Chasing Past Performance is Expensive

A rigorous study from Vanguard  demonstrates that chasing the hot mutual fund is an inferior investing strategy compared to good, old-fashioned buy and hold.

Vanguard analyzed a decade of data ending December 31, 2013 across nine asset classes.  In every case the investor would have been significantly better off just sticking with the index.  On average the indexes generated 50% higher returns than the performance-chasing strategy!

Buy and hold may not be perfect, but it can be a lot better than flitting from mutual fund to mutual fund.

 

Investors are Still Their Own Worst Enemy

Our core belief is that the dominant factor in long-term, real-life financial outcomes is not investment performance, it is investor behavior.  Therefore, our true value as a trusted advisor lies in establishing and guiding our clients’ investor behavior, not in managing investment performance.

This philosophy of advice is data driven as many academic and industry studies demonstrate a perennial pattern that investors on average fail to capture the returns that their own investments offer, largely because of behavior.

In the recently released DALBAR study for the 30-year period ending December 30, 2016, the S&P 500 stock index produced an excellent annual return of 10.2%, while the average stock fund investor earned only 4.0%, a gap of 6.2%.  Bond investors did not fare any better. During the same 30-year period, the Barclays Bond Index yielded an annual return of 6.0%, while the average bond fund investor earned just 0.6%. Note these three decades include the crash of 1987, the tech boom-bust of 2000, the Great Recession crash of 2008, and the current bull market run — in other words a very fair sampling of good and bad times.

These results, illustrated above, reflect the fact that we experience powerful emotions when markets move up and down that cause us to make investment decisions that are not in our best interests (e.g., panic selling, euphoric buying, performance chasing, etc.).  This is a profound observation of the “behavior gap” that exists between investment and investor returns.  Investors are more often than not their own worst enemy when it comes to investing.

When we welcome new client families to our firm, we hand them a card.  The front consists of a bear market chart designed to prepare them for the fact that the market pulls back on average about every five years or so and not to panic.  The back of the card is a summary of What We Do / How We Earn our Fee:

  • 20% — Quantifying goals, crafting a long-term plan, funding the plan with a long-term portfolio
  • 80% — Coaching clients to continue working the plan through all the cycles of the economy, and all the fads and fears of the market
  • 0% — Analyzing/interpreting the economy and current events
  • 0% — Timing the market, calling tops and bottoms
  • 0% — Identify consistently top-performing investments

 

 

10 Truths Mutual Fund Firms Won’t Admit

mutualfunds

  1. “Cheap funds often outperform pricey ones.”
  2.  “We can’t beat the market.”
  3.  “When skill fails, we just double (or quintuple) our odds.”
  4.  “People aren’t buying our product…”
  5. “…except when we pay them kickbacks.”
  6.  “Hedge funds are our idols.”
  7.  “Our boards are rubber stamps.”
  8.  “Blame us for runaway CEO pay.”
  9.  “We played a starring role in the financial crisis.”
  10.  “Our lobby crushed bipartisan efforts at reform.”

Source: MarketWatch

Chasing Past Performance is Expensive

vanguard-chasingA new study demonstrates that chasing the hot mutual fund is an inferior investing strategy compared to good, old-fashioned buy and hold.

Vanguard analyzed a decade of data ending December 31, 2013 across nine asset classes.  In every case the investor would have been significantly better off just sticking with the index.  On average the indexes generated 50% higher returns than the performance-chasing strategy!

Buy and hold may not be perfect, but it can be a lot better than flitting from mutual fund to mutual fund.

 

75% of Americans get the Most Important Investing Question WRONG

Powerful observation from Vox.com regarding public perception versus reality when it comes to how to best invest your money:

Which of the following do you think is the best long-term investment?

  1. Real Estate

  2. Gold

  3. Stocks/Mutual Funds

  4. Savings Account

Don’t feel bad if you didn’t get the answer right. You’re in good company.

Recently, Gallup asked Americans what they thought their best investment bet was over the long run. 24 percent of Americans named stocks and mutual funds — but the same share named gold, and even more (30 percent) named real estate. The trend lines are actually positive, as in 2011 a baffling 34 percent of Americans named gold as their top pick:

gallupThere’s a right answer here — and it’s one that about two thirds of respondents who answered the question got wrong. If history is any guide, stocks are the best bet in the long run, and gold and real estate certainly are not.

siegel_returns

Source: Vox.com

Running in the Wrong Direction (CHART)

Click to zoom

The S&P 500 has more than doubled since March 2009 but individual investors have been selling stocks almost the entire time!

In January 2013, equity funds took in $19.6 billion. This was the largest inflow since ICI started tracking the data six years ago. During the prior 4 year rally, outflows exceeded $435 billion.

This is a very visual example of how emotions can wreak havoc on an investor’s ability to build long-term wealth.  Investors allowed fear to control their investing behavior and entirely miss this 4-year bull run.

This negative behavior is nothing new. Over the 20-year period from 1992 to 2011, the S&P 500 returned 7.8% annually, while the average stock investor in the U.S. earned only 3.5%. 

Source:
David Wilson
Chart of the Day, February 14, 2013
Bloomberg

Investors Continue to Avoid Stocks Despite Strong Performance

The recent buoyancy in the stock market hasn’t won over mutual-fund buyers. August marked the 16th consecutive month in which investors pulled more cash out of U.S.-stock mutual funds than they put in.

The painful bear market of 2007-09 has left investors with a skewed view of U.S.-stock performance. In investor surveys conducted in early 2010, 2011 and 2012, at least 48% of respondents each year said the stock market had been down or flat in the preceding year. In fact, the Standard & Poor’s 500-stock index was up strongly in 2009 and 2010 and eked out a 2.1% return (including dividends) in 2011.

source: Wall Street Journal

Facebook: You may have passed, but mutual funds loaded up!

The Facebook stock offering has been an unqualified debacle.  Many investors got lured into the hype, while others smartly passed.  The stock price is down nearly 50% from the initial offering price as of yesterday’s close at $19.44.  By the way, the S&P 500 has gained more than 9% during the same time period.

What’s a bit more surprising is how some mutual funds dove in without abandon.  For example, Morgan Stanley funds took big bets on Facebook.  Eight of their funds have >5% of their assets invested in Facebook.

In June, a commentary on Morgan Stanley’s fund website reported that Facebook and other tech stocks were “the leading detractor in the portfolio this quarter,” discounting the decline in Facebook shares “to post-IPO volatility.”

Myth Buster: Individual Investors are NOT Fleeing Stocks

The reports of my death are greatly exaggerated — Mark Twain

Stocks may be feeling a lot like Mark Twain once felt — discounted prematurely!

The financial media would have you believe that retail investors have been running, not walking, away from stocks. However, a massive, new study of U.S. investors shows the cold, hard facts say otherwise.

A recent Vanguard study sheds light on how individual investors are approaching stocks.  Vanguard reviewed the retirement accounts of 3 million Americans.  As of 2011, the average individual investors had an asset allocation that consists of

  • 65% in stocks
  • 17% in cash
  • 10% in bonds
  • 10% in balance funds
    (these add up to >100% because of rounding in the components)

Retirement savers have two-thirds of their money riding on stocks.  This allocation has declined only 8 percentage points since peaking in 2007.

Moreover, 71% of new contributions are going to purchase additional stocks, up 1% from 2010 and 3% from 2009.

What has changed significantly is how investors are purchasing their stocks.  Purchases directly through diversified stock funds is only 38% of contributions — down sharply from 51% in 2007.  However, stocks purchased via target-date funds are up.

So investors may be thinking they have been selling stocks but they continue to invest in them indirectly.

To quote Jason Zweig:
the public’s infatuation with stock funds isn’t dead. It’s alive and well, but it’s going in by the back door.

“Shelf-Space” – Another dirty little secret about big brokerage firms

Cereal companies pay grocery stores to place their products at eye level on the shelves.  Higher visibility leads to higher sales.

Mutual funds do the same thing.  They pay big brokerage firms big money to tout their products.  So when you call up a firm like UBS or Morgan Stanley Smith Barney and ask for an investment recommendation, they have a list of preferred mutual funds that they want you to buy so they can make more money.

These “revenue sharing” payments can be very big revenue sources for brokerage firms.  For example, nearly one-third (33%) of Edwards Jones’ $481.8 million profit in 2011 came from “revenue sharing” fees.  Note that Edwards Jones is forced to disclose more information on sensitive matters like this than its competitors thanks to a 2004 regulatory settlement.

Though “revenue sharing” payments are legal, many critics question if they are ethical since it calls into question whether recommendations are based solely on what’s in the best interest of the client.  Brokerages are not fiduciaries and have no requirement to put client’s interests first.

“It’s an unholy alliance between mutual-fund firms and brokerages to exploit their customers,” says John Freeman, emeritus professor of business and professional ethics at the University of South Carolina Law School.

Investors who want to avoid questionable practices like “shelf space” and “revenue sharing” should seek advice from a fiduciary such as a registered investment advisor.

source:
Wall Street Journal: Brokers Raise Fees, but Not For Investors: Why You Should Care
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