The libertarian paternalism of a nudge culture in finance has created an industry of investors who care about fees but have forgotten about taxes, trading costs, slippage and behavioral costs of actively trading passive instruments.
Benjamin Graham famously said that the market is a voting machine in the short run, and a weighing machine in the long run. This is a right-sounding idea. It is also wrong. Behavior matters over every horizon.
Diversification is clearly one of the things that matter. Unfortunately, most investors pursue the meme of diversification! instead of the real thing, and end up with a false sense of security and inefficiency.
Part 1 of this note highlighted the supremacy of the risk decision in portfolio construction. In this follow-up, Rusty observes that many investors may be assuming that the natural risk of asset classes is “right” for them.
Of all the decisions you make as an investor, how much risk you take outweighs all of them. It is more important than costs, more important than diversification, more important than picking the right stock / fund / investment.
For the bored (read: profitable) investor, the bias to action is a constant threat. As we become more passive in our strategies, the moral license to ‘do something’ is exaggerated, and must be curtailed.