That’s Surprising; That Doesn’t Make Sense

Perhaps the single most surprising aspect of personal finance is the way individual investors pile money into investments that have little chance of success.

For decades, 85% or so of the mutual funds that attempt to out-select or out-time the broad stock market, (so called actively managed funds), have failed to beat their benchmarks. Why do investors continue to follow this strategy? It doesn’t make sense.

I am continually surprised that prospective clients, (and yes, even some clients), believe that financial success is dependent upon selecting funds that will outperform; correctly determining the direction of the economy; or predicting where interest rates are headed.

Spending time on these matters is a waste of time and mental energy. Despite the clamor of the media, you don’t have to know any of these things to achieve what’s most important to you. However, thinking that you actually have knowledge about these issues can lead you to react. That’s the real danger.

BETTING AGAINST THE MARKET

When you invest in an actively managed fund, you are essentially betting against the market. The overwhelming stretch of long-term history is stacked up against you. You are therefore taking a risk that you really don’t need to take.

Investing in actively managed funds with relatively low expenses doesn’t make the risks disappear. For example, Vanguard Group which is known mostly for low cost index funds actually offers about 70 actively managed funds totaling a whopping $1.4 Trillion in value. While their direct fund expenses are below the industry average, these funds still can’t escape the added costs that impact all actively managed funds as a result of turnover and trading costs.

Many actively traded funds have annual turnover of 100% or more of their portfolios, (meaning everything that was in the portfolio at the start of the year has turned over by year-end), which simultaneously increases costs and decreases the chance of achieving good long-term outcomes.

Ultimately, you have to “unknow” your forecast about the future and instead concentrate on what you can actually control. That is, how much you save, the allocation within your portfolio, and your behavior.

Trying to “beat the market” can be seductive but usually very costly in terms of the long-term outcome. Instead, follow the path that improves your chance of winning. Start there. Ready for a good conversation?