Perceived Value vs. Actual Value

Perceived Value vs. Actual Value

There have been studies that show that when people pay more for something, they believe the product is better.  For example, people rate wines better if they are told it is expensive.

Based on this study, the wine doesn’t actually have to be better, people just have to believe it’s better and their mind takes over from there.  In the wine example, when the isolated variable is price, people were forced to assume that the higher the price, the higher the quality, and therefore tasted better as a result.

The higher price forced people to change their expectation.  From there, thanks to confirmation bias, their expectation was fulfilled regardless of whether the wine was actually better or not.  In other words, we see what we want to see.  We tend to be just as enamored with complexity in investing.

The other day, I came across a portfolio from a prospective client that held 31 different mutual funds in a “managed account” from another firm.  I was honestly baffled as I flipped through the pages.  My immediate thought was, “In what world is 31 mutual funds necessary to achieve proper diversification?”  That’s rhetorical.  But of course, we see what we want to see.

For the moment, I won’t speculate on whether or not the 31 funds included in the portfolio were providing “revenue sharing” to the other firm, but as an FYI, it is a question that should absolutely be raised if you find that you have a portfolio with a similar number of funds.

For benefit of the doubt, let’s say that’s not the case.  Then, why the 31 funds?

Complexity sells better than simplicity.

Here are just a few reasons a firm might (unnecessarily) overcomplicate client portfolios:

  • By having 31 funds, it offers the appearance of working hard for you as a client.
  • It could make it seem intimidating as if it’s something that you can’t do on your own.
  • It’s almost too complicated to ask questions about.
  • Any one fund, no matter how poorly it’s performing, can get lost in the shuffle.
  • It could have a secondary benefit to the firm of burying the comparative benchmark because conveniently there “isn’t one” that appropriately matches their overly complicated portfolio.
    • And if you have nothing to compare it against, how can you know how your portfolio is doing?  You can’t — which is exactly what they are hoping for.

And on and on we go.  Unfortunately, this unnecessary ruse has staying power.  If it didn’t, we wouldn’t see so many “big firms” taking this very same approach.

It’s an effective subterfuge right up to the point that a client or prospective client begins to question the need for 31 mutual funds to properly diversify.

Right up to the point that a client understands that costs truly do matter.

Right up to the point that a client understands that they may have been underperforming a simpler, much less costly portfolio for quite some time without even realizing it.

I haven’t been able to locate a study on investments that shows that complexity correlates to a feeling of higher value, but I can only presume it to be true.  Otherwise, why would so many investors stick with complicated, overpriced portfolios if the perceived value wasn’t there?

Even further, why would many of the wealthiest families so often invest in some of the most complicated and expensive investments instead of just indexing?  It’s the perception of value.  It’s just not sexy enough.  I mean, surely there must be a better way than just indexing, right?

Since there are so few ways to show empirical evidence of true value, many firms stick with marketing “perceived value”.  The marketing message of many firms is designed to sound complicated and special.

One of my favorite all-time movie quotes is from The Big Short:

“Wall Street loves to use confusing terms to make you think only they can do what they do.”

It’s a truism that we inherently don’t like cheap things.  And we don’t like simple things.  We like expensive and complicated things because they have more perceived value.

The trouble is there is little to no evidence to support a narrative based, subtly promissory investment approach.  Because in reality, that’s what is being sold in these overly complicated portfolios – the sizzle.  The hope of beating the market, no matter how unlikely that may be.

Perceived Value vs. Actual Value

Unfortunately, people seek perceived value when what they should really want is actual value.  And when it comes to investing, perceived value and actual value are rarely correlated.

More Complex = More Perceived Value
Less Complex = More Actual Value

Higher Fund Expenses = More Perceived Value
Lower Fund Expenses = More Actual Value

More Trading = More Perceived Value
Less Trading = More Actual Value

“Picking the Best Funds” = More Perceived Value
Having a Strategy You Will Actually Stick With = More Actual Value

More complicated, more trading and higher fee strategies very often end up underperforming.  All the issues above labeled as “More Perceived Value” are primarily a distraction.  But it works because we’re human and therefore believe there has to be a better way.

In lieu of that idea, what if your strategy was to do all you could to minimize the possibility of underperforming the markets?  Additionally, what if your approach was simply to control the things you can control such as cost and establishing a strategy that you can stick with through all markets?  What would that do to your chances for a successful retirement?

Don’t listen to the narrative or fall for window dressing and fancy wording.  Find a firm that will tell you the pure, unvarnished truth and invests in a way that is evidence-based and fee conscious.  They should be able to describe a very clear, evidence-based approach that resonates with you.  Any advisor that tells you that they are going to identify the superior managers or are planning to “beat the market”, I’d encourage you to walk in the other direction.

Never confuse perceived value with actual value.  In the world of investment management, you often do not get what you pay for.

This begs the question:  When it comes to your overall retirement income portfolio, what are the things that can provide actual value thereby increasing your chances for a successful retirement?

  • A portfolio strategy you can have faith in to provide the income you need through all market environments.
  • Establishing an effective withdrawal strategy.
  • Tax efficiency at the fund level.
  • Structuring your portfolio to pay fewer taxes over the long run.
  • Lower fund costs.
  • Structuring your portfolio for a more tax-efficient estate transition.
  • Taking advantage of charitable giving options.
  • An investment policy statement to minimize behavioral mistakes.

This list could go on and on.  It’s my opinion that if I’ve done my job well, my clients understand exactly what’s going on within their investment portfolio and retirement plan.  An educated client that fully understands what they are doing and why they are doing it is going to be a client that will have a much more enjoyable and confident retirement.  And in the end, that can make all the difference in the world.

 

 

What I’ve Been Reading:

Medicare’s Time Bomb, in 7 Charts (politico.com)

Long Term News (collaborativefund.com)

Finding qualified workers might be the biggest right now (calculatedriskblog.com)

Some interesting thoughts on target-date funds especially applicable for retirees  (mathinvestor.org)

Manufacturing appears to be alive and well in the U.S. (aei.org)

The U.S. remains as the world’s most competitive big economy, by far (aei.org)

Wage Growth vs. The Stock Market (awealthofcommonsense.com)

 

Thanks for reading!

Ashby Daniels

 

 

Disclaimer: Any opinions are those of Ashby Daniels and not necessarily those of Raymond James.  The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete.  This material is being provided for information purposes only and is not a complete description, nor is it a recommendation.  Past performance is not a guarantee of future results.

 

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