Long-Term Wisdom in a Short-Term World: Barry Ritholtz’ Investment Playbook
The blogger, wealth manager and podcast host has written a valuable book on the science of investing.
Barry Ritholtz could not have written this book at a more appropriate time.
How Not to Invest arrives at a moment when market participants are besieged by uncertainty – from tariff wars and shifting immigration policies to geopolitical strife and domestic regulatory upheaval. In a climate rife with noise, Ritholtz argues that disciplined, long-term investing – not frantic attempts to outsmart the market – is the surest path to success.
Ritholtz is the founder and chief investment officer of Ritholtz Wealth Management, a financial planning and asset management firm with over $5 billion dollars in assets under management. He serves as the host of Masters in Business, a podcast produced in collaboration with Bloomberg.
His message and material will not be new to financial advisors. But Ritholtz is a great storyteller and provides compelling evidence for his arguments. He will reinforce your views on the drivers of market performance, investor psychology, and the costly mistakes investors too often make.
He will entertain you with enlightening anecdotes and research that illustrate his key points. I recommend this book to absorb the full scope of Ritholtz’ advice.
Here are a few select examples that are representative of his thinking.
Ignore the pundits and the predictions
Don’t pay attention to anyone who claims to know when it is time to get in or out of the market, no matter how highly regarded they are or how credible their advice appears.
Ritholtz discusses the work of Phillip Tetlock, who studied the predictions of experts over a multi-decade period in a variety of fields, including politics, business and economics. He used sophisticated methodology that incorporated how confident forecasters were in their predictions. But few were any better than a dart-thrower.
Tetlock called those exceptional few the “superforecasters.” I will accept that they exist in some domains, but I have yet to find one in the field of investing. Consider the failed predictions of the noted economist Larry Summers and the “bond king,” Jeffrey Gundlach.
Ritholtz is similarly dismissive of economic and market forecasters. His harshest words were for a poor fellow by the name of Donald Luskin, the chief investment officer for Trend Macrolytics LLC, a consulting firm he founded in 2001. On September 14, 2008, the eve of the great financial crisis, Luskin confidently predicted there would be no recession. Here is what Ritholtz had to say:
Breathtaking in its ignorance, shocking in its fallibility, astonishing in its authors’ perversely misperceived worldview, it stands a monument to the sheer cluelessness any single person could possibly possess.
But pundits find forecasting irresistible. Indeed, just a week ago, James Mackintosh wrote the following in the Wall Street Journal: “It doesn’t quite feel like it’s time to buy just yet. But here are three tests to help you decide.” Investors are surrounded by unreliable advice, and Ritholtz is right to dismiss it.
We are survivorship bias
Ritholtz expertly dissects the behavioral biases that cloud investors’ decisions – loss aversion, the endowment effect, anchoring, etc. His discussion of survivorship bias was particularly entertaining.
Asset managers routinely extol the track record of the investment products and strategies they market. Invariably, these products perform well, besting their peers, benchmarks and competitors. But left out of the discussion are the products and strategies that failed and were shut down by their managers. The only products we see are those that survive.
For example, I recently wrote about model portfolios and covered-call ETFs. Their performance was disappointing but would have been even worse if the universe I analyzed included all the failed models and ETFs that providers liquidated and shut down.
Ritholtz’ astute observation is that the world we inhabit – everything we see and experience – represents survivorship bias. “Anything that is successful – products, funds, people – are the result of millions of small and large failures,” he writes.
We don’t see those failures. Approximately 5% of mutual funds are liquidated, merged or closed every year. Survivorship bias overstates the performance of winners and understates the track record of losers.
When analyzing investments, often the data we don’t see tells us more than what we do. For example, there is a trove of literature that studies how good investment managers are at selecting securities to purchase. Much less is known about their selling skills.
But Ritholtz tells of a very interesting study that looked at 2 million sell and 2.3 million buy decisions from a universe of 783 portfolios with an average value of $573 million. The researchers analyzed the track record of those sell decisions. Rather than comparing the results to a benchmark, they created a “counterfactual” portfolio: for every security that was sold, they compared its performance to that of a sale of randomly selected security selected from those not sold.
The counterfactual portfolio outperformed the actual one by 50 to 100 basis points. That is the performance sacrifice managers made by selling the securities they did rather than a randomly selected one. The takeaway is that investors devote disproportionate resources to making buy decisions as compared to analyzing what should be sold.
The mismeasurement of risk
The investment industry has never embraced a consistent definition of risk, but the most common is volatility, as measured by the standard deviation of returns. It is easy to calculate, and it lends itself to creating nice-looking graphs of the efficient frontier, depicting whether products are delivering an appropriate degree of return for their riskiness.
But the standard deviation of returns is not what matters to most investors. Consider an investment product whose value declined steadily and precipitously in a straight line, all the way to zero. Its volatility would be very low, but it would be the riskiest product imaginable.
Ritholtz solves this by defining risk as the “probability of not getting your expected returns.” That is the appropriate definition, but often it is hard to quantify in advance (“ex ante”).
One way to measure that risk is by looking at how similar products have performed in the past, ideally over a representative time horizon that includes a full market cycle. If you are looking at a covered-call option-writing strategy, for example, look at how similar products have performed.
Opportunities for more research
Ritholtz’ approach to investing is sound and I fully endorse it. There are some areas, though, where I would like to see additional research.
Ritholtz endorses direct indexing (DI). DI is a strategy where investors purchase the components of an index and sell securities with losses to offset gains elsewhere in the account. DI can also be used to create customized indices.
He cites research by the vendor his firm uses that, in 2020, DI was able to use “in excess of 4.75%” of the portfolio for tax-loss harvesting. In fairness, he says that Q1 of 2020 was very unusual and investors should not expect DI benefits that large every year.
I am skeptical. At best, DI can only delay the payment of capital gains taxes, presumably to a time when the investor is in a lower marginal tax bracket. Capital-gains taxes must always be paid, unless the asset is held until death and there is a step-up in basis. DI is designed to produce the same performance as the underlying index/fund.
About a year ago, I moderated a panel discussion on DI. One of the panelists was Patrick Geddes, the founder of Aperio, a DI provider that was sold to BlackRock. His conclusion was that DI was most appropriate for clients with short-term capital gains (typically generated by limited partnerships like hedge funds and private equity) in high-tax-rate states. Geddes said DI is not appropriate for mass affluent clients.
DI is a computationally intensive solution that is (appropriately) targeted to high-net-worth investors. The taxes saved by those wealthy investors will be paid by everyone else – those not sufficiently wealthy to afford DI. That is an ethical question that should not be ignored. The same question applies to section 351 ETFs, a newer innovation that Ritholtz mentions.
I wish Ritholtz did not have a chapter on how to succeed in active management. He doesn’t provide any answers, except to invest only in the top decile if you are choosing among alternative asset managers.
But with survivorship bias and considering that many top-performing alternative asset managers don’t report their results (because they don’t accept new investors), identifying the top decile is not easy.
Ritholtz correctly says that it is exceedingly difficult to consistently identify top-performing active managers ex ante, and it is not worth the time and effort to try.
In the end, Ritholtz gives a full-throated endorsement to indexing:
All other things being equal, simplicity beats complexity every time. A portfolio of passive low-cost indexes should make up the core of your holdings. If you want to do something more complicated, you need a compelling reason.
Ultimately, Ritholtz advocates for simplicity in investing. His unwavering endorsement of low-cost, passive indexing underscores a broader philosophy: a disciplined strategy, unclouded by short-term noise, is paramount. In a market awash with punditry and fleeting forecasts, sticking to a well-thought-out asset allocation remains the most reliable guide.
Robert Huebscher was the founder of Advisor Perspectives and its CEO until the company was acquired by VettaFi in 2022. He was a vice chairman of VettaFi/TMX until April 2024.