Track record is everything. I have often heard the popular phrase that “pass performance is no indicator of future results,” particularly in the investment world. I agree with this statement, and basing a decision on which mutual fund to invest in because of past performance is playing with fire. However, I would argue that pass performance becomes more meaningful the longer the money-manager is able to deliver on that performance. Investors should refrain from dumping funds for other funds in a futile attempt to increase their investment returns. That way is ruinous. Nevertheless there can be much said about money masters that have outperformed the indices for ten years or more. For me, there is a distinction between chasing funds’ performances and investing with proven masters. A term, John Train coined in his seminal book Money-Masters, as ‘reverse engineering’--a concept in which an investor invests on the coat-tails of master investors. It is like taking a math exam and having the answers in front of you. It is up to you to prove the answers right. And this can be very difficult in and of it-self. Without ‘proving’ the investment, an investor may not be confident enough to hold on to investments that possess the qualities of violent volatility. Having conviction in any investment is the key to success. A friend whom I respect very much recently asked me the ultimate question: why stocks? Why not go through the proven way of opening a small business and watching your net-worth grow? Although I dream of starting a small business one day, I feel marketable securities offer compelling opportunities due to the madness of crowd psychology. I have personally witnessed investors willing to sell assets at ridiculous prices in the stock market. Conversely, in the small business world, one is almost always dealing with rational businessmen who are less willing to sell their businesses at bargain prices. I agree with a lot of what John Bogle of Vanguard has to say about investing—that trying to beat the broad stock-market index is a very difficult task. (on a side note-for those that do not have a finance back ground--the stock market index is a grouping of companies trading in the stock market and when people site an ‘index’ they are usually referring to the S&P 500 Index. It comprises of 500 of the largest companies domiciled in the U.S. So if you were to invest in an S&P 500 index fund you are distributing your capital across these companies for diversification and simplicity purposes) In fact, Bogle argues, trying to beat this index would deter people from reaching their financial objectives. Bogle shares a parable that Warren Buffett wrote, in which, they ask readers to picture in their minds eye a fictional family called the Gotrocks. Now bear with me, I’m not the best story teller. These people, in this fictional tale, own the whole of American enterprise, and the family was happily earning 10% off of their businesses for hundreds of years. But one day, some of the brothers and sisters decided that they wanted a bigger piece of the pie, so they hired ‘helpers’ to trade their ownership of some of these businesses with other members of their family. The initial helpers got some of the Gotrocks more than their fair share of the business returns and with this success spawned on even more helpers to help the original helpers get an even bigger piece of the pie. But did the second, third, or forth set of helpers achieve their objectives of a greater return? No. As a result of all of these financial intermediaries, the family has seen its wealth depleted and has witnessed Wall Street own more of what the Gotrocks were rightfully heir to—the investment return of these great businesses. The first task for all investors is to invest their capital so as to have their capital keep up with and appreciate over inflation. Not a small task. Historically, inflation is at 3%. When investing in actively managed accounts (mutual funds), investors are paying the money-manager an additional 2% of assets. (1% for an advisory fee and roughly another 1% due to a higher turnover rate in the portfolio) Then, the investors would usually have to pay another 1-2% to the financial advisors who recommended the fund. All of a sudden, investors would have to earn 6% on their money just to break-even. To add insult to injury, most actively managed funds do not even outperform the S&P 500 index at all and reach that coveted return of 10%. Growing your money at only a 4% real rate of return and taking on all of the risks associated with investing in equities is a difficult pill to swallow. (10% U.S. stock market return minus 6% in fees and inflation=4% real return.) The laymen may not care about a few percentage point difference in performance and fees, but over the long term it is everything. For simplicity, think of it as your mortgage rate—how a 4% mortgage rate is a whole heck of a lot better than a 10% rate—a game changing difference. If you don’t have the inclination to approach the stock market as you would approach owning a small business, then do not. It will save a lot of energy, money and time by just investing in a broad market index, like the one John Bogle pioneered at Vanguard—The Vanguard SP 500 index fund. This fund charges a modest fee of .1% of assets. No one will really ever push this product too aggressively because there is virtually no financial compensation for the agent or for the brokerage houses involved in the transaction. So if you want to get wealthy over time invest in broad US and international stock index funds. Quoting Bogle when speaking about the financial industry as a whole: “It’s amazing how difficult it is for a man to understand something if he’s paid a small fortune not to understand it.”
Posted on: Wed, 17 Jul 2013 07:19:19 +0000
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