Asset Location

Mal-location of Capital

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Asset Location

I used to play a lot of golf, probably far too much. When my friends would ask for advice, the number one question I would get is, “What kind of driver should I buy?” I suppose this was my introduction to the efficient mal-location, excuse me, allocation of capital. Like investing, throwing money at the non-issue doesn’t solve any problems, nor should it. The unfortunate truth is that allocation of both money and time is mostly wasted in golf and investing. From my personal experiences:

Golfer’s optimal allocation of capital

Golf Lessons > Golf Balls > every club except the driver > driver

Golfer’s actual allocation of capital

Driver > another driver if that one doesn’t work > every club except the driver > golf balls > golf lessons

It comes as no surprise to me that the actual allocation of resources is the opposite of the optimal allocation, mostly because the optimal allocation requires the most discipline and the willingness to do something you don’t want to do. The assumption that drives this behavior is that money spent on something tangible has an explicit yield. In reality, while services such as financial advice and golf lessons don’t have any tangible utility, they provide an invaluable albeit intangible benefit--they prevent YOU from making mistakes. Why someone would opt to forgo the chance to solve the real problem, which offers the most potential for improvement, to waste money on the most substitutable piece of the puzzle, is beyond me.

As Benjamin Graham said, “The investor’s chief problem- and even his worst enemy- is likely to be himself.”1 The behavioral component of investing is just as likely to negatively impact investor returns, if not more so, than the actual investments themselves. Even investors who own funds with good performance can find their actual returns to be severely lagging the investment’s return due to behavioral mistakes. A recent Dalbar study  and episode compares the average investor’s return compared to that of market indexes; the former woefully lags the latter, unfortunately. Education is the antidote to the destructive behavioral tendencies experienced by most investors.

Many of these investors will throw good money after bad by purchasing expensive actively-managed mutual funds that they hope will capture all of the upside while protecting them from a down market. Others will make the same mistakes time after time. It’s analogous to purchasing driver after driver thinking that it is going to make you a better golfer. Tiger Woods takes golf lessons and pays a handsome sum of money to have his caddie give him advice on the course. In fact, Tiger Woods’ caddie (earning 10% of tournament winnings) would have made over $1 million in 2005, enough money to finish 70th on the PGA Tour ® money list by himself. That would have been enough to earn his own PGA tour card for the 2006 season had he been swinging the club. Is it more likely that Woods paid his caddie big bucks because $1 million is the going rate for raking bunkers and replacing divots, or that even for the best in the world, great advice can be extremely valuable, especially when you need it the most?

A golfer who can minimize his mistakes during the round is most likely to post the lowest score. While he may not make as many birdies, he knows that his score at the end of the day will be the envy of his fellow players. This is directly analogous to taking a guided passive approach to investing. While a well-advised passive investor may forgo the possibility of owning the single investment with the highest return, the returns that she will receive over the long term are likely to be superior to the returns received by the vast majority of investors.

1Benjamin Graham, The Intelligent Investor, A Book of Practical Counsel, 1949