Too Much Complexity Isn’t a Good Thing

A year ago, I began including doodles with my weekly commentary. The first one was a sketch discussing the impact of changes in earnings forecasts on stock prices. The purpose was to visually highlight and graphically explain one of the points I was making. Being a writer who thinks in terms of communicating by text instead of graphics, coming up with doodles has been challenging at times.

Part of the challenge has been converting the inherent complexity of investing and personal finance into a graphic that I could actually draw. Both investing and personal finance are based on accounting rules, advanced mathematical equations, economic theories, psychology, regulations and law. Our job at AAII is to convey all of this in a manner that those of you without financial degrees or high levels of expertise can understand. In doing so, we regularly give thought to how we present information both in terms of text and through graphics.

Making use of graphics is more than just about including doodles in a weekly email. We want to ensure that concepts and strategies are explained in a manner someone else can understand. For some people, this means a well-written article. Others prefer a good infographic. Still others prefer presentations—either in-person or via the Web. Regardless of the outlet, properly explaining key and potentially complex concepts is the goal.

In the world of investing, this is no small thing. There are so-called financial advisers who pitch strategies and investment products they themselves do not fully understand. There are also investors who follow strategies and buy securities, funds, annuities or even life insurance policies that they don’t fully understand. Both scenarios increase the risks of something going wrong.

If you don’t understand the characteristics of an investment or how a strategy works, you’re likely not going to be able to differentiate between when your timing is simply off (e.g., small-cap value is simply out of favor) and when things are actually going horribly wrong. You will also expose yourself to unexpected volatility, costs and/or an inability to get your money out when you want to. A very large gap exists between too much complexity and a person’s ability to stick with a strategy.

At the same time, if an adviser doesn’t fully understand the investment or strategy, his or her clients will be put at risk. This is why the best thing you can do when working with an adviser is to ask questions, and keep asking questions until you fully understand what’s being pitched. If you don’t get satisfactory answers, grip your wallet tightly and walk out the door.

It can also be a good exercise to try and explain your investing strategy to someone else. See if you can do it in a short period of time. If this proves to be a difficult task, it may be that your strategy is too complicated. Alternatively, it may be that your spouse, adult child or whoever you are counting on to step in and manage your finances on your behalf cannot replicate what you are doing. In either case, a simpler strategy is needed or at least a simpler plan B that can be reverted to.

Complexity itself is not inherently bad. Some complexity can help you invest better. Examples would be concepts such as portfolio allocation, financial statement analysis, screening and retirement withdrawals. The common ground between seeking simplicity and accepting some complexity is the point at which you understand the concepts well enough to apply in them in an ongoing manner and are able to explain those concepts to others. This is where self-awareness really has big benefits. Knowing the limits of your knowledge, your willingness to deal with complexity and the amount of effort you want to put into investing can very much help you select a strategy you’ll be able to follow no matter how the market performs.