These things I've come to know. This is the title of a James McMurtry song. He is a brilliant song writer who writes Americana music. "These Things I’ve Come to Know" is a song about a woman and the quirks and qualities that you would only learn about her after spending vast amounts of time with her.
In the 16 years that I have been a financial planner, I have spent more time thinking, observing and learning about people and their money than most do in their lifetimes. I have tried my hand at trading, technical analysis, following gurus and newsletters, and have made every mistake in the book (some more than once). Here are the things that I have come to know about investing. (For related reading, see: How to Budget and Spend to Maximize Your Happiness.)
Mobile and the Internet Have Made Us Worse Investors
I think I was born impatient. I am the guy that will leave a restaurant when there is more than a 20-minute wait and I have been known to walk out of a barber shop when they aren’t moving fast enough. Amazon.com has helped us all avoid the unpleasantness of driving to a store and searching through hundreds of rows for the obscure item that we want. We now get disappointed when it takes more than two days to get our gadget magically delivered to our doorstep. If we want to start reading a book now, we can instantly have it downloaded to our Kindles. I can see a future where we all have 3-D printers at home and instead of waiting for our products, we buy the right to 3-D print them so we can have them immediately.
Having so many of our wants satisfied immediately has made us even less patient and that makes investing all the more difficult. Warren Buffett famously said: “The stock market is a highly efficient mechanism for the transfer of wealth from the impatient to the patient." I have received a few calls in the last month from clients asking why they don’t seem to be making money in their investments. I point them to the chart of the The iShares MSCI ACWI exchange-traded fund (ETF) that attempts to track the MSCI All World Index below. As you can see here, global stocks have crashed and recovered three times, but haven’t made investors money for two long years. (For more, see: The 3 Largest Global Ex-U.S. ETFs.)
Global stocks, as represented by the ACWI ETF, have gone nowhere fast for the past 24 months.
The impatient investor wants an 8% return every single year and to see a nice rise in their account every single quarter. The only person that was able to accomplish that was Bernie Madoff and we now know how he did it. The impatient investor will not be able to stick with a globally diversified portfolio and will move their money at the precise wrong time to a more U.S.-centric stock portfolio because it seems to be “working” better right now. The impatient investor will abandon a well-thought-out diversified portfolio and find the one investment “guru” that advised putting all of your money in FANG stocks in 2015 and then fortuitously moved 100% of the portfolio to gold miners and emerging markets at the turn of the calendar year. Eventually this “guru” will be painfully wrong and the impatient investor will sell his investments for a loss and chase whatever seems to be “working” again.
The World and Markets are Unpredictable
As I write early on a Saturday morning, it is supposed to be raining. The weather app on my phone said there was going to be a 60% chance of rain this morning when I went to bed. When I woke up this morning, it had gone down to a 0% chance. In 1995 the World Meteorological Organization estimated that the global budget for weather services was about $4 billion and they still can’t predict the weather only one day out.
The Fortune Sellers by William A. Sherden is one of the most influential books I have ever read. His book covers everything from weathermen to economists to hurricane modeling. We all want to believe that there is an expert out there who knows what is going to happen. We want to believe that Janet Yellen and the world’s central bankers can guide our economy and know what they are doing. The reality is that there are too many variables and the nature of the future is that it is largely unpredictable.
How did Sony Corp., the maker of the Walkman, not see the iPod coming? How did Kodak invent the digital camera in 1975 and still go bankrupt? How did the brilliant founder of IBM Corp. say “I think there is a world market for maybe five computers in 1943”? Next time you want to take action with your portfolio based on a prediction watch this compilation of Ben Bernanke’s comments on why we were not in a housing bubble in 2005 and 2006. (For more, see: The Legacy of Ben Bernanke.)
I have followed a lot of gurus over the years that have been trotted out on financial television to be asked what is going to happen to markets over the next few months. Some of them have been uncannily right for a few years and then out of the blue their streak is over and they start to make bad calls. It is better to have a well-thought-out diversified portfolio than to follow the guru of the day’s “expert predictions.”
Active Management and Stock Pickers
Let me tell you a dirty secret about the money management industry: it is fairly easy to get licensed to become a stock broker or financial planner. The hard part is building up your clientele, and therefore most training programs are 75% sales training and only 25% actual financial planning. I had to memorize word for word almost 20 pages of a sales script or I would have been fired from my first job in this business.
There is also no book, academic study or special class that financial advisors go to that shows them how to find the next George Soros or David Tepper. Morningstar Inc. has built a very large business around rating mutual funds from one to five stars and even they admit: “The expense ratio is the most proven predictor of future fund returns.” Most financial advisors will tell you they chose XYZ mutual fund because of process of the company, the consistency of the style, or the integrity of the manager. The reality is that most funds are chosen by recent performance and later switched out for funds with better recent performance by the advisor or the advisor’s fear of losing a client. (For more, see: George Soros: Success Story.)
Please take a few minutes to read the first few pages of the most recent SPIVA® US Report Card. On page five you can see what percentage of U.S. mutual funds underperformed their benchmarks over the last 10 years. According to Standard & Poor's, the author of the report, 82.14% of large-cap funds lost to the S&P 500, 89.16% of small-cap core funds lost to the S&P 600, and 86.08% of REIT funds underperformed the S&P US Real Estate Investment Trust over the last 10 years.
I have listened to many a portfolio manager in my day. They are impressive people with perfect backgrounds that will blow you away with their uncanny ability to memorize every interest rate move the Central Bank of Brazil has ever made and speak fluently about why they think the Turkish lira/Japanese yen cross trade is the most obvious “fat pitch” in the market today.
Larry Swedroe and Andrew Birken explain in the Incredible Shrinking Alpha that the underperformance of so many managers is not because they are dumb, but because of how insanely competitive the money management industry has become. The possibility of riches has attracted the best and brightest people in the world to the asset management business. As they all battle it out to try and make the best risk-adjusted returns, they make it very difficult to beat the averages. (For more, see: Active Management: Is It Working for You?)
Although nobody wants to be average, most of the peer-reviewed academic research will tell you that most investors are way better off owning low cost index funds and sitting on them for years. When I see that only about 20% of mutual funds are beating their index over the last 10 years, I realize that the odds are not in my favor of finding the unicorn manager in every single asset class I want to own. By buying the index, I expect to beat about 4 out of 5 mutual funds for each asset class that I own. I would not be disappointed toward the end of my life to learn that I had beaten 4 out of 5 funds for my entire investing career.
The things I have come to know is not what sells ads on financial television. They are really quite boring and simple, but very hard to implement. We are innately attracted to things like the headlines in January of 2016 that advised us to sell everything. How’s that working for you? We often think that taking action is the most prudent move for our investments when in reality being diversified and having a strategy that is short-term boring and long-term rewarding is the best path for most. (For more, see: Using Indexed Universal Life for Retirement Income.)
The foregoing content reflects the opinions of Domestique Capital LLC and is subject to change at any time without notice. Content provided herein is for informational purposes only and should not be used or construed as investment advice or a recommendation regarding the purchase or sale of any security. There is no guarantee that these statements, opinions or forecasts provided herein will prove to be correct. All investing involves risk, including the potential for loss of principal. There is no guarantee that any strategy will be successful.