Search the Internet for a phrase like, ‘how may individual investors beat the market’, and you’ll turn up headlines like this:
- You Can’t Beat the Market So Stop Trying (CBS Moneywatch)
- Try As You Might, You Probably Can’t Beat the Stock Market (Forbes)
- 86% of Active Fund Managers Failed to Beat the Market in 2014 (CNN Money)
Stop there and you’re likely to close your browser thinking, no way can I pick stocks on my own and perform better than the market. So what’s the point of investing in anything other than Passive Index Funds?
Chewy Bit. Passive Index Funds mirror the holdings of a market index such as the NASDAQ or S&P 500. If the index goes up, the value of your fund goes up. Likewise on the way down.
But don’t close your browser just yet ’cause it’s not that straightforward. You have to question the integrity of headlines. Because media is in the sales business. Sexy headlines attract eyeballs (I know, I know, I’m guilty on this post with its double meaning – my saving grace: I’m not selling anything). Buckets full of eyeballs attract advertisers. And advertisers are revenue sources.
That’s all fine; we live in a society where commerce greases the wheels. What isn’t fine is when media is irresponsible, publishing poorly researched articles for the sake of filling print or web space, rather than accurately informing the consumer. Regardless, to use a well worn phrase, it is what it is. Unreliable reporting happens and will continue to happen. This is our world. So what do you do? Question the source, research the issue, and bring a healthy dose of skepticism to whatever you read (yes, including BuddhaMoney … we can handle it).
Let’s get back to headlines. Searching the same phrase, ‘how may individual investors beat the market’, also brings up the following, entirely contrary, headlines:
- Beating the Market: Yes It Can be Done (The Economist)
- Look Who’s Beating the Market (Wall Street Journal)
- Shiller says Easy to Beat the Market Long Term (Bloomberg)
Agh! Now what?! From all these presumably respected sources comes polar opposite advice … who do you believe?
Enter Buddha. Reflect upon contradictory information before making a decision. And know that there is no certainty when it comes to investing, and life in general.
Fair enough, you say, both views are valid, they are simply judgment calls. Still, which one is right for me? Before anyone can speak, you answer with the silver bullet question that impresses even BuddhaMoney: knowing that stock picking is higher risk, knowing the odds are stacked against me, why would I try to achieve investment returns that exceed market indexes? Sure, I may get lucky here and there, feel good and pound my chest when the bet pays off, but in the long run, odds are that I’ll have more losers than winners, and my portfolio will be worse off. So , why would I want to swing for the fence with stocks rather than hit singles with an Index Fund?
Warren Buffett’s company, Berkshire Hathaway [NYSE: BRK.A], manages a stock portfolio worth somewhere in the stratospheric neighborhood of $130 Billion. Does this mean you should follow Buffett’s lead and invest in stocks too?
Well, consider this: Buffett is one of the fortunate few who follow an active investment strategy (see Chewy Bit, below) that is consistently successful, long-term. But before you go and think you can emulate his success, think about how you stack up to his knowledge, wisdom, experience, temperament, and all star team of experts who engage in this sort of work 5, 6, 7 days / week.
Chewy Bit. The purpose of an active investment strategy is to find pockets of the market, and particular companies sitting in those pockets, that are undervalued and provide the opportunity for above-average returns at average or below-average risk. If an active investment strategy is not able to reliably identify and seize upon such opportunities, then the strategy is worth bubkus.
Let’s pull back on the reins here. I’m not saying you cannot be successful at the stock game if you’re not Warren Buffett. Not at all. What I am saying is that if you’re intent on implementing your own active investment strategy, know that the bar is set high, and not a whole lot of folks clear the bar on a year-in, year-out consistent basis (see, Is Stock Investing For You – http://buddhamoney.com/stocks/is-stock-investing-for-you/.
But hey, if you have a system that works, then good for you, that is truly excellent. I’m not here to dump cold water on investing in stocks, only to say: be cautious, do your research, analyze objectively, know the challenges that lie ahead. And if glitches arise, you always have the option of re-balancing your portfolio and switching to Index Funds.
The Road to Retirement is Paved with Index Funds, Not Gold
According to the master himself, “… by periodically investing in an index fund, the know-nothing investor can actually outperform most investment professionals.”
Reinforcing this quote, in his 2014 annual letter to Berkshire Hathaway shareholders, Buffett says that, upon his death, the trustee should place: “90% [of his money] in a very low cost S&P 500 Index Fund. I believe the trust’s long-term results from this policy will be superior to those attained by most investors — whether pension funds, institutions or individuals — who employ high-fee managers.”
Buffett goes on to say: “Both individuals and institutions will constantly be urged to be active by those who profit from giving advice or effecting transactions. The resulting frictional costs can be huge and, for investors in aggregate, devoid of benefit. So ignore the chatter, keep your costs minimal, and invest in stocks as you would in a farm.”
The farm reference is a telling analogy. When planting seeds, it takes time for a crop to grow. Same with investing in an Index Fund. You buy the Fund and you wait for it to grow, rather than frequently buying and selling and being obsessed with the stock markets daily movements. Over the long term, if the past 100 years of stock market activity is any guide, the stock market will grow and you will make money. It’s an utterly humdrum, low cost way to invest in stocks. And it’s been shown to be a heckuva way to grow your wealth.
Nitty Gritty: What Funds To Buy
Alright then, Passive Index Funds it is. Still, which Funds to buy? Like most investing issues, you’ll get opinions all over the map on this one. Here’s my calm, collected thinking:
Buy funds only from reputable financial behemoths, ones that would shake planet Earth to its core were they to falter, i.e., would be bailed out by government should geo-political meteors strike. In particular, Vanguard and Blackrock’s iShares. Canadian investors may also check out BMO funds.
Chewy Bit. American readers may be familiar with BMO through its American bank, BMO Harris Bank. Chewy Bit beneath the Chewy Bit: three Canadian Banks – Royal Bank of Canada, TD Bank and BMO – went on a shopping spree of sorts in America some time after the recession debacle of 2008; enhancing the two countries continuing path toward commercial integration.
For Americans with stock funds on their radar, you need only two:
- US Large Cap. Vanguard S&P 500 ETF (VOO:NYSE)
- Global Small Cap. Vanguard Small-Cap Growth ETF (VBK:NYSE)
For Canadians, consider these two:
- CAD Large Cap. BMO S&P / TSX Capped Composite Index ETF (ZCN:TSE)
- Global Small Cap. Mawer Global Small Cap Fund (Fund Code: MAW150)
Why a small capitalization Fund you may ask?
Buying small companies (i.e., market capitalization under $500 million) on an individual basis is generally higher risk, no question. But in a Fund that comprises hundreds of companies, this risk is mitigated simply because of the number of companies involved. If one or two or three companies blow up, the effect on the fund’s value would be minimal
presuming those companies make up only a small percentage of the total value of the fund.
According to Morningstar Ibbotson data, from 1926 through 2012, small-cap stocks averaged an annual return of 12.28 percent, compared to 10.08 percent for large cap.[http://www.bankrate.com/finance/investing/small-cap-funds-versus-large-cap.aspx] You’re recommending a Mawer mutual fund? That doesn’t wash! Mawer follows an active investment strategy.
True, Mawer Global Small Cap is a no-load, actively managed mutual fund, not an Index Fund. And the management fee for this Fund is definitely higher than that charged by Index Funds.
But based on the long term performance of this Fund, Mawer makes a compelling case for being cut from Buddha/Buffett cloth. And those pricier management fees are more than made up for in net return: the Fund has been crushing the benchmark Russell Global Small Cap Index [http://www.mawer.com/our-funds/fund-profiles/global-small-cap-fund/]. For what its worth, I have happily held this fund for many years for friends and family whose investments I manage.
It’s important for me to end this post by telling you that, in no way, shape, or form have I received any sort of compensation from any of the financial companies mentioned. Just sharing my knowledge and opinion, folks, for the greater good. Would you expect anything less from BuddhaMoney?