Improve Your Odds of Success
Last month, Morningstar reported that only 36% of stock pickers piloted their actively managed funds to better performance than a comparable index fund through the first half of 2018. Wait, what?!
You might be thinking, does this matter to me if my funds have done better? After all, these fund managers are terribly smart and work hard, right? Is this just a short-term phenomenon?
No. Bad performance accumulates over time. It’s hard to rise to the top if you’re consistently below average, and the more than you finish below the averages, even a solid year every now than then can’t make up for cumulative underperformance. Ready to see how ugly this gets with time? You better sit down before I share this with you.
The report card is in, and according to Dimensional Fund Advisors, the data shows that only 14% of US equity mutual funds (and 13% of fixed income funds) have survived and outperformed their benchmarks over the past 15 years.
But the real reason tolerating sub-optimal performance matters to you has nothing to do with bragging rights. It is because failing to secure your goals and to optimize your resources has real-world implications: postponing your retirement, cutting your standard of living in retirement, saving more today, needing to take more risk than you must to grow your nest egg to where it should be.
Simply put, don’t try to outguess the market.
The market’s pricing power works against those who try to outperform through stock picking or market timing. This is heavy evidence in our opinion, and one of the primary reasons why we construct the foundation of our portfolios with low-cost exchange traded funds (ETFs). In fact, the average portfolio we manage has a cost of less than 1/10 of one percent. Compare that to the average advisor whose typical model portfolio has an internal expense more than 5X as much (38 basis points* for ETFs, 110 basis points for mutual funds).
While it’s difficult to believe hard work doesn’t pay off in investing as it does in all other walks of life, it’s only because all this hard work makes the market more efficient, which makes stock picking less able to add value after expenses. It’s not that managers are inherently bad, it’s just that their fees are too darn high relative to the value they offer. If there’s one last way I could convince you to take the high road, it’s that Warren Buffett – the single greatest investor of our age – plans to index his estate.
Follow the smart money, and happy indexing!
*A basis point is 1/100 of one percent.