How to Beat the Performance of Most Professional Money Managers

S&P Dow Jones Indices published a report on March 12, 2015 called the SPIVA® U.S. Scorecard which you can download for free from their website. They publish this report on a regular basis so this article’s concepts will apply going forward. Quoting from this report:

The S&P 500® had its third straight year of double-digit gains in 2014, returning 13.69% (returns were 32.39% in 2013 and 16% in 2012). Based on data as of Dec. 31, 2014, 86.44% of large-cap fund managers underperformed the benchmark over a one-year period. This figure is equally unfavorable when viewed over longer-term investment horizons. Over 5- and 10-year periods, respectively, 88.65% and 82.07% of large-cap managers failed to deliver incremental returns over the benchmark.

That is incredible, over 80% of fund managers failed to beat the index! There are a few reasons for this:

  1. Bad timing. Trying to time when to buy or sell is extremely difficult even for professionals; nobody owns the proverbial crystal ball.
  2. Bad stock picks. Picking the right stock to buy is also extremely difficult because of all the different variables that going into stock pricing. Ultimately stock prices are driven by the emotions of fear and greed in my opinion.
  3. Management fees and expenses. These expenses are deducted from fund assets directly by the fund company before unit-holders get their piece. Even if the fund loses money, you still pay a percentage of your assets in expenses each year.

So as an individual, how can you compete with professionals who themselves can’t beat the benchmark. Simple; invest in an index fund at the lowest possible cost and you will not only beat the average investor but the majority of professionals as well. For the stock allocation of a Permanent Portfolio I suggest a broader stock market index than the S&P 500; a total stock market index. The S&P 500 only includes the biggest 500 stocks trading on the U.S. stock markets. A total stock market index fund includes large, medium and small cap stocks and is a better proxy for prosperity in the economy. If you live outside of the U.S., all countries have comparable total stock market indices and funds that you can use for your portfolio. I suggest you explore some of the total stock market exchange traded funds (ETF) that are available, some of which have annual fees of only 0.05% versus the industry average of 1.03%. Some of the discount brokers also sell these funds commission free.

Now as part of out Permanent Portfolio we only hold 25% in stocks; then we only buy or sell when any of one of the four asset classes reach 35% or 15% of the total value of the portfolio. Following this approach and strategy, we have addressed our earlier concerns:

  1. Bad timing. We don’t time when we buy or sell; we only rebalance when necessary.
  2. Bad stock picks. We don’t pick stocks; we just buy the index.
  3. Management fees. We only buy the lower cost total stock market index funds available which guarantees that our costs will be minimal.

Source by Joseph Gal

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