Driving a stick shift is fun.

Whether a sports car or a 4×4, driving with a manual transmission imparts a feeling of complete control of the car and a tight connection to the road (or the trail). On a beautiful empty stretch of road on a nice day with the windows and/or the top down, winding through the gears and downshifting around corners, it puts a smile on your face. Manual transmission enthusiasts can often come up with sensible and practical sounding reasons for their choice. In the case of gas mileage, their arguments even hold some water although the gap has narrowed significantly in the last 30 years. In the final analysis though, they drive a stick shift because they think it is cool, they feel in control and it makes them happy. It is mostly about emotional gratification.

But, the reason that most cars are equipped with an automatic transmission is because most driving does not involve tearing around coastal highways and scenic mountain passes in Italy. Most driving takes place in the cities and suburbs. In stop and go traffic, working the clutch and shifting the gears becomes tedious for all but the hardcore enthusiast. Despite the glamorous car advertisements, cars are utilitarian vehicles: commuting, shopping and ferrying children are the primary tasks. The automatic transmission is the “standard” option for almost all new cars because that is what the market demands.

The manual versus automatic transmission argument has very real implications for your investment program as well.

There is no doubt that a more “hands on” approach to investment “feels” right. Investments should be individually weighed up and they should pass the “gut check” test that has been finely tuned by years of experience. A seasoned market veteran can happily regale you about the big homeruns he or she has belted out over the years. All of these winners came by relying exclusively on the finely tuned senses that can only work through a “hands on” approach to investment. By exercising “full control” from start to finish, the pro is able to deliver stellar results.

But, the question to ask is: does all this extra effort produce better results? If “total control”, “hard work”, “hands on approach” and “gut feel” were the ingredients to building a successful investment process, then why does the financial literature show that active managers underperform benchmarks well over half the time (70-85% according to this Standard and Poor’s report)?

The automatic transmission equivalent (Index Funds, ETFs, Systematic Investment) actually performs better in the long run because investing is not just about hitting homeruns. Most investing is like most driving. Markets jerk up and down just like suburban and city driving can be described as stop and go. While there are times when it can be fun, for most of us, investing is just a vehicle to achieve one’s long term financial objectives.

As you evaluate your investment options, watch for emotional words. Watch for the financial equivalent of the sports car winding along a beautiful two lane highway on the northern California Coast. Is your investment advisor selling you a dream or a practical method for achieving your investment objectives? Wall Street spends as much effort building the mystique of the investment process as car companies spend on marketing cars. Certainly the rapid growth of the hedge fund industry is driven in no small part by the same glamour of exclusivity that drives Ferrari sales. But, given the recent performance of hedge funds, one has to wonder whether the expense and noise is actually getting one closer to one’s destination.


Full Disclosure: This is me out on the trail with my fully manual Jeep Wrangler (which I also drive in stop and go traffic).

For most of my career, I have prospered by selling the financial equivalent of manual transmission sports cars. We called it “bespoke research” and tossed around terms like “value added”, “corporate access”, “datapoints” and “mindshare” with gusto. There are managers who were able to turn that into index beating performance but as the numbers show, they are in the distinct minority.

Black Box or Automatic Transmission?

So, while a System like the Fund King System may seem like a Black Box, it actually is more like the automatic transmission in your car. With a lot of extra effort and under the right conditions, you might be able to squeeze better performance out of your portfolio with a “hands on” method than you would using a non-emotional systematic approach. But, you have to question the cost, your motivations and your ability to deliver. Every stick shift driver thinks he or she is an above average driver. Unfortunately, the numbers do not back up that assertion for drivers or investors.

How does this apply to current market conditions?

Our view is that the market conditions are more likely to resemble rush hour conditions than the open roads of the 80’s and 90’s. As such, we would recommend taking a serious look at how you invest. Most of your return will be due to your asset allocation process rather than your skill in bottom up stock picking. This is the time for a practical automatic rather than a heart pumping manual transmission.

Filed under: Investment ProductMarket Psychology

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