The Real Danger in Overstating Returns

While we should all be attentive to the results of this probe—because I’d bet my lunch money that its implications will be felt beyond just PIMCO—there is an even deeper issue to consider. And this issue has a more direct impact on our individual portfolios and money management choices. The real danger in overstating returns, and indeed the root of most financial missteps, is self-deception.

“How’s your portfolio?”

Who among us wants to feel like a failure? We’ll generally avoid experiencing this sensation at all costs. So, absent conspicuous success, we permit ourselves to believe that we’ve at least not failed, frequently through self-deception.

Defining “success” in investing can be an especially tricky endeavor and comes with a number of challenges. Is success attained by reaching a certain number, or a particular account balance, however arbitrary? Or is success found in earning a particular rate of return? Or outperforming one’s peers or a particular benchmark?

There are so many variables unique to each investor that gauging true success becomes almost impossible. This is where self-deception becomes a handy tool. It allows us to artificially create and meet arbitrary objectives, resulting in a feeling of progress. And progress, like success, feels good. In a classic scene from the movie Meet the Parents, Owen Wilson’s do-no-wrong character asks Ben Stiller’s still-finding-himself character, “How’s your portfolio?”

As so many do, Stiller responds self-deceivingly, “I’d say strong…to quite strong.” But is it really?

Unfortunately, self-deception is all-too-often our instinctive, default response.

The Financial Industry Fosters Self-Deception

The financial industry encourages confusion among investors by offering a seemingly limitless array of solutions and strategies. These solutions are marketed in a way to foster self-deception and lead investors to believe they are pursuing real success. Unfortunately, those who manage money have an even greater incentive to deceive themselves.

Maintaining an unwavering belief in the virtues of their investment philosophy is what helps money managers continue to attract new clients. It’s an act of self-deception driven by the most powerful human impulse—self-preservation.

I have seen many gross examples of the industry’s imperative for self-preservation. Some of them border on the hilarious. Once I was invited to a conference at a swanky hotel in Las Vegas. A number of the world’s most expensive platform speakers were on the bill. It didn’t take long to see that the whole event was sponsored by a large company whose business included acting as a middleman for financial advisors that sold equity-indexed annuities (EIAs) offered by insurance companies. The company took an “override” commission on every piece of business placed, so they worked tirelessly to brainwash advisors to see themselves as “the safe money experts.”

Advisors were swept into willful blindness by the siren’s song of double-digit commissions. They eventually talked themselves—and their prospects—into justifying the sale of products with surrender charges in excess of 10% that lasted for a decade or more.

Even more dangerous, however, is a less noticeable variety of self-deception. Take the money manager, for instance, who has convinced himself (and his firm’s investment committee) that beating the S&P 500 stock index over the past 14 years was a stroke of brilliance, all the while underperforming a simple, diversified blended benchmark. For an industry that has so consistently failed to add value during the investing process on behalf of its clients and customers, self-deception may be the only way for many to get a good night’s rest.

A Better Way

Fortunately, there is a better way. Investors, advisors and money managers alike can choose intellectual honesty. We can set in place deliberate systems of accountability designed to check and balance tendencies toward self-preservation through self-deception. We can choose evidence over opinion. We can choose transparency over sleight of hand.

We can redefine success by centering our planning on the values unique to each investor, and developing an evidence-based strategy tailored to an individual’s goals and objectives.

I’m a speaker, author and director of personal finance for the BAM Alliance. If you enjoyed this post, let me know on Twitter or Google+, and click here to receive my weekly post via email.

This commentary originally appeared September 25 on Forbes.com

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