Always Go with Simple

Karl Cheong now says that to stay relevant the investment industry needs to meet investors where they are. But the industry’s job isn’t to follow investors. It’s to lead them.

And leading isn’t about lecturing or pretending demand doesn’t exist. It’s about making sure investors know what they’re doing and why they’re doing it.

Now I agree with Cheong when he says disagreement sharpens the conversation and the rise of single-stock ETFs deserves scrutiny. But that’s about all I agree with because all three of his counterarguments flatter and placate the behavioural biases so many investors fall victim to.

“Investors should focus on total return (income plus changes in value) rather than yield alone.” That’s from Ninepoint’s website. All investors should prefer terminal wealth maximization over cash flow because it’s all the same pool of capital. If you want a well full of water, it doesn’t matter if it snows or rains. Mental accounting is a cognitive error. And $3 of dividend income (or option selling income) on $100 is the same as $100 growing to $103. It doesn’t matter how you frame it.

On taxes, dividend income can be tax-preferred but with limited control. Capital gains from covered call ETFs are tax-preferred but provide limited control – you get the income when the ETF provider issues it. Capital gains from selling shares are tax-preferred and provide total control – you decide when to sell.

Sequence of returns risk is real. It’s one of the most important risks for retirees to consider, especially for investors prone to loss-aversion. But how does an investment product with no protected downside help? There are two simple methods to minimize sequence of returns risk. First, lower the investment portfolio’s expected standard deviation (and expected returns) by adding cash, GICs, or short-term bonds. Many advisors call this a war chest, cash wedge, or bucket strategy. Draw income from the war chest during bad market environments, otherwise draw from the equities. Second, use a dynamic withdrawal strategy. If the portfolio drops to a certain level, decrease the withdrawal amounts until markets recover.

Yes, unregulated markets exist too. And yes, the incorrect use of margin accounts, option strategies, or crypto products can be destructive. But just because an investment product is fully regulated doesn’t make it appropriate or suitable for investors.

Full credit to Cheong for commenting on my gross oversimplification of how leverage is used in his products. I accept that critique.

But lead investors not to temptation. Lead them to simplification. It’s not always easy. But it works.