Book Review: DIY Financial Advisor
“Life is not complex. We are complex. Life is simple and the simple thing is the right thing.” — Oscar Wilde
“ . . . there is always a well-known solution to every human problem — neat, plausible, and wrong.” — Henry Louis “H. L.” Mencken
Before proceeding with this review, I should confess two personal biases: First, I’m a fan of Wesley Gray’s work. His background as an academic turned practitioner puts him in a unique position to examine the sacred cows of both the investment industry and academia under the harsh light of data — decades of it from markets around the world. Some cows don’t make it, including one of my favorites.
Second, as a CFA charterholder who has suffered through the required hundreds of hours of study, I am wired to regard simple investment formulas with more than a grain of salt. Surely, my training was not a waste?
DIY Financial Advisor: A Simple Solution to Build and Protect Your Wealth is an ode to simplicity. The book is structured in two parts. The first, “Why You Can Beat the Experts,” is a quick primer on behavioral economics. It reviews studies comparing decisions made by experts to those made by simple quantitative models in a variety of fields (models win). This content is necessary for the narrative of the book, and is well written enough, but I prefer the originals, most notably Thinking, Fast and Slow by Daniel Kahneman, which is apparently now required to be quoted in every new investment book.
The second part, “How You Can Beat the Experts,” is where the practical advice comes in, and it is fascinating. In the space of 122 pages, the authors present concrete prescriptions for selecting advisers and investment vehicles, allocating across asset classes, managing portfolio risk (market timing), and selecting securities! The models are all simple and accompanied by a quantitative “debunking” of their more elaborate and complex alternatives.
In short, I found the presentation and logic quite appealing. For example, in the asset allocation section, the authors present compelling evidence that fancy weighting schemes, such as risk parity or modern portfolio theory, often fare no better in practice (out of sample) than simple, equally weighted portfolios. In the security selection section, DIY Financial Advisor proposes a portfolio which capitalizes on the two asset-pricing phenomena most well-studied and confirmed by academia: Value and Momentum. The recommendations are, by and large, sound and consistent with my training and experience. Much of this advice can be deployed by individual investors and should lead to perfectly satisfactory results. That is quite an accomplishment for 122 pages, and the authors deserve considerable credit for their effort.
Having said this, a few details do get “lost” in the translation from academic literature to practical counsel. For example, the authors recommend a “momentum” strategy for part of the portfolio. This strategy selects individual securities and rebalances every month. That level of turnover incurs substantial transaction costs — the authors estimate them at 2.4% per year — but the costs are not deducted from the backtest. All backtests in the book are presented gross of transaction costs, but the integration of exchange-trade fund (ETF) and individually-selected stock portfolios is misleading because the latter (including the momentum strategy) are orders of magnitude more expensive to implement. Readers seeking to match backtest results will be particularly disappointed with the momentum part of the portfolio.
Another more problematic example gets at the limitations of formula investing: In the asset-allocation section, the authors begin by reverently examining Yale’s target allocations for its endowment for 2015. Yale targeted 5% in bonds and cash. In the final chapter, the authors recommend 20% of the portfolio be allocated to short-term bonds. What is missing is a reconciliation or at least some discussion of the difference between the two figures: Why should I allocate 20% to Treasuries when Yale is allocating 5%? Interest rates have been dropping for decades and are at all-time lows. Does this increase or decrease expected returns for bonds moving forward? Is this a factor I should consider for asset allocation or should I rely on backtests covering those same decades?
I don’t claim to have an authoritative answer to the question above, but I think it does reveals a limitation of formula-based investing: A formula derived from multi-decade backtests cannot, by definition, consider current market conditions, which render some securities much more expensive — and less attractive — than others. The future will most assuredly not be like the past.
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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.