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You Can Beat the Pros

You Can Beat the ProsIf there was only one idea that I could convey to you, it would be this: Do not leave the responsibility for your financial livelihood in the hands of others. Not only is it completely inappropriate, but you can do much better than the so called “professionals.”

I realize this is a bold claim and requires further explanation. We’re going to attack this from a few different angles.

They Want You to Stay Out

Most people who are new to investing and the financial markets become easily overwhelmed. This is not surprising considering that much of the financial industry is designed to confuse and confound outsiders.

This is done on purpose. Information has always been and will always be a commodity. By eclipsing basic concepts with complicated and intimidating terminology, financial professionals make themselves out to be the gatekeepers of the world of investing.

Most of this is BS. If you understand basic math and have the ability to assess emotional states such as euphoria, fear and greed, you can be a very successful investor.

Yes, it’s possible to make investing extremely complex, but I’m going to let you in on a little secret: Those who use the KISS principle – keep it simple, stupid – consistently outperform their quantitative, borderline autistic counterparts. This is because at the end of the day, financial markets are made up of people, and people are emotional and relatively predictable.

In fact, an entirely new area of study, behavioral finance, has crept up over the last decade and is helping shed tremendous light on the nature of financial markets. In today’s financial environment, a working knowledge of psychology can be much more valuable than being able to explain options pricing models or run a discounted cash flow (DCF) analysis.

The key to successful investing is seeing the big picture, and because so many professionals mire themselves in one specific area of expertise, they’re constantly seeing the trees and not the forest.

Don’t get me wrong, you will need partners on your journey, but handing your money over to someone else to manage is ludicrous. It becomes even more ludicrous when you dig deeper into the fees these professionals charge and the performance they attain.

Professional Investors Don’t Consistently Beat the Market

Let’s dissect this a bit further. Chances are you’d recognize the names of a few illustrious investors who have done exceptionally well over the years. You probably know who Warren Buffett is, and George Soros. You may have heard of John Paulson and his “Greatest Trade Ever.” But these household names are the exception and not the rule.

By and large, money managers do not outperform the market. Let me repeat that before I present evidence to back it up: Money managers as a group DO NOT outperform the market. In fact, they don’t even outperform index funds, which are extremely easy to invest in and available to investors of all shapes and sizes.

Year after year, decade after decade, evidence piles up that shows professional investors cannot consistently outperform the broader market.

Consider research recently released by Standard and Poor’s in their year-end 2013 S&P Indices Versus Active Funds Scorecard. This data compares the performance of actively managed mutual funds to their benchmark indices. For the five years ended December 31, 2013:

  • 73% of large-cap domestic funds underperformed their index
  • 78% of mid-cap funds underperformed their index
  • 67% of small-cap funds underperformed their index
  • 80% of REIT funds underperformed their indexes

Do you notice a trend? Rather striking isn’t it? This is the type of information the industry doesn’t want you to see. They don’t want you to see this because it’s going to make you wonder why you’re paying hefty management fees to earn less money than you could have made investing on your own.

Now let me provide the argument that active management proponents will bring up in response to this data. They’ll tell you that the real benefit of active management comes in down markets, not in rising markets like we had from 2009 -2013.

I’ll save you the anticipation … the majority of actively managed funds do not outperform the market in bear markets either. From 2007 to 2009, during one of the most horrendous bear markets in modern history, 54% of all actively managed funds failed to outperform the larger S&P 1500 index. So much for that argument.

I could quote dozens of other studies that mimic these results, but I don’t think that’s necessary. In another post I’ll also address the main challenges that these managed funds face, which inhibit their ability to outperform the market. (Hint: it’s not only about the fund managers and their stock picking, there are structural issues at play as well).

The Benefits Don’t Outweigh the Costs

Now let’s talk about the fees that unknowing investors pay for these subpar returns. The average expense ratio, a complete measure of all the various costs associated with a fund, is currently about 1.5%. That may not sound like a lot, but it adds up quickly, especially when you take into account compounding. A fund would have to consistently beat the market by at least 1.5% every year for an investment to simply break even when compared to alternatives. As you know by now, that simply is not the case.

The style of investing we promote at Model Investing is unique in that it provides a consolidated playbook that anyone, regardless of their profession, can deploy effectively in their spare time. Make our playbook part of your game plan, and you can stop being hustled by financial “professionals,” and beat them at their own game.

Posted in: Motivation

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