The financial industry loves complexity. There is an ever-growing number of computerized models designed to maximize the returns from securities and optimize portfolio allocations, among other things (including executing trades faster). This complexity has led to new research, new strategies and new products.
Complexity can lead to unintended consequences, however. We saw this in 1998, when hedge fund Long-Term Capital Management imploded. We saw it again during the last financial crisis. Wall Street’s process of stripping and repackaging mortgage loans resulted in securities that looked good on a spreadsheet, but were disastrous in a portfolio.
Complexity also exists at the individual investor level. The investment industry is currently pitching alternative funds designed to follow hedge fund-like strategies. The strategies used by these funds often are not easy to understand (even by the advisers selling them). Complexity even exists at the stock selection level, where it is very possible for a strategy to be misunderstood by all but a small group of investors.
What is complex to one person may seem simple to another. Answering three questions can determine whether a strategy is too complex for you: Do you understand what the strategy is designed to look for? Can you easily follow the strategy? Do you understand what its potential risks are? If you cannot answer yes to these questions, then the strategy may not be right for you. At the very least, you need to learn more about the strategy before proceeding.