Stop Wasting Time being Busy with Your Investments

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The path to success in many areas of life is paved with intense activity and a day-to-day focus on results. In long-term investment, however, that philosophy is turned upside down.

The Chinese philosophy of Taoism has a phrase for this: "wei wu-wei". In English, this translates to "do without doing". It means that in some areas of life, such as investment, greater activity does not necessarily translate into better results.

That doesn't mean we should always do nothing. For instance, it's important to regularly rebalance a portfolio so that money is reallocated from strongly performing assets to maintain a desired asset allocation.

But re-balancing is a disciplined, premeditated activity based on each person's circumstances. It contrasts with the "busyness" of reflexively following investment trends and chasing past returns promoted through financial media.

In other words, investment is one area where constant tinkering is not well correlated with success. Look at the person who fitfully watches business TV or who sits up at night researching stock tips. That sort of activity is inevitably counter-productive. It can add cost without any associated benefit.

In Taoism, students are taught to let go of things they have no control over. To use an analogy, when you plant a tree, you choose a sunny spot with good soil and water. Apart from regular pruning, you leave the tree to grow.

Likewise, financial science says you are best to direct your investment efforts to things you can control. These include taking account of your own preferences and sensitivities when choosing investment strategies, diversifying your portfolio to moderate the ups and downs, being mindful of the impact of costs and exercising discipline when emotions threaten to blow you off course.

Now while that makes sense, many people find it tough to apply those principles because the media tends to look at investing through a different lens. The focus is on today's news, which is already priced in, or on speculating about tomorrow. It can be interesting, sure. But is it relevant to your long-term plan? Probably not.

The media trades on fear and greed.

Many people caught up in the day-to-day stuff constantly switch money managers based on past performance, attempt tactical changes in asset management and respond in a knee-jerk way to news events that turn out to be noise.

Again, the assumption underlying these approaches is that if you put more effort into the external factors and you adjust your position constantly based on short-term movements in the market, you will get better results.

Unfortunately, the actual result is people end up earning poorer long-term returns than are available to them. In fact, most professional asset managers struggle to earn the returns available to them from a simple index.

According to Standard & Poor's, who have been publishing a scorecard on fund manager performance since 2002, over 10-year periods most Australian fund managers fail to produce returns that exceed their benchmark net of fees, as the graph below demonstrates:

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Source: SPIVA reports from 2002 to 31 December 2018.  In Australia, this involves comparing the performance of approx. 860 Australian equity funds, 436 International equity funds and 116 bond funds against their respective benchmarks.

And keep in mind this doesn't consider the actual returns earned by end investors, many of whom further damage their chances by holding concentrated portfolios, over-trading, chasing past performers or attempting to time the market.

Many people underestimate just how hard it is to pick winning stocks.  In one recent academic paper[i],  a number of interesting conclusions were reached:

  • Since 1926, only 4% of the total number of stocks (1,092 out of a total of 25,967) accounted for the net gain for the entire US stock market

  • The remaining 96% of firms that issued stock collectively produced returns equivalent to 1-month US Treasury bills over their lifetime. 

  • Four out of every seven stocks had lifetime buy and hold returns less than the 1-month US Treasury bill return.

A US Treasury bill is regarded as a zero-risk investment.  So investors who bought those stocks took on additional risk, for no reward. 

These studies support the importance of broad diversification and using low cost funds.  It’s the only way of ensuring your portfolio includes the winners. If you buy individual stocks, you are statistically more likely to buy a dud rather than a winner.

Indexing pioneer Vanguard has coined a term for the value added by investment advisers who adhere to these principles: "Advisor's Alpha."

As Vanguard note, "In creating the Vanguard Advisor's Alpha concept in 2001, we outlined how advisers could add value, or alpha, through relationship-oriented services such as providing cogent wealth management through financial planning, discipline, and guidance, rather than by trying to outperform the market,"  

Decades worth of research has led Vanguard to estimate that a well-conceived and executed approach by advisers can add about 3% in net returns for a client. Of course, such gains can vary "significantly," according to Vanguard, depending on individual circumstances and how such a process is handled by a financial pro. 

In Vanguard's 2019 research piece aimed at quantifying Advisor Alpha, the concept can be summarised as revolving around wealth managers who deliver in four key areas:

  • Being a behavioural coach who helps clients get on the right path and prevent them from taking wrong turns.

  • Being tax-efficient through prudent asset allocation and tax-smart spending strategies.

  • Keeping investment costs low.

  • Re-balancing in a disciplined fashion

In explaining Advisor's Alpha, Vanguard includes this very important caveat: "Because clients only get to keep, spend, or bequest net returns, the focus of wealth management should always be on maximising net returns. We do not believe this potential 3% improvement can be expected annually; rather, it is likely to be very irregular. Further, the extent of the value will vary based on each client's unique circumstances and the way the assets are actually managed." [ii]

In other words, not following the practices outlined above can lead to a diminution of returns. Conversely, advisers acting as a true fiduciary by putting their clients' interests first and acting in a consistent manner with such fundamental wealth-building principles stand to come closest to helping investors realise a better investment experience -- as well as reach their long-term financial goals.  

Ultimately, that's just another reminder of the benefits available to disciplined investors who stay focused on what they can control, or as the ancient Chinese proverb says: "By letting it go, it all gets done. The world is won by those who let it go. But when you try and try, the world is beyond the winning."

 

Author: Rick Walker

[i] Do Stocks Outperform Treasury bills? by Professor Hendrik Bessembinder, Department of Finance, W.P.Carey School of Business, Arizona State University, May 2018

[ii] Vanguard, "Putting a Value on Your Value: Quantifying Vanguard Advisor's Alpha," Feb. 2019.


Rick Walker