Rationalizing Our Way to Another Crisis

8koeusir1zm-jimi-filipovskiFrom a pretty early point in my time as a representative of a big financial corporation, there was always a small part of me that had to rationalize the mediocrity of the products I was offering my clients.

That rationalization went something like this: “The fees to buy and own these mutual funds are high, and cheaper options exist for these people, but I don’t get paid if they buy those cheaper options and they’ll be better off for having invested in something, rather than not invest at all.”

At the beginning, I didn’t know what I didn’t know, and I was just excited to be a part of something that big, but it didn’t take too long for doubt to start creeping in. Rationalization is a basic human defense mechanism, and there’s an awful lot of it going on right now.

I pay very close attention to the ads and images the industry puts out and there are times when I shake my head and think, “What a load of garbage. How can they even say that?” But as is evidenced by the horrible things we human beings do to each other, we can rationalize anything.

The financial industry rationalizes molding the truth to meet their profit margins, and investors, big and small, rationalize spending and investment decisions to ease their conscience. These rationalizations feed on each other and snowball into crises like the one we had ten years ago (yeah, it’s been just about that long since the global financial crisis), and the ones we had every ten years or so before that.

I’ve been saying for years that the broad stock and bond markets are overpriced and that individual investors should exercise caution. I’ve issued so many warnings that I often feel like I’m out of step with the rest of the investment world. Valuations in these markets have continued to defy fundamental investment logic even when something happens that’s expected to result in a sell off. But then, markets have never been logical and maybe I should know better than to try and justify decisions based on logic.  I guess I just can’t bring myself to buy something that I want to go up in value when it’s already higher than it’s ever been because, buy low sell high, right?

Well, we’re herd animals and we rationalize staying with something even if part of us tells us it’s wrong when everyone else is doing it. But now as we enter the second week with a new president who, love him or hate him, seems to embody the very idea of volatility, something tells me sooner or later the last straw will fall.

They say every prognosticator is eventually right. I don’t consider myself to be one, but if I’m now rationalizing, I suppose I just don’t think I’d be doing my job if I didn’t tell my clients how concerned I am about the level of risk to their 401(k)s and brokerage accounts. I really don’t want to be right about this.  But every week I see people that have all, or the vast majority of their money in broad market funds that they think are “diversified” and “pretty conservative.”

If you haven’t been paying attention, thanks to the massive increase in the money supply, the stock, bond, and real estate markets have all gone up to very high levels. These three asset classes have been positively correlated since the crisis (and before), so owning funds that invest in them offers very little in the way of diversification. Commodities and natural resources are the only asset class that is not highly priced, which is not a good indicator for the other three.

Politicians have been rationalizing policies that favor the industries and companies that heap favor upon them, and continue rolling the debt snowball bigger and bigger. Investors rationalize plowing money into their 401(k) funds, partly because they don’t know what else to do, but also because they don’t want to fall out of step.

There is another way. But you must be willing to consider that what everyone else is doing may not be right for you. And stop rationalizing.