It's Complicated

Bill Parrott |

Complicated investment strategies attract attention because investors want to get rich quickly or impress their friends. Complexity is another word for job security on Wall Street. Options and hedge fund strategies are intricate and convoluted products requiring multiple disclosures and hours of explanation to innocent investors.

My two mentors wrote covered calls and sold options for their clients, so that's what I did as well. Why not? They were successful. We sold options because option buyers lose all their money 90% to 95% of the time. When you sell option contracts, you take the other side of the trade from the buyer or speculator. If buyers lose money, then sellers make it. An option contract is complicated to understand because you must be correct on the security, direction, timing, price, and maturity all at once, and if you're not, you'll lose money. In addition, you must understand the Greeks: Delta, Gamma, Theta,  Vega, and Rho. Implied volatility is another vital component of option pricing. Regardless, investors will continue to buy options, especially in a bull market.

In 2008, Warren Buffett bet Protégé Partners that a simple S&P 500 index fund would outperform five separately managed hedge funds over ten years, and the winner would receive $1 million. How did it turn out? Protégé threw in the towel before the end of the contest date because the hedge funds were getting trounced. At the time, the index fund was up 85.4%, while the average return for the hedge funds was 22%.[1] Simple wins.

Several Nobel prize winners and Wall Street Legends founded Long Term Capital Management in 1994, and in 1998, they brought the global financial markets to their knees with their complex trading strategies. The firm relied on complicated bond arbitrage strategies, and when Russia defaulted on its debt in 1998, it destroyed the fund and required a $3.6 billion bailout from several banks.[2] Roger Lowenstein wrote an excellent book about this ordeal, When Genious Failed. In this case, the long-term time horizon was about four years. Long-term US Government bonds averaged 9.52% annually during this same period.[3] Safe and simple.

Complicated investment strategies look good on paper because they promise huge profits and outsized gains, but it's probably too good to be true. Most investors would benefit from a simple strategy of owning low-cost index funds in a diversified portfolio rather than focusing on byzantine investment strategies.

Vanguard's Balanced Index fund is simple and has performed well over time. The fund's allocation is 60% stocks and 40% bonds and has returned more than 900% for the past three decades, or about 8% annually. A $100,000 investment is now worth $1 million – not too shabby.

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To succeed as an investor, focus on simple solutions and avoid complex strategies.

Everything should be made as simple as possible, but not simpler. ~ Albert Einstein

August 3, 2023

Bill Parrott, CFP®, is the President and CEO of Parrott Wealth Management in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process so our clients can pursue a life of purpose. Our firm does not have an asset or fee minimum, and we work with anybody who needs financial help regardless of age, income, or asset level. PWM's custodian is TD Ameritrade, and our annual fee starts at .5% of your assets and drops depending on your asset level.

Note: Investments are not guaranteed and do involve risk. Your returns may differ from those posted in this blog. PWM is not a tax advisor, nor do we give tax advice. Please consult your tax advisor for items that are specific to your situation. Options involve risk and aren't suitable for every investor. Prices and yields are for today only and are subject to change without notice.






[3] Source: Dimensional Fund Advisors Returns Web, 1/1/1994 to 12/31/1998.