Overview – Does Your Investment Strategy Need to Be Complex?
We live in a very complex world. Everything from large, interconnected systems such as global finance and agriculture all the way down to the phones we use on a daily basis grow more complex by the day.
Take for example the iPhone. The current model, at the time of this writing, is the iPhone 12. Compared to the first generation model released in 2007, the iPhone 12 is a considerably more complex device than the one that was released 14 years ago.
The features on an iPhone 12 would’ve been unimaginable back in 2007, yet here we are, a device that can monitor your heart rate, act as a credit card, and can access all of the information you want, right in the palm of your hand. The level of complexity between the iPhone 12 and the first generation model is truly mind-boggling
It seems that one of the hallmarks of human progress is complexity. The more complex something is, the better, right?
In investing, especially when it comes to investment strategy, this isn’t necessarily the case.
Don’t Forget the Purpose of an Investment Strategy
I previously looked at the relationship between investment goals, strategies, and paradigms. How these three elements were connected was presented visually, as shown below:
In that article, I defined an investment strategy as “the specific actions an investor plans to take to reach their investment goals.”
This article’s focus is on investment strategy because it is by far the element that is the most prone to becoming too complex.
An investment paradigm is a framework an investor follows to guide all their investing activities. Most investors simply choose to adhere to pre-existing paradigms such as value investing or ESG investing.
Investment goals are simply the targets an investor ultimately wants to work towards.
When it comes to investment strategy, however, these can range from very simple to very complex. A retail investor and an institutional investor may adhere to the same paradigm and have similar goals, but their strategies may differ considerably.
Theoretically, there are countless ways for an investor to work towards their investment goals. Some investors may opt to take the most direct route, while others may choose to exercise a bit more creativity in their actions.
Not only are there countless strategies that investors can follow, but strategies change and evolve all the time.
Your Strategies Will Constantly Change, But is Complexity Inevitable?
As you gain more knowledge and experience as an investor, it should come as no surprise that how you choose to reach your investment goals will naturally change over time.
Maybe you learned that certain actions aren’t as effective as they used to be, or perhaps your approach is too simple and needs the addition of a few more elements to get the efficacy you desire.
They may change substantially, or they may only change a little, but your investment strategies definitely won’t stay the same forever. I know that the strategies I used to come up with when I first started investing and the ones I have now have changed, but not that drastically.
Not only will you grow as an investor over time, but as I’ve mentioned in other articles before the investing landscape is constantly changing.
Changing investor behaviour, new investment trends such as ESG investing, and other variables such as the constant creation of new asset classes such as cryptocurrency will compel investors to continuously re-assess how they plan on reaching their investment goals.
As your investment strategies evolve and improve, is an increased level of complexity inevitable?
There are countless empirical observations that support the notion that “improvement = more complexity”.
Take Graphics Processing Units (GPUs), for example. One of the earliest GPUs was the NVIDIA GeForce 256, which the company marketed as “the world’s first GPU“. At the time of this writing, the most advanced NVIDIA GPU is the RTX 3090.
The RTX 3090 is packed with some incredibly advanced features. Compared to the GeForce 256, the RTX 3090 is infinitely more complex, specifically because of its heavy use of AI and its cutting-edge infrastructure.
So, this naturally leads to the question of “is an investment strategy today bound to be more complex tomorrow?” Not necessarily.
Remember that an investment strategy is simply the actions you plan on taking to help you reach your investment goals – that’s really are there is to it.
Investors need to get rid of the notion that complexity is the outcome of improvement because that isn’t true at all when it comes to investing. Sometimes, cutting down on inefficiencies and reducing complexity is a sign of progress.
Let’s say one of your current strategies involves you looking at a minimum of 30 prospective investments in a specific industry in hopes of finding at least one to pursue. However, your recent experience has demonstrated that you don’t need to exceed 15 prospects before finding one worth investigating further.
So, you re-adjust the number of prospects you analyze down to 15. By reducing your workload, you still end up achieving your desired outcome.
Or imagine that one of your strategies is to invest in a minimum of at least ten different industries. However, you find that of the ten industries you currently have money in, only four are posting superior returns, while the other six aren’t really contributing to your portfolio.
It would only make sense to divest from the six laggards and focus on the four standouts.
Improving an investment strategy doesn’t mean you need to add more layers. Sometimes, cutting down is more effective than building up.
Complexity Does Not Mean Increased Efficacy
No matter what your specific investment strategies are, at the end of the day all that matters is that they work.
You can spend all the time you want crafting intricately designed strategies, but none of that effort will matter if these strategies don’t help you advance towards your investment goals.
Just because you add more complexity to a strategy doesn’t necessarily mean it will work better than its previous, simpler version. In fact, because your strategy has so many elements to it, it may be more prone to error – it’s very difficult to keep track of several parts all at once and to pinpoint a specific source of error.
In engineering, one of the things you want to avoid is overdesigning something. Not only does overdesign result in significantly higher costs, but the expected outcome may not justify the amount of time, effort, money, and energy put into this over-the-top design.
Is a cutting-edge distillation column or reactor truly necessary if simpler versions still get the job done in a safe, efficient, and economical manner? A skilled engineer knows increased complexity is sometimes unavoidable, but will do everything they can to avoid adding more complexity if they don’t need to.
If a simple investment strategy works, and there’s no compelling reason to dramatically change it, then don’t. There are other, less stressful ways to waste your time than complicating an investment strategy that doesn’t need to be changed.
Before you plan on adding more layers of complexity to your investment strategies, ask yourself if what you’re doing will result in a more effective strategy – if your answer to this question is “no”, then you’re simply wasting your time.
Wrapping Up
The purpose of an investment strategy is simple – they are the specific actions an investor intends on taking to help them reach their investment goals.
Your investment strategies will no doubt change over time, but does that mean they will naturally grow more complex? Not necessarily. Complexity isn’t always a sign of progress, and this is especially true in investing.
Sometimes, cutting down on inefficiencies and reducing layers of complexity are more effective ways to improve a strategy.
At the end of the day, all that matters is that your investment strategies work, no matter how simple or complex they are.
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