Year End Investment Advice: No… Active Management Strategies STILL Don’t Work

Sometimes it takes a while for individuals to see the light on certain topics. Active management with investments is one of those topics. Often, investors become so polluted with incorrect information that it takes a while to realize all the misinformation they’ve been buying into. As a business advisor, motivational speaker, and radio host of The Financial Coach Show, I spend a lot of time unraveling the mistruths put out there by financial planners, wealth managers, (and other financial titles) who are pushing financial products to trusting and often uneducated investors. I don’t like to see people taken advantage of, especially with their life savings.

Last week’s CNBC news ran an article entitled “Market Pros Had a Bad Year” in which they poked fun at mutual fund managers who should be expecting coal in their Christmas stockings as a result of their poor performance. Although this was meant as a joke, there are countless investors who believed in the active management lie who aren’t feeling as jovial about the situation.

According to Bank of America Merrill Lynch, only 23 percent of large-cap managers beat the Standard & Poor’s 500 and 27 percent outdid the Russell 1000. Mark Lamkin, CEO and chief investment strategist at Lamkin Wealth Management had this to say about active management, “We like to move on trends. You take the last couple of weeks, we had some really hot days and we missed it. All of a sudden we’re underperforming by a couple percent. Headline risk beat the hell out of us.”

Is Headline Risk to Blame?

Wait, what’s headline risk and why are the wealth managers using it as a scapegoat?

Headline risk can be defined as the risk that unexpected world events and the associated media coverage (headlines) will have when it negatively impacts their holdings. News such as fighting in Libya, catastrophic weather events, or unrest in the Middle East are examples of the way headline risk affects the market.

But is it actually the news event and the corresponding coverage that is affecting the stock prices? No. In reality, the true danger doesn’t lie in headline risk but instead in the emotional reaction to the events that cause individuals to become anxious or fearful.

The Glaring Flaws in Active Management

Besides the fees involved in active management, which should be enough to turn investors the other way, other obvious flaws lie in the potential for human error. You can see for yourself that when the sale is being pushed, there’s nothing but confidence and promises made. “Active management provides the clear advantage,” financial advisors will tell you. Newspaper advertisements attempt to build trust with 4 and 5 star ratings along with past performance claims. It’s all in an effort to portray actively managed funds as a safe haven and obvious choice.

Sounds good in theory, except for the fact that stock picking doesn’t work, regardless of who you are. And what happens when things go poorly, as they often do? Well, there’s the unstable economy to blame, headline risk, or whatever other excuse.

The article did offer some practical advice in this paragraph, “For investors, this year also posed the question of whether it was worth it anymore to pay for active mangers to pick stocks, or if they would just be better off going it alone with some simple fund picks based on the movement of broad market indices.” Yes, that is the perfect advice for investors as a matter of fact.

Want some additional sound advice? Here are some quotes on the topic by some of my favorites:

“In the world of investing, there are very, very few sure things. But the closest thing to a sure thing is that the Wilshire 5000 index will outperform actively-managed funds by 1.5 to 2 percentage points a year over a sustained period.”  — Jack Bogle

“There can be no question that indexng, for most categories of taxable investor and for most market conditions, will outperform conventional active management.” — Robert Arnott

“Of 355 stock funds in existence 30 years ago, 189 failed even to survive. And only 14– roughly one in 25–beat the return of the stock market as a whole by as much as a percentage point a year on
average.” — Jack Bogle

“As a group, investors in U.S. stocks can’t outperform the market because, collectively, they are the market. In fact, once you figure in investment costs, active investors are destined to lag behind Wilshire 5000-index funds, because these active investors incur far higher investment costs.” — Jonathan Clements

“Indexing is a marvelous technique. I wasn’t a true believer. I was just an ignoramus. Now I am a convert. Indexing is an extroardinarily sophisticated thing to do.” — Douglas Dial

“Why waste your time trying to select and manage a portfolio of individual stocks when you can replicate the market average returns (and beat the majority of professional money managers) through an exceptionally underrated and underused investment fund call an index fund?” — Eric Tyson

“Most investors, both institutional and individual, will find that the best way to own common stocks is through an index fund that charges minimal fees. Those following this path are sure to beat the net results (after fees and expenses) delivered by the great majority of investment professionals.” — Warren Buffet

“Over the past 30 years, a $10,000 investment in the S&P 500 index would have grown to $311,000 (after expenses); in the average general equity fund the same investment would have grown to $17l,950.” — Burton Malkiel

“Over the long term the superiority of indexing is a mathematical certainty.” — Jason Zweig

Think The Current Economy is to Blame?

Maybe you think it’s all because of today’s economic climate. If so, here are a few quotes from the late 90′s.

Your Money (6-1997): Only three out of 25 brokerage houses surveyed by the ‘Wall Street Journal’ have beaten the market over the past five years.

Forbes (6-14-1999): According to data from Morningstar, Inc., index funds have beat their actively-managed counterparts in the past one, three, and five years.

Morningstar Q&A (6-3-1999): Question: How many U.S. diversified equity funds have beaten the S&P 500 during the past five years AND have been less volatile than the index?
Answer: Three funds that are open to new investors carry better five-year returns and lower standard deviations. None of these funds outlegs the index on an after tax basis.

Consumer Reports (3-1998): Without high-priced market wizards to manage them, the index funds have outperformed 97% of actively managed funds in each of the last three years.

Fortune (3-15-1999): Fewer than 20% of all equity funds outperformed the unmanaged S&P 500 index in the past year. The percentage drops to 11% over ten years and to 4% over a 15 year stretch.

For more information on prudent investment strategies, we invite you to access the free resources available on our site. We want you to know that markets DO perform and there is a PROVEN and SIMPLE method of investing that works.

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.

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