I don’t watch a lot of live TV, but when I do, I turn on business news, Jim Cramer is there telling me what stocks to buy. If it’s not Cramer, it’s an analyst explaining what manger she recommends, or some economist is out with his latest forecast.
Even if this form of financial “infotainment” is what business TV (CNBC, Fox Business and Bloomberg) thinks they need to do to get the ratings, you’re better off, healthier financially, by ignoring them.
Most of the industry is going to want you to focus on:
- Stock picking
- Manager selection or
But, these are all things that can’t be counted on to reliably add value to your portfolio. Let’s find out why.
Every year, Standard & Poor's produces research on the performance of actively managed funds. These are funds managed by professional, highly skilled and hard-working managers trained to pick stocks. Despite all their education and hard work, the data show they don’t consistently add value. In fact, the majority of time, they cost you money.
As you can see, the overwhelming majority of managers actually perform worse than their benchmark. Over as long as a 10-year period, 80–90% of managers had performance worse than the index they are attempting to beat.
And to make matters worse, the managers who do outperform don’t stay consistent from year to year!
Standard and Poor’s also produces research on fund persistence—the ability of top-performing funds in any area to remain the top fund. And the results are not pretty. A couple quotes from their research (emphasis is mine):
Very few funds can consistently stay at the top. Out of the 687 funds that were in the top quartile as of March 2012, only 3.78% managed to stay there by the end of March 2014. Further, 1.90% of the large-cap funds, 3.16% of the mid-cap funds and 4.11% of the small-cap funds remain in the top quartile.
It is worth noting that no large-cap or mid-cap funds managed to remain in the top quartile at the end of the five-year measurement period. The figures paint a poor picture of the lack of long-term persistence in mutual fund returns.
So, let’s put this in perspective. If roughly 10% of funds outperform in any given period, should you try to identify them in advance?
Imagine for a second you’re sitting at a blackjack table and are dealt two face cards—you’re sitting on twenty. Would you ever hit? Risking a highly likely win for a chance of hitting twenty-one?
Probably not. Yet the odds of getting one of the four aces needed to hit 21 is about 8% or roughly the same odds as selecting an outperforming fund.
So, the question becomes, even with overwhelming odds against it, can you simply pick the few managers who DO outperform each year? Going back to the blackjack example, is it possible to know when to hit, despite the long odds, on twenty? Let’s find out…
When it comes to manager selection, unfortunately it’s the same story. Even the professionals don’t reliably add value in this area.
A recent study examined the performance of investment consultants providing manager selection advice. The study found the recommended mangers actually underperformed the managers who weren’t recommended by 1% annually.
So not only did these consultants cost their clients the fees paid to them, their investment results were worse.
Dr. Howard Jones a Research Fellow at Saïd Business School (University of Oxford), and one the authors of the study summed it up like this:
“Investment consultants as an industry appear to add no value in fund selection.”
Now we are zero for two. Stock picking doesn’t work and neither does manager selection. So, what about forecasting? Simply put, forecasting is basing investment decisions on someone’s predictions of the future, which just sounds like a bad idea.
Again, forecasting has been extensively researched. The conclusions? Humans aren’t very good at predicting the future—especially in highly complex systems like world events, politics or financial markets.
This chart below shows Wall Street equity analysts’ (these are the experts, the people paid big bucks) earnings forecasts for S&P 500 companies over time. The green line is their forecast at the time it was made. The blue dots represent the actual results.
What you should notice is the forecasts were not accurate—not even close to accurate in most cases.
We just looked at three examples of where the whole industry would like you to focus: stock picking, manager selection and forecasting, and found even the professionals struggle to reliably add value in these areas. So, if they can’t do it, what chance do you have?
Instead, we suggest that you focus on areas you can control and add value. Things like: maintaining the proper asset allocation, minimizing behavioral mistakes, minimizing investment costs and taxes, integrating all your investment assets inline with your financial plan, and if you’re retired developing a customized withdrawal strategy. These are the things that add value to your portfolio: the things that matter when it comes to accomplishing your financial goals.
You’re going to be better off, more financially healthy, by ignoring the financial “infotainment” industry and focusing in on what really matters.
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