Fees And Gimmicks Are Squandering Your Investment ReturnsAdvisor Perspectives
Advisor Perspectives welcomes guest contributions. The views presented here do not necessarily represent those of Advisor Perspectives.
The following article is intended for retail investors. However, our editors believe it merits use by financial advisors for their clients.
Why do we invest? Most of us need to invest in order to fulfill our financial and retirement goals. By taking risks in capital markets, we expect a return on our investment that will at least outpace inflation. Inflation determines how much the purchasing power of our wealth will erode over time. Although investing means taking risks, not investing also means taking risks.
Unfortunately, most investors still don’t know which actions will help their odds of investment success. There is just too much noise and nonsense that confuses, scares and nudges us into making the wrong decisions.
For example, when you tune in to any financial news channel, you are persuaded with sensationalized market information. The flashing visuals about stock price movements, the conveyor belt of talking heads and the broadcasts from the chaotic, noisy floors of the exchanges enforce viewers’ anxiety about being left out of the game. It seems that every day is full of opportunities for making profits and avoiding losses. Indeed, the financial media and the investment industry want you to think that you need their knowledge. Otherwise, why would you watch? And, the more confusing investing in the markets seem, the more you are willing to pay the experts for their advice.
Investing based on the evidence
What if decades of data, peer-reviewed research and real-world evidence suggest that forecasting is a losing investment strategy? This would then say that market-timing, stock-picking and other conventional strategies that try to outguess or outwit the markets are cost-generating gimmicks. It would argue that the talking heads and the so-called market “gurus” have no more insight about where the markets are headed than you do. And it would mean that financial news and headlines have no impact on your long-term investment success. It would contradict everything that you’ve been taught about investing.
Well, that happens to be the case, and academics and many professionals have known this for a long time.
In 1933, Aldred Cowles III published in the journal Econometrica a paper entitled Can Stock Market Forecasters Forecast? He found that the financial institutions produced returns that were 1.20% worse a year than the DJIA; and media forecasters trailed the index by a massive 4% a year. We can even go back further to 1900, when the French mathematician Louis Bachelier, in his PhD thesis, The Theory of Speculation, demonstrated that security prices move in such a random fashion that, “the mathematical expectation of a speculator is zero.”
John Bogle, founder of Vanguard, knew that fees chewed up returns and that most investment managers underperformed the market. In 1976, he introduced the first index fund, the Vanguard 500 Index Fund, which instead of trying to beat the market, simply matched the market (in this case, the S&P 500 index). It didn’t require much overhead, there was no active manager and he kept the fees to a minimum, far lower than the rest of the industry. When he died on January 16, 2019, investors who stuck with his philosophy by investing in the first index fund have had a cumulative total return of 8,559%. Warren Buffett once said, “If a statue is ever erected to honor the person who has done the most for American investors, the hands-down choice should be Jack Bogle.” Vanguard continues to be among the best options for low management fee index funds.
There happens to be a simple, yet powerful idea that helps explains why forecasting is difficult – an idea that should convince you to embrace the markets, rather than trying to beat or outwit them.
Read the full article here by Dejan Ilijevski, Advisor Perspectives