I’m more and more amazed by how much time and how much money is spent and earned on the process of figuring out what people should invest in and how to make the investment. Most of that time is trying to differentiate an investment strategy so that it’s easier to convince people to pay for it.
And to what end? Are these investment strategies successful? Are they improving the financial well being of the people who are paying for them?
Comparing them against a benchmark is the typical way in the financial services industry. The most popular benchmark comparison is the S&P 500 which is roughly the 500 largest publicly traded companies in the U.S. So how do the financial professionals stack up against the S&P 500. Not very well.
As friend recently pointed out, “there are a few who have beaten the S&P 500, even after fees, but they are few and far between over a long period of time”
A recent study concluded that. “Over the 15-year period ending Dec. 2016, 92.15% of large-cap, 95.4% of mid-cap, and 93.21% of small-cap managers trailed their respective benchmarks, as reported by this recent study”
So in the end everything is NOT ok. Over the long term most investors have made about 2-3% per year while the S&P 500 (and other whole market benchmarks) has made more like 8%.
Why are we all being left out in the cold. Partly our own doing, and partly the industry’s fault. Two terms sum up the problem. Modern Portfolio Theory and Alpha. The former is the theory that drives almost all retirement investing today. It’s doesn’t really matter what it means because at this point because it has become a great sales tool for the financial industry to sell their expertise to clients through a nice colorful chart that shows the change of possible returns versus the possible risk taken, so clients keep changing adviser’s and strategies. I have yet to meet someone who has stuck to their original chosen trajectory or the adviser who presented it to them for long enough to realize the intended goal. I’m sure they are out there but like those managers who have beaten the S&P 500, they few and far between.
And Alpha is the term for how much you can beat the benchmark by driven by the insatiable appetite for more. And the result is Enantiodromia, a psychology term modernized by Carl Jung. He said that if an extreme one sided tendency dominates conscious life, eventually the opposite happens. Whether Jung would agree that his theory has anything to do with personal finance or not he would certainly say there is no such thing as coincidence.
In our quest for Alpha, or trying to improve our risk/reward we end up selling low and buying high.
Since the saying goes “In the end everything will be ok”, how do we make it so.
Put your rainy day fund in a money market account or short term treasury fund. Buy the S&P 500, Vanguard Total Stock Market fund or something like it, hit the “reinvest dividends”button (because doing so makes a big difference in the end) and go back to work. You will increase your Alpha by adding more savings to your investment account and reducing the fees you pay to the financial services industry.
See for yourself. Use this application to back-test your portfolio or a portfolio being proposed to you.
Your financial adviser, consultant, guru, planner, coach should be helping your understand the benefits of saving and a concierge to financial services. Make sure you are getting what you pay for!
Next article will be a discussion of what do if social and environmental responsibility is Important to you when investing.