I came across an article today from Larry Swedroe who is one of my favorite authors. In the article he discusses the fallacy of chasing hot investments, sectors, or asset classes. My favorite line from his article is that investors should behave more like a postage stamp. A postage stamp does one thing and one thing very well- it sticks to its letter until it reaches its destination. Investors should create and stick to their investment plan- asset allocation. This plan involves more than just buying and holding your investments. It means reviewing your investments and rebalancing as necessary to bring it back to its targeted levels.
I also recommend the Callan Periodic Table of Investment Returns which is far more interesting than anything you might remember from chemistry class. Whenever I show this to prospective clients I ask them to find the ‘pattern’ in the past returns of previous asset classes. (If you find one, please let me know!) What is really interesting is to view the returns of Emerging Markets over the past two decades. In the 1990s there were five years when this asset class was the worst performing asset class for that year. In the past decade it was at the bottom only once (in 2008) and that interrupted six years where it was the best performing asset class- and boy were those six really good years. When one stares at the ‘colors’ on this table and really thinks about how likely it is that anyone can choose in advance which asset class will do one year versus, it becomes painfully clear that the likelihood of that is close to zero!
My recommendation is to diversify across all asset classes and accept the fact that you will have some of your investments in the best and worst performing asset classes each year. By controlling the things you can control, like investments costs and taxes, and rebalancing as necessary across your investments, you will be far more likely to achieve your goals and reach your destination.
“Past performance is not an indicator of future outcomes.” You see this all the time in investment literature, especially related to mutual fund performance. Yet, many people still make their investment decisions mostly, or entirely, based on the past performance of the investment. In S&P’s November Persistence Scorecard a few results were cited:
* For the five years ending September 2011, only 9.72% of large-cap funds maintained a top-half ranking over five consecutive one-year periods. The results for mid-caps was only 6.08% of funds, and for small-caps it was only 3.27%. Random expectations would suggest a rate of 6.25%.
* Looking at longer-term performance, 12.23% of large-cap funds with a top-quartile ranking over five years ending 09/2006 maintained a top-quartile ranking over the next five years. For mid-caps it was only 20.22% and for small-caps it was 20.22%. Random expectations would suggest a rate of 25%.
* While top-quartile and top-half rates have been at or below levels one would expect based on chance, there is consistency in the death rate of bottom-quartile funds. Across all market cap categories, bottom-quartile funds have a much higher rate of being merged or liquidated.
The evidence continues to be clear that trying to successfully pick stocks over a long period of time is extremely difficult. There has been some news recently about the retirement of Bill Miller of the Legg Mason Value Trust fund which won Mr. Miller accolades for his 15 straight years of outperformance compared to the S&P 500 index. Unfortunately ,for many investors in his funds, for the five years ending December 31, 2010 his Value Trust fund was dead last among 1,187 US Large Cap funds tracked by Morningstar. Did Mr. Miller lose his touch suddenly? Or maybe, just maybe, his ‘winning’ streak was nothing more than luck. Of all the actively managed mutual funds out there it would seem that someone out there, by chance, is going to have an especially long winning streak. The problem for investors is this: how do you identify who this person is, AND, how do you identify this person in advance of their winning streak? Furthermore, how do you know when to get out before the inevitable losing streak begins? Identifying skill from luck is a daunting task.
Feel free to use the comments section below to add your thoughts.
Ben Franklin once said, “Don’t put off until tomorrow what you can do today.” I love this call to action. When it comes to doing our taxes we are all compelled by a deadline (April 15th) to complete a tax return. Some of us hire someone to do this chore while some do it themselves.
When it comes to managing the rest of our financial lives there is no deadline. For example, beginning a savings program for a specific goal (a house, college, retirement) is often delayed due to ‘current’ circumstances. The excuses go on and on and then before you know it, years and even decades have gone by and nothing has been saved. There are other aspects of our financial lives that frequently get pushed to the side: purchasing insurance we know we should get, or setting that appointment with the estate planning attorney to draft crucial documents like wills and health care directives. There are of course other areas of our lives where we could all benefit from being more proactive: exercise and eating better are the obvious ones that many of us struggle with.
For me it simply helps to be reminded of Ben Franklin’s call to action. Once you start taking action you will hopefully develop the habit of taking action and do the things you know you should.
If there is one thing you have been meaning to do (financial or non-financial), take a moment and do it right now. You will feel much better for the rest of the day.
I saw a great movie last week, The International, and there is a fantastic scene that describes the essence of the banking industry. Before continuing, you may wish to watch this clip by clicking HERE.
This notion of ‘controlling the debt’ is something to ponder. At a larger level we saw what happened in the middle of a financial crisis: those who controlled the debt (i.e. big banks) received the immediate attention of our political leaders. They controlled everything during that crisis. To this day, nearly three years from that crisis, the banks are doing just fine and most individual Americans are not doing just fine.
Now, let’s break this down to the individual level. Those who have little or no debt are less susceptible to control by others. (i.e. banks) They are more likely to have financial security or financial freedom. For the vast majority who are in debt to the banks, they are more likely to not feel in control of their financial situation and more likely to not feel optimistic about their financial future.
Is all debt bad? Well, no. For younger couples starting out in life the path to owning a home usually involves a mortgage. The problem that developed in our society was that very few people wanted to save for a proper down payment before buying that home. And now with the housing bust, so many people actually owe more than their house is worth. My prescription is for a minimum down payment of 20% before buying a home. (Ideally, this should be over 30%.) I actually think this should be mandated through government regulation. Given what has happened in the housing market over the past 10 years, do we really need another example of why this should be so?
Beyond a fixed rate mortgage, we need to think long and hard about borrowing for other purchases. A habit of saving for the things we want is not a lost art; it just seems to have been forgotten by so many.
Please use the comment form below for any additional thoughts or questions.
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