You think you can out-perform the market do you? Millions of people apparently think they can: anyone who invests actively is implicitly claiming just that. Unless you are one of a tiny handful of people who have proven they can do it consistently, I do not believe you. You are just wasting money funding the huge industry that sells suckers like you financial information and advice.
You presumably either believe you have a strategy of trading mechanism that is superior to the market, or that you are a gifted bottom up stock picker. Lets demolish those two beliefs.
First, lets talk about superior strategies. Can you tell me what market inefficiency your strategy is exploiting? If not, you do not know what your strategy works. Not exactly confidence inspiring. If you do claim the inefficiencies exist, I hope you can provide some evidence.
Can you produce any evidence at all that your strategy actually works? Does it outperform consistently if you back-test it over different periods of time? Please do not bother telling me that it outperforms over the last five or ten years. There are all sorts of one-off conditions that occur over such as short period (like the dotcom boom and bust).
So what happens if you back test over the last forty years? What happened in earlier decades? Is it still outperforming consistently. Oh no it isn’t!
Now, lets think about the odds that you can pick stocks (or markets or sectors) that will out-perform. I am somewhat tempted to limit my discussion to “ha, ha. if you say so”, but lets take this idea seriously for a moment.
So what do you know, or what ability do you have that other investors do not? Think of all the fund managers out there: mostly intelligent, highly trained, highly motivated and spending all day, every day, trying to outperform. What do you have that they do not?
If you are going to tell me that you have outperformed, can you tell me how high a level of risk you have taken? Getting higher returns for higher risk is not smart: you can do it just was well with a bookie as in the financial markets.
One thing you may have that others do not: inside information. It works: but it can also land you in jail.
How many small investors have you heard of who have become rich by their investments have out-performed? Few enough for them to merely represent the far end of the probability curve.
The vast majority of really successful investors either started off rich, or started from jobs that gave them good financial sector contacts. Just the sort of people to have access to inside information. Do you disagree? If so can you guarantee that the super-rich investors do not whisper secrets to each other? The evidence shows that someone is insider trading. The evidence is only there because they, whoever they are, have enough to move the markets.
Just give up and put your money in a nice diversified tracker fund or two with low charges, and leave it there till you retire.
My goodness. You’ve got my goat Graeme! You’re going to get a fulsome reply from me in the form of a major blog posting a. when I’ve calmed down and b. when I get back from holiday :-)
Very interesting view point and one which has really got me thinking about my own ‘strategy’. However could you please explain why you should pick an index tracker or two. Why not just one?
Many thanks
For many people, a single tracker will fit their needs.
Some possible scenarios in which you may want more than one tracker:
Hi Graeme,
Many thanks for taking the time to reply. I am actually very interested in the idea of investing through trackers long term. My concern is that because there are so many index trackers out there, for so many different things, it is no longer possible to be passive in how you go about it.
For example, should you go big cap, medium cap or small cap?
Which regions?
Which assets?
Which investing styles?
Global or local?
In what proportions?
How often should you rebalance, if at all?
If you get it wrong you could be seriously lagging the market in 30 years time.
Perhaps my understanding of being a passive investor is incorrect. I think of ‘passive’ meaning that everything is done on automatic pilot by computers. However I do not think there is any investment vehicle out there, for your average investor, which you can use in this way (e.g. a fund which specifically implements MPT for example).
If you have time, let me know what you think?
The question is very interesting, so I answered in a separate post.
In short, tracker funds do not need to explicitly consider portfolio theory because of the properties of the market portfolio. I would over-weight one’s home country and value (preferably small cap value). I do not have a precise answer to setting proportions and rebalancing and would take an informal common-sense approach.