FINANCIAL INSIGHTS ARCHIVES (2013 Year)
Hindsight is 20/20
September 18th, 2013
By Matthew Petersen
Most everyone likes the idea of “winning big”, whether it be romanticizing about buying Microsoft in the 80s, Google in the 2000s, or winning the outrageous Powerball jackpot. That romance has a tendency to convince us that there is some way to create or duplicate those past successes experienced by others. The very same idea can be analogized with the acquisition of above average sports skills. If you’re a fantastic golfer today, what if you started earlier in life and spent more time playing golf and less time focused on school – how would your life be different? There is nothing wrong with romanticizing over these “what if” scenarios, but there is danger in developing a belief in their possible reality. The irrational exuberance of confidence in one’s ability to duplicate past investment success by either themselves or others is all too common throughout the investment world. Those individuals that seek out professionals to produce above market returns through conventional stock picking are only less disappointed than those whom invest for themselves. Some professionals do manage to outperform the general marketplace on a gross return basis, but once costs (trading cost, management costs, 12b-1 fees, fund expenses, etc) are accounted for the net return, on average, is either equal to or less than the general marketplace. The statistics for “do-it-yourself” investors are even worse. Chart 1[i] shows the percentage of active public equity funds that failed to outperform their respective indices over a five-year period (as of December, 2012). Over a ten year period (not shown), the percentage of actively traded funds that fail to outperform their respective indices increases. Chart 2[ii] shows the performance of an average individual investors over a 20 year Period (1993-2012) with an investment of $100,000, as you can see the individual investor greatly underperforms the S&P 500 Index.
These statistics would be less alarming if this methodology/practice of investing was in the minority, but, unfortunately, this active style of investing is best labeled as conventional with at least 87% of the financial industry operating in this capacity. The suitability standard by which these brokers and investment banks are held to allows them the ability to erode returns with high costs. If over 87% of the financial industry is acting in a capacity that is providing statistically poor performance relative to their cost and index then what is the best, most pragmatic solution?
First and foremost, work with an advisor that is held to a fiduciary standard, which means that they are legally obligated to work in your best interest, and not just in a suitable capacity. Next, the advisory firm should utilize an investment methodology that consists of structured portfolio construction. Structured portfolio construction focuses on asset allocation to produce greater risk-adjusted expected returns overall the long-term. This methodology applies Nobel Prize winning theorem of Modern Portfolio Theory to the real world by recognizing and adjusting to different style premiums, such as low price and small company stocks. Rebalancing provides a buy low, sell high opportunity that keeps a portfolio within the specific asset allocation mix and risk tolerance of the client. In simpler terms, this is not a buy and hold strategy, but one that works with the movement of the market and not against it. For a more in-depth explanation of how structured portfolio construction works, please contact a Petersen Hastings Wealth Advisor to schedule a complimentary Evidence-Based Analysis[iii] of your current portfolio.
[i] Source: Standard & Poor’s Indices Versus Active Funds Scorecard, year-end 2012. Index used for comparison: US Large Cap—S&P 500 Index; US Mid Cap—S&P MidCap 400 Index; US Small Cap—S&P SmallCap 600 Index; Global Funds—S&P Global 1200 Index; International—S&P 700 Index; International Small—S&P World ex. US SmallCap Index; Emerging Markets—S&P IFCI Composite. Data for the SPIVA study is from the CRSP Survivor-Bias-Free US Mutual Fund Database.