When Complexity Looks Like Wisdom

In the years before the 2008 financial crisis, Wall Street transformed something most people understood (a home mortgage) into something very few could explain. Mortgages were bundled together, sliced into pieces, assigned ratings, insured against losses, repackaged into new securities and sold worldwide using language like mortgage-backed securities, collateralized debt obligations and synthetic exposure.

That complexity reassured many investors. Surely a system involving so many formulas, ratings, models and highly compensated experts must have diminished the risk, right? But when housing values declined, the truth appeared: Rather than remove risk, complexity had simply disguised it.

Investors believed they owned something extraordinarily safe. Instead, the illusion of safety was built on a simple idea made palatable by complexity: People always pay their mortgages.

Since then, finance has only become more complicated. Leveraged funds, options strategies, private lending arrangements, cryptocurrency products, etc. often promise protection, enhanced yield or access to “hidden” opportunities.

Some of these tools may indeed serve the right person in the right circumstance. Complexity itself is not inherently wrong. But the trouble begins when complexity replaces understanding.

Why is complexity so convincing? One reason is that we naturally assume complicated problems require complicated solutions. Retirement (and money in general) can feel overwhelming. Taxes, inflation, healthcare costs, longevity and market declines can make even successful people wonder whether they’ve done “enough.” When someone counters anxiety with a strategy filled with formulas, proprietary terminology and an impressive presentation, complexity can feel appropriate to the problem — and “smart.”

It may feel like the right thing to do.

In finance, people often worry about being unprepared or falling behind. Complicated language can sound like a hidden advantage — like a private door into better results, available only for those wise or wealthy enough to understand it. When an investor fears a traditional plan may be insufficient, that suggestion can feel persuasive.

Two emotional forces are at work. The first is insecurity: “Maybe everyone else knows something I do not.” The second is hope: “Perhaps this strategy will finally put me ahead.” Complexity can satisfy both emotions, making an investor feel sophisticated while allowing them to avoid admitting they don’t really understand what they own.

Research has identified this tendency. When presented with industry jargon, those with no previous knowledge often become skeptical, walking away from what they don’t understand.

But those with a little familiarity are far more susceptible. They recognize enough of the language for it to sound credible, but not enough to evaluate whether the investment is actually better. In one study by the Journal of Accounting and Economic, investors with some industry knowledge wanted to invest more when jargon made the product feel more premium.

That’s a dangerous middle ground. Someone who knows they don’t understand will often ask questions or refuse something. Someone who understands just enough to feel confident may be easier to deceive.

Finance rewards confusion because complexity makes comparison difficult. A straightforward investment invites straightforward questions. If I own shares in a business, I can ask what that business sells, whether it earns money, if it pays dividends and what risks I’m accepting. A complicated financial product may require pages of disclosures simply to describe how returns are calculated.

Again, the point is not that every complex investment is unsuitable, but that no investment becomes wise simply because it’s complex.

There’s nothing unsophisticated about owning explainable assets. Many of the world’s most enduring businesses sell products and services people use every day: food, medicine, electricity, transportation, communication and household necessities. Their prices will fluctuate, their results will vary, and no company is without risk. But an investor can generally understand how these businesses make money and why owning them may serve a long-term plan.

More often, simplicity is wise. Investors are more likely to remain committed to a plan they can explain. When markets decline, complexity often converts into anxiety because people no longer know how an investment is supposed to behave, where its risks are hiding or whether their original reasoning for owning it remains valid. Confusion rarely inspires confidence during a difficult market.

A clear plan is not the same as a simplistic plan. Financial lives can require thoughtful tax planning, estate documents, insurance, reserves, retirement income strategies and diversified portfolios. But the purpose of each element should be understandable. What problem is this solving? How does it help fund my life? How do I earn money? How can I lose money? What does it cost, and what flexibility am I giving up?

Those simple questions expose a great deal.

Charlie Munger encouraged investors to take simple ideas seriously. Warren Buffett has long spoken about staying within one’s circle of competence. Neither means that investing doesn’t require thought. Their point is that genuine wisdom often resides in simplicity.

The financial crisis provided a costly reminder that complexity can resemble safety right up until the moment it fails. Investors need an understandable plan, investments with a clear purpose and confidence to stay disciplined amidst discomfort.

In finance, confusion is not sophistication, and complexity is not wisdom. Before investing, ask yourself whether you can explain what you own, including why you own it and how it could disappoint you. If you cannot, then keep asking questions.