Our clients often have questions about the success rates of "Aggressive" versus "Passive" investing. Some investors feel that those who use the services of a highly active investment firm tend to earn higher returns. Is this true?
We certainly understand these questions; after all, the debate between proponents of active and passive investment strategies has been ongoing for almost half a century. But decades of empirical evidence support our firm's conviction that aggressive, active-management strategies employed by many investment professionals don’t work for most investors. Here’s why.
Should "Slow And Steady " Be Part Of Your Comprehensive Financial Plan?
Proponents of active management often parrot the refrain that passive investment amounts to settling for slower and "boring" results. For most of us, the thought of having boring returns isn’t acceptable; in fact, American culture in many ways denigrates it. But while this charge may score rhetorical points, what does “boring” actually mean in an investment context?
Is acceptance of market rates of return equivalent to "boring? And if so, what’s the alternative? What if boring -- like achieving par in golf (say, in the Masters at Augusta) -- actually generates highly satisfactory results? You’d be pretty happy if someone could teach you to consistently achieve par at the Masters!
A passive management strategy means duplicating market -- or asset-class -- rates of return. Whether an investor will see the value in this slow and steady approach can depend on their previous experience trying to beat the market.
Is Your Investment Professional Wasting Your Time?
If you operate under the assumption that securities markets are efficient, attempts to beat the market represent:
A colossal waste of time
Costs that far exceed the benefits
In fact, when speaking of settling for mediocrity, Nobel laureate Paul Samuelson observed, “Isn’t it interesting that the best brains on Wall Street can’t achieve mediocrity?”
Of course we’d all like to achieve market-beating rates of return, but it’s not a necessity. For the past century, the S&P 500 has achieved a compound rate of return of almost 10%. At that rate, investments multiply eight-fold every 22 years. If that’s not sufficiently rapid growth, the problem lies in lack of time – and that’s not a problem that beating the market will solve.
Legalized Gambling and Your Financial Plan
The role of a wealth advisor isn’t to argue with anyone’s tastes or priorities, but to identify costs and benefits so investors can make better-informed decisions. While at least a part of the pleasure of attempting to beat the market lies in the perception that it’s possible, if investors could measure the true costs of playing the market and recognize the extremely low probabilities of beating it, this knowledge may well impact their choices – and lead them to get their kicks by taking up less-risky recreational outlets, like golf, tennis, or skydiving.Active management does have one benefit that’s hard to deny: Entertainment value. Essentially, playing the stock market amounts to legal gambling, and the proliferation of online trading sites means investors can experience all of that excitement without even setting foot in a smoky casino.
Using investments as entertainment is among the most costly and high-risk forms of recreation. The more money you have to invest, the greater the cost – you may easily be losing 5% a year, damage that’s far greater when you measure the impact on the compound rate of returns over time.
Are you getting your money’s worth?