Most investors, both institutional and individual, will find that the best way to own common stocks is through an index fund that charges minimal fees. Those following this path are sure to beat the net results of the great majority of investment professionals
- Warren Buffett
Why Science Beats Speculation
Wall Street has spent billions over decades to perpetuate a myth. The myth is that hiring a "smart guy" or team of smart guys and paying them lots of money to pick stocks will bring an investor great success.
The truth is I spent a large portion of my career actually believing and personally perpetuating this myth. While I had never done the research to know better - I attribute my folly to a naïve desire to believe that diligent effort could produce superior results. I just had never stopped to consider that I could only be successful at the cost of other equally intelligent and well-intentioned advisors' failure. The reality is - we were all playing a losers game.
After a personally painful awakening which took place in the midst of the 2008 - 2009 market collapse, I have found four indisputable truths you should consider if you are working alone, with a broker or active manager:
1) Behavior is MOST important
A noted annual study of investment returns called QAIB or Quantitative Analysis of Investor Behavior has been conducted by Dalbar since 1994. It attempts to measure the impact of investor decisions to buy, sell and switch into and out of mutual funds
Each year, the study has shown the average mutual fund investor earns significantly less than the actual mutual funds over the same time period. In fact, the report issued in April 2013 opened with this headline: "The Disease of Investor Underperformance."Dalbar's 2014 QAIB study succinctly states, "No matter what the state of the mutual fund industry, boom or bust: Investment results are more dependent on investor behavior than on fund performance."
Investor behavior is inherently emotional - and therefore tends to chase past performance and attempt to "avoid" market corrections. It may surprise you to know that the underperformance because of this bad behavior is quite large - in fact on average over 7 percent annually!
2) Free Markets are BEST Determiner of Price
Most high school grads can tell you that Socialism is a complete failure as an economic system. Why? Because a couple smart guys in a room are not near as good at allocating scarce resources as self-interested buyers and sellers in a free market. Never have been - never will be...
These smart mutual fund managers sit in their Wall Street corner offices consistently produce negative returns relative to just buying the asset class index alternative. Again, ivory tower intellectuals fail compared to free markets.
3) Return is ALWAYS Correlated with Risk
Your momma told you that if it sounds too good to be true - it is. Momma was right. The return you can demand as in investor is directly correlated to the type of risks you are willing to take and your ability to sustain this level of risk during perceived "good" and "bad" times.
Various annuity and insurance products which promise high returns regardless of market volatility are widely sold to an unsuspecting public. These products returns are reduced by incredibly high fees and rules which "cap" the maximum return that can be achieved in good years. Beware...
Prudent and successful investing takes not only deep research into what mixture of asset classes produces the highest returns at a given level of risk - but also a fair amount of emotions management.
4) Markets, NOT Managers Determine Returns!
Ninety-six percent of your return as an investor is determined by the asset classes you own, NOT the manager who is picking stocks in those asset classes.
Most portfolio managers focus on activities which ultimately mean very little - trying to pick the "right" stocks and time when to buy or sell. As a result - the most critical elements of returns are frequently neglected in pursuit of the small portion actually in their control. All this with high management fees, increased taxes and transaction costs.
So why work with a manager like Pillar Capital? Its because you need an expert who is independent of troublesome Wall Street conflicts of interest. Someone who is an expert about what really matters - behavior management and skillful allocation across asset classes (domestic and foreign stocks, bonds, real estate) in a way which maximizes your chance for success.
Your alternative to the science of capital markets is a speculative rolling of the dice. Neither you nor your advisor know the future - why waste money speculating on future unknown events? Make the wise choice - focus on a scientific approach rooted in the efficacy of free and open capital markets and independence from expensive Wall Street products, behavior, and conflicts of interest.