‘When the facts change, I change my mind. What do you do, sir?’ said John Maynard Keynes.
All of us want the best possible return on our money. This may take the form of savings, investments, life assurance endowments, pensions, or all four. With that being said, have any facts changed over time, affecting the way we should take care of our money?
Well, having given investment advice for more than 35 years, I know that the financial marketplace of today is not my father’s, nor does it resemble the marketplace when I started my career.
Today, the prospect of large salaries and bonuses attract some of the brightest talents into finance and the investment industry. They all have access to an extraordinary amount of data, thanks to the advancement in information technology. The regulator demands that information be given at the same time to all of them but they are all so good at what they do that, for one to gain an edge, another must make an error. The competition is ferocious. Whether we are professionals, amateurs, providers or consumers, we all make up the market. We are all average before costs and below average after costs. Then what is the average? What the market delivers or fails to deliver. It is therefore difficult for a manager to achieve consistently a return that will outperform the market.
For those who say “Don’t confuse me with the facts,” here are three: First, an investor puts up 100% of the capital and takes 100% of the risk; second, 84% of all active fund managers will fail to beat the market rate of return; and third, the average actively managed fund costs seven times more than the average passive index fund. (Investment Company Institute 2014 and Morningstar Inc.)
Since 1976, passive index funds allow investors to hold an index of securities. The index consists of companies held in the same proportion as they are listed in the market. Assuming the facts above, by accepting the market rate of return with the market risk, at a hugely reduced cost, the average investor can outperform 84% of all active managers.
Effective allocation of capital to diversify risk and control costs is, without a doubt, the key to investment success. The rest is just speculation. The gravy train, which has fed investment managers over past decades, has also fed the regulator. Sensible investors should analyse costs carefully.
The facts have changed, and so should our thinking. For the majority of investors, accepting the market rate of return and market risk through a very low cost index fund will put the odds of investment success, over time, firmly in their favour, therefore delivering more for less.
With interest rates at historic lows, European bonds with negative real yields, historic public deficits and a weak global economy, it is likely that during the next decade investors will receive more modest returns than those of previous decades, making costs an ever more critical factor.
The comments and observations by the author are a reflection of his opinion and do not constitute an offer to buy and hold securities, nor does he receive any remuneration of any kind from names referred to.