughingstock who wasted clients’ money on his pet theory when “everyone knew” NuTime.ly was going to win. At least if he chooses NuTime.ly and it underperforms it was a fluke that none of his peers saw coming, save for a few wingnuts who keep yammering about the arcane theories of Gene Fama and Benjamin Graham.

A financial adviser advising an individual investor that only buys few assets might have this problem, but a fund could diversificate on thousands of different assets, therefore reducing this "reputational" risk. Which brings us to the following point:

Though traditional index funds are a reasonable option, in recent years several “enhanced index” mutual fund and ETFs have been released that provide inexpensive, broad exposure to the hundreds or thousands of securities in a given asset classes while enhancing exposure to one or more of the major factor premiums discussed above such as value, profitability, or momentum. Research Affiliates, for example, licences a “fundamental index” that has been shown to provide efficient exposure to value and small-cap stocks across many markets.56 These “RAFI” indexes have been licensed to the asset management firms Charles Schwab and PowerShares to be made available through mutual funds and ETFs to the general investing public, and have generally outperformed their traditional index fund counterparts since inception.

Why in recent years? Why aren't these funds more common? And since you are talking about "rebalancing" in the next paragraph, are these funds really automatic, like index funds, or do they still require active portfolio managment?

I think there is a kind of "meta" risk you are not considering here: index funds are proven investment strategies, based on empirical evidence and economic theory. The investment strategies you propose here are more uncertain.
You link many studies in favor, but I don't have the expertise to evaluate their relevance, and I suppose this holds true for pretty much anybody who isn't a professional investor.
From the "outside view", the strategies you propose are inherently more risky than index fund investment.

One of the greatest misconceptions about finance is that investing is just a zero-sum game, that one trader’s gain is another’s loss. Nothing could be further from the truth. Economists have shown that one of the greatest predictors of a nation’s well being is its financial development.

Correlation doesn't imply causation. It is plausible that correlation actually goes in the way opposite than what you are proposing: in wealthier nations people have more disposable money to play zero-sum games with.

Comment author: IlyaShpitser 14 September 2014 07:44:00AM *  2 points [-]

but as far as I know

You need to do more reading. CDT is basically what all of statistics, econometrics, etc. standardized on now (admittedly under a different name of 'potential outcomes'), since at least the 70s. There is no single reference, since it's a huge area, but start with "Rubin-Neyman causal model." Many do not agree with Pearl on various points, but almost everyone uses potential outcomes as a starting point, and from there CDT falls right out.

The subfield of causal graphical models started with Wright's path analysis papers in the 1920s, by the way.


edit: Changed Neyman to Wright, I somehow managed to get them confused :(.

Comment author: V_V 14 September 2014 07:58:10AM 1 point [-]

This looks like an approach to model inference given the data, while CDT, in the sense the OP is talking about, is an approach to decision making given the model.

Comment author: V_V 14 September 2014 07:18:31AM *  0 points [-]

CDT is the academic standard decision theory. Economics, statistics, and philosophy all assume (or, indeed, define) that rational reasoners use causal decision theory to choose between available actions.

Reference?

I'm under the impression that Expected (Von Neumann–Morgenstern) Utility Maximization, aka Evidential Decision Theory is generally considered the ideal theory, while CDT was originally considered as an approximation used to make the computation tractable.
In 1981 Gibbard, Harper and Lewis started to argue that CDT was superior to Expected Utility Maximization (which they renamed as EDT), and their ideas were further developed by Pearl, but as far as I know, these theories are not mainstream outside the subfield of causal graphical models founded by Pearl.

Comment author: skeptical_lurker 08 September 2014 07:16:14AM 4 points [-]

Moreover, while stupid children might be protected from their stupidity by smarter parents, smart children might be harmed by stupid parents that pick bad matches for them.

Children's intelligence correlates with their parents, while their parents have more life experience, so on average parental advice ought to be fairly good.

Comment author: V_V 08 September 2014 02:18:28PM 1 point [-]

Ceteris paribus, yes, but arranged marriage systems generally entail little time for the parents to get to know the prospective spouse for their child (up to the extreme case of black-box marriage) and generally also make divorce difficult or impossible.
Overall, I think that, even if the parents interests are perfectly lined to the interests of their child, the chances of landing a bad match and getting stuck with it are higher in an arranged marriage system than in a free-choice system.

South Asia, where arranged marriages are still commonplace, with its high rates of domestic violence (India, Pakistan) and honor killings, is a piece of evidence pointing in that direction.

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