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KISS Investment Principle

December 04, 2023

The KISS Investment Principle: Keep It Simple & Sound

by Michael E. DeMassa, CFA, CFP®

Yes, the last “s” is modified from the original KISS principle – “Keep it simple, stupid!” – that was first noted by the U.S. Navy’s “Project KISS” in 1960 and popularized in the 1970s. This slight change should keep me out of trouble with my daughter, who informed me back when she was in elementary school that the original “s” word at the end of KISS was a really bad word, not to be said, ever.

Regardless of that minor update, one thing that hasn’t changed is the underlying principle of “keeping it simple,” which many scholars, artists and entrepreneurs have reiterated over the years in a variety of ways. From “Simplicity is the ultimate sophistication,” attributed to Leonardo da Vinci, to Steve Jobs’ “Simplicity came not by ignoring complexity but by conquering it,” there are a plethora of quotes to reinforce the value of the “simple” approach.

In today’s financial world of algorithms and the quest for artificial intelligence, I am reminded of a quote from Benjamin Graham’s book, “The Intelligent Investor”:

In 44 years of Wall Street experience and study, I have never seen dependable calculations made about common stock values, or related investment policies, that went beyond simple arithmetic or the most elementary algebra. Whenever calculus is brought in, or higher algebra, you could take it as a warning signal that the operator was trying to substitute theory for experience, and usually also to give to speculation the deceptive guise of investment.

Despite having 20 years fewer of investment experience than Mr. Graham when he wrote this, I have seen my fair share of new complex investment solutions and I don’t expect Wall Street to slow down with new product pushes in the coming years. After evaluating many of these products and having successfully taken higher-level math classes – up to and including Differential Equations at MIT – I wholeheartedly agree with Mr. Graham about keeping it simple; this is one of the core principles at Forza.

To help investors in following the KISS approach, here are three things to look out for when investing:

1) Leverage: Many financial calamities from the past* involved some form of leverage. When utilizing leverage, additional due diligence is required as the slightest miscalculation or change in assumptions will have an amplified effect. Private equity, hedge funds, closed-end funds, and listed non-traded REITs (real estate investment trusts) may incorporate leverage in their strategies to boost potential returns. Problems can occur, though, when borrowing limits are reached, cutting off the funding source, and/or when the cost to borrow becomes greater than the return on investment. Knowing the maximum leverage ratio for the fund helps but, during times of stress, this ratio can quickly adjust in the wrong direction to become the next headline-worthy failure.

Leverage is like turbo jets: you’ll get somewhere faster but the destination is unknown.

2) Layers: To diversify certain risks (like leverage), there might be an additional layer introduced. This could be in the form of a fund of funds (or manager of managers) approach. By having exposure to many funds, the manager risk is diversified away at the cost of adding another level of fees. While diversification of risk is important, owning a fund of funds can often be similar to owning an expensive index fund. Having the ability to “look through” the layers and view the underlying investments is imperative to understanding and managing portfolio risk.

Adding an insurance layer (i.e., annuities, life insurance, etc.) as a means of limiting risk will also result in additional costs. Reviewing the associated benefits of these policies to determine if the costs are warranted can be difficult, given the variable terms of some contracts and the ability of the insurance carrier to adjust factors in their favor.

Know what you own; dig through layers until you reach the underlying investments.

3) Loans: Another form of leverage that raises the level of complexity are loans investors may take out against their assets without a predetermined plan to pay off the balance. “Tax-free” loans against insurance policies, collateralized loans (including margin) and lines of credit are ways to access cash without selling assets. During much of the past 20 years, a low interest rate policy by the Federal Reserve enabled investors to borrow based on short-term rates, with the ability to invest longer-term at higher rates. This is no longer the case, with short-term rates higher than most longer-term rates (inverted yield curve). As a result, the financing costs for the average borrower recently reached the highest level in over 20 years by some measures: 8% mortgage rates, 10% auto loans, and 24% credit card interest rates.

The power of compound interest can work for you as a lender, or against you as a borrower.

Being aware of leverage, layers and loans when investing will help to uncover risks that may not be so obvious at first glance. Reducing these as much as possible is part of the “Keep It Simple & Sound” investment philosophy at Forza. As such, we specialize in building transparent portfolios for our clients, consisting mainly of individual stocks, bonds and ETFs. We firmly believe that keeping it “simple & sound” will serve you well in achieving your financial goals.

*Past financial calamities include: Continental Illinois (1984), Long Term Capital Management (1998), Bear Stearns (2008), Lehman Brothers (2008), Washington Mutual (2008), Archegos Capital Management (2021), Silicon Valley Bank (2023), Silvergate Bank (2023), First Republic (2023), to name a few.