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Rising Above the Noise

Investing Behavioral

Some investment professionals work hard to make their work confusing. They believe they have a vested interest in creating investor confusion. They use jargon that can intimidate and make it difficult for you to understand relatively straightforward concepts. 

But investing is actually not that complicated. It can be broken down into two major beliefs: 

  • You believe in the ability to make superior security selections, or you don’t. 
  • You believe in the ability to time markets, or you don’t. 

Let’s explore which investors have which belief systems and where you should be with your own beliefs.

Exhibit 1 classifies people according to how they make investing decisions. Quadrant one is the noise quadrant. It’s composed of investors who believe in both market timing and superior investment selection. They think that they (or their favorite financial guru) can consistently uncover mispriced investments that will deliver market-beating returns. In addition, they believe it’s possible to identify the mispricing of entire market segments and predict when they will turn up or down. The reality is that the vast majority of these methods fail to even match the market, let alone beat it. 

Unfortunately, most of the public is in this quadrant because the media play into this thinking as they try to sell newspapers, magazines and television shows. For the media, it’s all about getting you to return to them time and time again. 

Quadrant two is the conventional wisdom quadrant. It includes most of the financial services industry. Most investment professionals have the experience to know they can’t predict broad market swings with any degree of accuracy. They know that making incorrect predictions usually means losing clients. However, they believe there are thousands of market analysts and portfolio managers with MBAs and high-tech information systems who can find undervalued securities and add value for their clients. Of course, it’s the American dream to believe that if you’re bright enough and work hard enough, you will be successful in a competitive environment. 

Unfortunately, as un-American as it seems, in an efficient capital market this methodology adds no value, on average. While there are ongoing debates about the efficiency of markets, most economists believe that, fundamentally, capital markets work.

Quadrant three is the tactical asset allocation quadrant. Investors in this quadrant somehow believe that, even though individual securities are priced efficiently, they (and only they) can see broad mispricing in entire market sectors. They think they can add value by buying when a market is undervalued, waiting until other investors finally recognize their mistake and selling when the market is fairly valued once again. We believe that it’s inconsistent to think that individual securities are priced fairly but that the overall market, which is an aggregate of the fairly priced individual securities, is not. No prudent investors are found in this quadrant.

Quadrant four is the information quadrant. This is where most of the academic community resides, along with many institutional investors. Investors in this quadrant dispassionately research what works and then follow a rational course of action based on empirical evidence. Academic studies indicate that investments in the other three quadrants, on average, do no better than the market after fees, transactions costs and taxes. Because of their lower costs, passive investments—those in quadrant four—have higher returns on average than the other types of investments.[1]  

Our goal is to help investors make smart decisions about their money so that they are firmly in place in quadrant four. To accomplish this, we help investors move from the noise quadrant to the information quadrant. We believe this is where you should be to maximize the probability of achieving all your financial goals.

Over the next several weeks, we'll be exploring the five key concepts institutional investors use to develop their investment plans, and how we employ these same concepts to help our clients achieve financial success and avoid being distracted by the noise.

Questions about our investment philosophy? Please call our office or contact us here to schedule a time to discuss further.


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[1] Michael C. Jensen, “The Performance of Mutual Funds in the Period 1945–1964,” Journal of Finance, May 1968.
Mark M. Carhart, Jennifer N. Carpenter, Anthony W. Lynch and David K. Musto, “Mutual Fund Survivorship,” unpublished manuscript, September 12, 2000.
Christopher R. Blake, Edwin J. Elton and Martin J. Gruber, “The Performance of Bond Mutual Funds,” The Journal of Business, 1993: 66, 371–403.
Edwin J. Elton, Martin J. Gruber, Sanjiv Das and Matt Hlavka, “Efficiency with Costly Information: A Reinterpretation of Evidence from Managed Portfolios,” The Review of Financial Studies, 1993: 6, 1–22.