The Stunning Odds That Can Doom Your Returns
- Created on Sunday, 31 May 2015 19:00
By Dan Solin
Few investors understand the stunning odds that are likely dooming their returns. The system is rigged against investors and in favor of those who “manage” their money. Active mutual fund families, brokers and insurance companies are the big winners in this process. Investors barely scrape by.
Here’s some historical data for your consideration. It may fundamentally change the way you invest.
Overview of the mutual fund industry
Most of you probably invest in mutual funds. Since 2000, assets under management in these funds have grown more than 213 percent. The number of funds available in the marketplace has increased by 46 percent. By the end of 2014, there were more than 5,200 U.S.-based mutual funds, collectively managing about $10 trillion in shareholder wealth.
With such a broad array of choices, selecting the mutual funds that are optimal for your portfolio can be a daunting experience. Many of you rely on brokers and insurance companies for guidance. Part of their standard sales pitch is that they have the ability to recommend mutual funds likely to “beat the market” by outperforming a standard benchmark (like the S&P 500 index).
The odds of surviving
Despite the SEC-mandated warning that “past performance is not necessarily indicative of future results,” brokers frequently tout past performance and imply that it’s likely to continue into the future. It’s easy to identify managers with stellar track records. Unfortunately, past outperformance often does not persist.
For fund-picking brokers, the initial hurdle is not identifying outperforming actively managed mutual funds. It’s a far lower bar. Selecting funds that will simply survive over a long period of time is far more difficult than you might imagine.
Most mutual fund investors plan to hold their funds for at least 15 years, which makes long-term data meaningful. For the 15-year period ended Dec. 31, 2014, only 42 percent of stock funds in existence at the beginning of that timeframe managed to survive until the end of it. The survival rate of fixed income funds was about the same.
The next time your broker recommends a stock or bond mutual fund, ask this question: “How likely is it that this fund will survive for 15 years?” Run for the door if the response is anything other than, “It’s more than likely the fund I’m recommending will not survive that entire period.”
The odds against outperformance
Let’s assume you were one of the few lucky investors. You beat the odds and the mutual fund you, or your broker, selected at the beginning of the 15-year period managed to survive. How likely is it that your stock or bond fund outperformed its benchmark over that entire 15-year period?
This is a significant issue. If your fund did not outperform, you would have been better off in a low management fee index fund.
For the 15-year period ended Dec. 31, 2014, only 19 percent of stock mutual funds and 8 percent of bond funds survived and outperformed their benchmark. Those are depressing odds.
Winners don’t persist
It would be easy to pick a winning mutual fund if you could rely on past performance. Unfortunately, as the evidence indicates, you can’t. Mutual fund families, however, spend vast quantities of marketing dollars extolling the track record of funds that beat their benchmark. Don’t be fooled.
For the period from 2000 through 2009, 25 percent of stock funds that survived managed to beat their benchmark. There were a total of 682 “winning” funds in this category. Perhaps your broker made a compelling case that the long track record of outperformance achieved by these funds was an excellent reason for buying them. If you fell for this pitch, you likely would have been disappointed. For the subsequent period, from 2010 to 2014, only 28 percent of those funds repeated their outperformance.
The data was better for bond funds. While only 7 percent of bond funds both survived and outperformed during the period from 2000 through 2009, 52 percent of the outperformers beat their benchmark for the subsequent period from 2010 to 2014.
Costs matter
If you are looking for one factor likely to determine whether a fund will outperform, focus on its costs. Because costs reduce your net return, a fund has to add sufficient value to exceed its costs. Costs can include not just expense ratios, but also trading costs and bid-ask spreads.
Over the 15-year period ended Dec. 31, 2014, 29 percent of lower-cost stock funds outperformed, compared to only 9 percent of more expensive stock funds. Only 11 percent of the lower-cost fixed income funds outperformed. That’s compared with 2 percent of the more expensive funds.
Here’s the bottom line: costs matter. You may be able to reduce the odds of picking a persistent loser by avoiding expensive, actively managed funds.
The takeaway
The harsh reality is that the vast majority of actively managed funds are unable to outperform their benchmarks. Funds that do are often unable to repeat their outperformance over extended periods of time.
The odds are stacked against you if your investing strategy is premised on your ability to find a “winning” mutual fund. The hurdle of high fees, high turnover and other costs will make your chances of finding this needle in a haystack daunting and unreliable.
Instead of engaging in this often fruitless exercise, and enriching your broker and mutual fund family in the process, consider purchasing only low management fee index funds as part of a globally diversified portfolio arranged in a suitable asset allocation. By doing so, you’ll increase the odds of achieving your retirement goals.
It’s time to switch the odds in your favor.
This commentary originally appeared May 12 on HuffingtonPost.com
Copyright © 2015, The BAM ALLIANCE. This material and any opinions contained are derived from sources believed to be reliable, but its accuracy and the opinions based thereon are not guaranteed. The content of this publication is for general information only and is not intended to serve as specific financial, accounting or tax advice. To be distributed only by a Registered Investment Advisor firm. Information regarding references to third-party sites: Referenced third-party sites are not under our control, and we are not responsible for the contents of any linked site or any links contained in a linked site, or any changes or updates to such sites. Any link provided to you is only as a convenience, and the inclusion of any link does not imply our endorsement of the site.
The Stunning Odds That Can Doom Your Returns
- Created on Sunday, 31 May 2015 19:00
By Dan Solin
Few investors understand the stunning odds that are likely dooming their returns. The system is rigged against investors and in favor of those who “manage” their money. Active mutual fund families, brokers and insurance companies are the big winners in this process. Investors barely scrape by.
Here’s some historical data for your consideration. It may fundamentally change the way you invest.
Overview of the mutual fund industry
Most of you probably invest in mutual funds. Since 2000, assets under management in these funds have grown more than 213 percent. The number of funds available in the marketplace has increased by 46 percent. By the end of 2014, there were more than 5,200 U.S.-based mutual funds, collectively managing about $10 trillion in shareholder wealth.
With such a broad array of choices, selecting the mutual funds that are optimal for your portfolio can be a daunting experience. Many of you rely on brokers and insurance companies for guidance. Part of their standard sales pitch is that they have the ability to recommend mutual funds likely to “beat the market” by outperforming a standard benchmark (like the S&P 500 index).
The odds of surviving
Despite the SEC-mandated warning that “past performance is not necessarily indicative of future results,” brokers frequently tout past performance and imply that it’s likely to continue into the future. It’s easy to identify managers with stellar track records. Unfortunately, past outperformance often does not persist.
For fund-picking brokers, the initial hurdle is not identifying outperforming actively managed mutual funds. It’s a far lower bar. Selecting funds that will simply survive over a long period of time is far more difficult than you might imagine.
Most mutual fund investors plan to hold their funds for at least 15 years, which makes long-term data meaningful. For the 15-year period ended Dec. 31, 2014, only 42 percent of stock funds in existence at the beginning of that timeframe managed to survive until the end of it. The survival rate of fixed income funds was about the same.
The next time your broker recommends a stock or bond mutual fund, ask this question: “How likely is it that this fund will survive for 15 years?” Run for the door if the response is anything other than, “It’s more than likely the fund I’m recommending will not survive that entire period.”
The odds against outperformance
Let’s assume you were one of the few lucky investors. You beat the odds and the mutual fund you, or your broker, selected at the beginning of the 15-year period managed to survive. How likely is it that your stock or bond fund outperformed its benchmark over that entire 15-year period?
This is a significant issue. If your fund did not outperform, you would have been better off in a low management fee index fund.
For the 15-year period ended Dec. 31, 2014, only 19 percent of stock mutual funds and 8 percent of bond funds survived and outperformed their benchmark. Those are depressing odds.
Winners don’t persist
It would be easy to pick a winning mutual fund if you could rely on past performance. Unfortunately, as the evidence indicates, you can’t. Mutual fund families, however, spend vast quantities of marketing dollars extolling the track record of funds that beat their benchmark. Don’t be fooled.
For the period from 2000 through 2009, 25 percent of stock funds that survived managed to beat their benchmark. There were a total of 682 “winning” funds in this category. Perhaps your broker made a compelling case that the long track record of outperformance achieved by these funds was an excellent reason for buying them. If you fell for this pitch, you likely would have been disappointed. For the subsequent period, from 2010 to 2014, only 28 percent of those funds repeated their outperformance.
The data was better for bond funds. While only 7 percent of bond funds both survived and outperformed during the period from 2000 through 2009, 52 percent of the outperformers beat their benchmark for the subsequent period from 2010 to 2014.
Costs matter
If you are looking for one factor likely to determine whether a fund will outperform, focus on its costs. Because costs reduce your net return, a fund has to add sufficient value to exceed its costs. Costs can include not just expense ratios, but also trading costs and bid-ask spreads.
Over the 15-year period ended Dec. 31, 2014, 29 percent of lower-cost stock funds outperformed, compared to only 9 percent of more expensive stock funds. Only 11 percent of the lower-cost fixed income funds outperformed. That’s compared with 2 percent of the more expensive funds.
Here’s the bottom line: costs matter. You may be able to reduce the odds of picking a persistent loser by avoiding expensive, actively managed funds.
The takeaway
The harsh reality is that the vast majority of actively managed funds are unable to outperform their benchmarks. Funds that do are often unable to repeat their outperformance over extended periods of time.
The odds are stacked against you if your investing strategy is premised on your ability to find a “winning” mutual fund. The hurdle of high fees, high turnover and other costs will make your chances of finding this needle in a haystack daunting and unreliable.
Instead of engaging in this often fruitless exercise, and enriching your broker and mutual fund family in the process, consider purchasing only low management fee index funds as part of a globally diversified portfolio arranged in a suitable asset allocation. By doing so, you’ll increase the odds of achieving your retirement goals.
It’s time to switch the odds in your favor.
This commentary originally appeared May 12 on HuffingtonPost.com
Copyright © 2015, The BAM ALLIANCE. This material and any opinions contained are derived from sources believed to be reliable, but its accuracy and the opinions based thereon are not guaranteed. The content of this publication is for general information only and is not intended to serve as specific financial, accounting or tax advice. To be distributed only by a Registered Investment Advisor firm. Information regarding references to third-party sites: Referenced third-party sites are not under our control, and we are not responsible for the contents of any linked site or any links contained in a linked site, or any changes or updates to such sites. Any link provided to you is only as a convenience, and the inclusion of any link does not imply our endorsement of the site.
At an Impasse but Finding a New Path
- Created on Sunday, 24 May 2015 19:00
By Carl Richards
“I can’t believe you see it that way!”
Just last week, I said this to my wife in the middle of a discussion (O.K., a fight) about money. We were experiencing something many of you have probably also faced. We needed to make a very important financial decision about how much of an emergency fund we wanted to maintain before we built a house, and we were both locked into our way of seeing it. I saw it my way and wanted more of a safety net. She saw it her way and needed much less of a backstop. Neither of us thought the other person was making any sense. We were at an impasse.
The fight dragged on for a couple of days, and then led to a discussion with some friends. As a result of these discussions, we started to believe that there might be a third way.
The third way will make a lot more sense if we first understand why we end up in “my way” versus “your way” arguments. It comes from being human and struggling with confirmation bias. Most of us make a decision and then after we have already decided, we do the research. What’s more, the research we do consists of gathering data that agrees with our position and summarily dismissing anything counter to it.
Once the “research” is done, we’re often stuck. We’ve put a stake in the ground and said, “This is my way.” At that point, it’s really hard to back down because now we have ego wrapped up in our decision. Being open to someone else’s way or even a third, alternative way means being open to change, and change can be painful. It also means that we have to be open to the possibility that we might actually be wrong, and that’s really hard for us to do.
A true third-way solution is not the same as a negotiated solution. Negotiation involves meeting in the middle. Each party gives a little (or a lot) and no one ends up entirely happy with the outcome. Negotiating solutions to money problems is often necessary, but it’s not a third-way solution.
Negotiated solutions are about in between; third-way solutions are about better. A third way is an alternative that we hadn’t thought of before, that both parties are thrilled with. Nobody feels like they gave in. Instead, there’s shared excitement.
Like many good things, finding a third-way solution is simple, but not easy. It requires a conversation, often a series of them, which have one very important ground rule: We have to listen to each other. This isn’t your fake, “Yeah, I’m listening.” It’s real, intense listening.
My friend, Scott Kelly, who is a wellness coach in Park City, Utah, describes it as listening with intense curiosity. We need to be interested in really understanding the other person. Before anything can change, before we can let go of the ground we’re defending, we need to understand the other person’s view completely.
Your goal should be to enter their world and see it through their eyes. Start by asking questions, like, “Help me understand why you see things that way,” and “I want to understand your way because I love you/I trust you/I respect you.” Whatever questions you ask, make sure they aren’t just an attempt to cross-examine the other person enough so that they give up and come to your conclusion. Both parties have to play by the rules. Ask a question to understand, and then listen with intense curiosity.
Real understanding only happens if you can listen without judging. We need to remember Stephen Covey’s warning that “most people do not listen with the intent to understand; they listen with the intent to reply.” It’s really hard to listen (and understand) if we’re mentally busy crafting a rebuttal.
Maybe this discussion happens right after an argument. Maybe you need to take a break. But when you decide to re-engage, both parties need to do it with respect. Only then will you be able to look past the territory you’ve staked out to see a possible third way.
I’ve seen this work with everyone from children to business partners. And it worked with my wife and me too. As we listened to one another, we realized that I was having trouble even conceptualizing the amount of money that would give me the security I craved, given the problems we had the last time we owned a home. So instead, we focused on structuring savings in a way that it at least stood a decent chance of feeling like “enough.”
So it was a guess. But my wife did helpfully remind me that someone with my name just wrote a book that made the case for taking a guess when setting financial goals.
This commentary originally appeared May 4 on NYTimes.com
Copyright © 2015, The BAM ALLIANCE. This material and any opinions contained are derived from sources believed to be reliable, but its accuracy and the opinions based thereon are not guaranteed. The content of this publication is for general information only and is not intended to serve as specific financial, accounting or tax advice. To be distributed only by a Registered Investment Advisor firm. Information regarding references to third-party sites: Referenced third-party sites are not under our control, and we are not responsible for the contents of any linked site or any links contained in a linked site, or any changes or updates to such sites. Any link provided to you is only as a convenience, and the inclusion of any link does not imply our endorsement of the site.