One of the most common questions we hear from prospective clients is which stock they should buy - or whether it is a good time to be in or out of the market. They ask for our recommendations about how to "buy low and sell high".
It sounds simple enough, but what this all means is that they are trying to beat the market. We understand the temptation; after all, Wall Street, the financial media, and even most investment professionals definitely want you to try. In fact, Wall Street and many investment firms spend most of their time and resources attempting to do just that!
However, we prefer that our clients understand the reasons behind Wall Street’s obsession with beating the market – and especially to understand why we feel it is a bad idea.
What are Active Management Financial Strategies?
Financial strategies based on attempting to gain income returns and greater capital gains than the S&P 500 – in other words, “beating the market” -- are known as active management. In a just world, active management would be called what it truly is: gambling. And, just like in a casino, the odds are overwhelmingly against you.
The unambiguous conclusion of countless empirical studies -- and our wealth advisors' decades of experience -- is that beating the market is the result of luck, not skill. That’s a big difference; if you’re looking for convincing proof that a single mutual fund has beaten the market through skill, you can stop now. It doesn’t exist. And while it’s true that a few may randomly beat the market through luck, Wall Street’s favorite scam is pretending that luck is skill.
Is Your Investment Professional a Lucky Duck?
So why does it matter if the results are based on luck or skill? Because unlike activities that require skill, knowledge and expertise, the outcomes of luck-based activities are unpredictable, unreliable, and uncontrollable – in other words, random. Do you really want to randomly invest your money?
A significant majority of all mutual fund assets are actively managed or, more accurately, mismanaged. The random, non-skill-based nature of the beat-the-market strategy has essentially turned actively managed funds into casinos. And in these casinos, investment professionals have maneuvered themselves into the enviable position of getting paid to gamble with your money.
Thanks in large part to this flawed approach, Wall Street is arguably the worst-performing sector in the economy. Consider that over the past three years ending in 2012, every category of actively managed domestic mutual funds failed to meet their benchmarks; in 2012, more than 85 percent of funds fell short. In no other part of the economy does there exist such a large discrepancy between what the consumer wants and is promised, and what they actually get.
The Greatest Obstacle to Your Financial Peace of Mind
Most investors’ overall goal is long-term financial peace of mind. Unfortunately, most Wall Street investment professionals lead investors in the opposite direction -- toward stress, confusion, excessive activity, and unnecessary risk.
How do wealth management firms get away with it? In other areas of the market, competition assures that most consumers get value for their expenditures, but on Wall Street, an unusual combination of factors and circumstances render the normal checks and balances moot.
Unfortunately, very few people know how to measure and evaluate the relative performance of investments, especially when it comes to mutual funds. Most investors aren’t even unaware that actively managed funds have under-performed the market as a whole. Index fund pioneer Rex Sinquefield summed up actively managed mutual funds and their managers by stating that, “If these guys were race horses, they’d be glue.” You’d think it would be easy to see which horse wins the race and which brings up the rear, but active fund managers consistenly and successfully hide their losing records.
So what’s the alternative? As with all endeavors, when it comes to investing, knowledge is power. As Benjamin Franklin said, “If a man empties his purse into his head, no man can take it from him. An investment in knowledge always pays the best interest.” In other words, the more you know about the workings of the market, the less likely you are to be a victim of unscrupulous practices.
Avoid financial advisors that base their investment strategies on beating the market. Instead, look for a wealth management firm that advocates for a holistic and passive approach to investing.