photos courtesy of Gary Morrison

The Most Difficult Part of Investing

by Steve on August 14, 2014

Over 20 years ago, in the book “Get Rick Slowly” William Spitz wrote that, “The most difficult part of investing is understanding and evaluating risk. ” This line struck me when I was reading this wonderful book recently.  The reason that understanding and evaluating risk is so challenging is that there are many types of  investment risk and without risk, there are no investment returns so it’s a part of life.

For example, there is:

  • Credit risk (the potential for a bond to default)
  • Volatility risk (the short-term ups and downs of the value of stocks, bonds and mutual funds)
  • Goal-risk (the potential that you won’t have enough money to send your daughter to college or the possibility that you won’t have enough money to retire on when you want and live in the lifestyle you want)
  • Inflation risk (the loss of purchasing power).

And several others. We’re going to dive into the topic of investment risk and how to address it in the next few blog posts. For now, keep this in mind: risk and return are related. While everyone wants a high return and low-risk investment, there is no such thing.

Here is what we know about active investment management:

1. Active Management is expensive. The average expense ratio of actively managed funds is 1.29% vs. an average of .80% for all passive funds and .38% for all DFA Funds. ETFs are even cheaper.

2. Active Management doesn’t consistently work well. Over the last 5 years (2009 – 2013), only 39% of U.S. Equity funds and 29% of International funds outperformed their benchmarks.

3. In those rare instances when Active Management works, it rarely lasts. Over the last five years (through March), only 2 out of 2,862 active U.S. Equity funds stayed in the top quartile of performance in each of the last 5 years. That’s right 2 funds! The other 99.93 % might have enjoyed a good year or two of performance but were unable to produce consistently good performance. And by the way, 852 of those funds (or 30%) merged with other funds or went out of business.

4. You’d get better results flipping a coin. While we don’t recommend coin flipping, roulette or other games of luck as an investment strategy, pure chance would suggest that at least 3 funds (instead of 2) should have achieved consistent outperformance over the last 5 years.

Think about these facts the next time you wonder if your investment approach is efficient and effective.

Predicting Investment Returns

August 7, 2014

We frequently tell clients that we can’t predict the future when it comes to investment return and no one can. However, while we have no idea what will happen to investment returns in the short-term, we can guess with a high level of accuracy about what will happen to investment returns in the long-term. This […]

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Every Dollar Has a Job

August 5, 2014

I read this line somewhere and we often repeat it to clients. The idea of giving each dollar a role or job to do is useful in several ways. It helps clients: 1. Be more aware of their money (“can’t have lazy dollars just sitting around doing nothing”) 2. Have specific purpose for their money […]

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Markets Are Very Efficient

July 31, 2014

Even skilled investment managers have a hard time overcoming the overall efficiency of the stock market, mainly because of transaction costs. Don’t believe me? Check out this chart of average annual returns for the ten-years ended in November 2013 of the legendary Warren Buffett Berkshire A Shares vs. the S&P 500 and the DFA U.S. […]

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Be Aware of Goldilocks Pricing Model in Restaurants

July 29, 2014

Our son and I recently ate out at a Mexican restaurant and when the bill was presented it showed a “suggested tip guideline. ” Now where I come from, a standard tip for good service is 15%. Poor service gets less and on rare occassion, the tip might be more than 15%. At this restaurant, […]

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Three Rules to Jump Start Investing Success

July 24, 2014

Carl Richards, the New York Times columnist, said: Rule 1: Decide to invest Rule 2: Make it automatic Rule 3: Never forget rules 1 and 2.

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Difference Between Saving and Investing

July 22, 2014

I read something recently that Pamela Yellen, author of The Bank on Yourself Revolution, wrote that struck a chord with me. She noted that too many people don’t understand the difference between saving and investing. Saving means putting money you can’t afford to lose in a vehicle that is safe and has guaranteed growth. For […]

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Surprising Stock Market Surge Continues

July 18, 2014

In the first half of 2014, the U.S. stock market continued its upward trend and has many people wondering “How high can this thing go?” The S&P 500 Index (a representative index for the entire U.S. stock market) increased 6% in the first six months of the year. This is on top of the 32% […]

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Efficient Markets

July 15, 2014

You may hear investment advisers say that investment markets are “efficient.” What does this mean? An efficient market has a large number of buyers and sellers, all the information about a security is known to all the buyers and sellers at the same time and transaction costs are low. For example, the U.S. stock and […]

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