Because We See What We Want to See When It Comes to Investing
I recently read some of the recaps from the John Bogle C. Legacy Forum, which was held in January of this year. The forum, which was a gathering of our nation’s investment leaders to celebrate John C. Bogle’s 60th anniversary in the financial field, had a theme which was discussed throughout the day. The theme, aside from a celebration of Bogle’s many contributions to the financial industry was, “Restoring Investor Trust in Financial Markets.” This brought up numerous conversations on fiduciary stewardship and took a look at what has to be accomplished in order to correct the current evils of the system.
Product simplicity, low cost, fees that are clear, transparent and easy to understand, and the future of fiduciary duty were all discussed during the session. Great topics but as we all know, there’s a long road ahead in order to achieve that.
One thing that occurred to me while reading the highlights had to do with a statement made by David Swensen, chief investment officer of Yale University’s fund and author of, Unconventional Success: A Fundamental Approach to Personal Investment. Now, David Swensen’s statement is absolutely spot-on, but I couldn’t help think of the filter that many investors have today and what they could read into it. Here’s the statement:
“Unless an investor has access to incredibly high-qualified professionals, they should be 100% passive. This includes almost all individual investors and most institutional investors.”
Later, in an NPR interview, David Swensen expounds on this viewpoint by saying, “When you look at the results on an after-fee, after-tax basis, over reasonably long periods of time, there’s almost no chance that you end up beating the index fund.”
What is he saying? Putting the two statements together, I nod my head in agreement, fully realizing that investors don’t have access to “incredibly high-qualified professionals” because there are no such gurus. No one can predict the future and actively managed funds are always a recipe for financial ruin. I picture all the unnecessary fees that are siphoned right out of investor’s accounts and directly into the “highly qualified professionals” pockets. Unfortunately that’s not what everyone thinks when they read David Swensen’s statement.
Seeing What You Want to See
The average investor who is experiencing the excitement of the possibility of financial gain but who doesn’t have an understanding of the way markets operate will probably see this in Swensen’s statement:
“Unless an investor has ACCESS TO INCREDIBLY HIGH-QUALIFIED PROFESSIONALS they should be 100% passive. This includes almost all individual investors and most institutional investors.”
That bit about “this includes almost all individual investors” almost becomes like the fine print in the mutual fund advertisement spec sheet. Why? Because the truth is that most individual investors don’t think they are to be included in the majority. In fact, reading the statement above will actually encourage some investors to believe they can indeed find incredibly high-qualified professionals with inside information and insights. And guess who is cheering on that thought? Their brokers and advisors. The very ones who are going to have their hand in the pocket of that investor as soon as they can sell him an actively managed fund will assure him that their company is indeed the one that David Swensen speaks of…”the one with the incredibly qualified professionals.”
The bottom line is that we see things through the filter of “how we want them to be.” It’s a very dangerous filter and in order to get on the right path of investing, we must be willing to adjust our perspective.
Performance Chasing Investors
Viewing things the way we’d like them to be or fueling a false sense of hope is what the mutual fund marketing campaigns rely on when they tout past performance or set one of their adivsors on the forefront as the latest, hottest mutual fund expert.
The advice by David Swensen is also likely to be used by mutual fund companies in their future campaigns. I can see it now: “Yes, you should remain passive if you don’t have the highly qualified professionals that our XYZ mutual fund company has.” They will tickle the ears of uneducated investors and the cycle of high fees, low returns will continue.
The Center for Research in Security Prices database of all mutual fund managers provides the real deal when we’re on the hunt for a highly qualified mutual fund manager. When looking at all the managers in the database, the average alpha, or return of a portfolio beyond what can be explained by exposure to risk, is -1.5% for the ten year span between 2000 and 2010. That’s a negative number, by the way. With this, and all the other evidence proving that mutual funds are a loser’s bet in every way, why do some still think that they will beat the averages and somehow locate the right mutual fund manager? From my opinion, it’s a basic lack of understanding of how markets work, coupled with our society’s romantic attachment to the advertisement industry. We would do well to absolutely refuse to view any form of advertisements whatsoever. Can you imagine what a clear understanding each of us would have if we had to do the digging for ourselves instead of allowing the marketing industry to spoon feed us whatever it wants us to believe?
More Fuel for Our Pipe Dreams
Advertisements aren’t the only offenders in this game. Sometimes journalists will become starry-eyed about a particular “professional” and once again help us to believe that it’s possible to beat the market by having the right stock picker.
Back in November of 2006, Fortune magazine published a piece entitled: The Greatest Money Manager of Our Time, which did nothing but tout the wonders of Bill Miller, fund manager for Legg Mason Value Trust. At the time it had 20 billion in assets. The author of the article, Andy Serwer applauded Miller’s ability to outperform the market for 15 years, even through the tech bull market, the crash and the recovery.
Yes, Miller was living the ultimate investment guru life at the time. With a yacht named Utopia that had its own gym, Jacuzzi and heliport, over $250 million in Legg Mason stock, and annual earnings of over $130 million in revenues generated by his fund, he seemed like the ultimate success story.
Unfortunately his winning streak came to a screeching halt in 2005, but instead of reporting the facts as they were, Serwer continued to boast about Miller, guiding investors not to lose hope in his abilities. Serwer compared Miller to Joe DiMaggio and his famous 56 game hitting streak. Yes, DiMaggio’s streak ended but he then started another streak which lasted 16 games. Serwer was certain that Miller was among this rare breed.
Well, that all sounds enchanting, but the story doesn’t end well. If you happened to follow Serwer’s extremely filtered viewpoint, you were in for a rough ride. The fund gave back all of the outperformance that was gained, including a loss of 55% in 2008.
What’s the Answer?
So, how do we effectively protect ourselves from viewing investment possibilities through the “I’ll believe whatever you tell me” filter? With knowledge. The number one fact to remember when it comes to actively managed funds is that the fees involved, (you know, the ones that bought a yacht named Utopia for Miller), provide an almost impossible barrier to overcome when it comes to earnings. The hidden and undisclosed fees will eat at your returns, chipping your balance away over the years. With that fact in the forefront of your thinking, it doesn’t really matter if there is a magical guru or not. The benefits of a winning streak will be transferred from your account right into the pockets of the “guru” and his company.
Don’t try to find those “incredibly high-qualified professionals” with the shiny track records. First of all, you won’t find them. But also, by looking for the stock-pickers and gurus you are focusing on the wrong thing. Instead, invest in a broadly diversified portfolio in an asset allocation appropriate for you. Cut out the fees and hidden costs. Demand transparency and refuse to work with anyone but a fee only registered investment advisor. Look past the hype and the advertisements and take ownership of your financial future.
Bryan Binkholder, The Financial Coach, is a catalyst for change in the financial industry. With a true passion to make a difference, Bryan offers practical insights on financial topics, investment strategies, and business success. As a business advisor, motivational speaker and author, Bryan is best known for exposing the inner workings of Wall Street and bringing clarity to common investment misconceptions. Be sure to take advantage of his two most popular resources: 7 Deadly Traps of Investing and The Six Pitfalls of Retirement Planning and look for his latest book, 401(k) Conspiracy, authored with Jim Winkelmann of Blue Ocean Portfolios. If you are a business owner, plan sponsor, or 401(k) plan participant, you’ll want this information.