February 23rd, 2015
by Lance Roberts, StreetTalk Live
In this section of the website I have compiled articles that I have written that cover topics on investing, behavior, analysis and economics to help you be a better "long-term" investor.
There is no one more invested in your money than you. It is from this viewpoint that I believe you should have a better understanding of the dynamics behind putting your hard earned "savings" at risk.
As I have written previously, Wall Street money managers are a highly conflicted lot. They are incented, because of the extraction of fees, to keep you always invested in the financial markets. The chart below shows the "excuse/rationalization" of portfolio managers over time.
While most portfolio managers have a great strategy for "buying" into the markets, the need to chase performance leads to an inability to "sell" when needed to protect investment capital. The fear of "missing out" on a market advance, or the negative impact of making a wrong "call," are emotional biases that impair their decision making over the long-term. This is why the vast majority of mutual funds perform relative to their benchmark index despite their stated goals of expecting to outperform.
This idea was best summed up by the famed investor/money manager William Bernstein (Hat Tip - S. Bishop)
"There are two kinds of investors, be they large or small: those who don't know where the market is headed, and those who don't know that they don't know. Then again, there is a third type of investor - the investment professional, who indeed knows that he or she doesn't know, but whose livelihood depends upon appearing to know."
For this week's missive, I have dug into the "Must Read" section of the website to give you some examples are articles that you SHOULD read to help you be a better individual investor. If you have an advisor, great, these articles will give you something to discuss with them. If not, they will give you something to think about as you manage your own investments.
"Step right up and try your luck...spin the wheel and watch where she lands...everybody's a winner"
- sometimes if you listen hard enough you can almost hear the Carney coaxing unwary investors to step up and try their luck in a game that has been rigged against them. During the last two decades, I have been amazed to watch as individuals strolled through the doors of the Wall Street casino to try their luck by betting "against the house" for a dream of riches. Just as with anyone who has ever gone to Vegas - you will win sometimes but the "house" wins most of the time.
However, there are always the "professional gamblers" that can do better than the average most of the time. Why? Because they understand "risk" in its various forms. Most amateurs tend to bet on most hands. They take speculative positions where the odds of success are stacked against them, or try to bluff their way through a losing hand. Professionals play cold, calculated and unemotional. The professional gambler understands the odds of success of every play and measures his "bets" accordingly. He knows when to be "all in" and when to fold and walk away. Do they succeed all the time? Of course not. However, by understanding how to limit losses they survive long enough to come out a winner over time.
There are 10 lessons that can be learned from being a good poker player.
I have often written about the emotional and psychological factors that inhibit long-term investment performance (most recently here). Despite repeated studies that suggest investors should just buy "passive index" funds and "hold on" until eternity, the reality is that it simply does not work that way.
If you were raised in a religious household, or were sent to a Catholic school, you have heard of the seven deadly sins. These transgressions -- wrath, greed, sloth, pride, lust, envy and gluttony -- are human tendencies that, if not overcome, can lead to other sins and a path straight to the netherworld.
In the investing world, these same seven deadly sins apply. These "behaviors," just like in life, lead to poor investing outcomes. Therefore, to be a better investor, we must recognize these "moral transgressions" and learn how to overcome them.
The 7-Deadly Investing Sins
Financial security is about not only the investing correctly but also the things that are important to long term capital preservation. The following are 16 thoughts in this regard and cover both rules of investing as well as rules of capital preservation.
In March of 2008 I was giving a seminar discussing why we had already likely entered into a recession and that a market swoon of mass proportions was approaching. While the advice fell on deaf ears as we were in a "Goldilocks" economy, and "subprime" was contained, the bubble ended just a few short months later as it was no "different" then versus any other time in history, or, even now.
The reality is that markets cycle from peaks to troughs as excesses built up during the up cycle are liquidated. The chart below shows the secular cycles of the market going back to 1871 adjusted for inflation.
This time is not different. The excesses being built up in the markets today will eventually be reverted just as they have been at every other peak in market history.
There are 10 basic investment rules that have historically kept investors out of trouble over the long term. These are not unique by any means but rather a list of investment rules that in some shape, or form, have been uttered by every great investor in history.
There are many reasons why you can't really beat the S&P 500 index over time and why you see statistics such as "80% of all fund underperform the S&P 500." The impact of share buybacks, substitutions, lack of taxes and trading expenses all lead to outperformance by the index over everyone else that is actually investing and doesn't receive those benefits.
I recently wrote a fairly deep study on the perils of benchmarking and why, despite your best intentions, it was highly unlikely that you will ever "beat the market" over the long term.
While Wall Street wants you to compare your portfolio to the "index" so that you will continue to keep money in motion, which creates fees for Wall Street, the reality is that you can NEVER beat a "benchmark index" over a long period. This is due to the following reasons:
1) The index contains no cash
2) It has no life expectancy requirements - but you do.
3) It does not have to compensate for distributions to meet living requirements - but you do.
4) It requires you to take on excess risk (potential for loss) in order to obtain equivalent performance - this is fine on the way up, but not on the way down.
5) It has no taxes, costs or other expenses associated with it - but you do.
6) It has the ability to substitute at no penalty - but you don't.
7) It benefits from share buybacks - but you don't."
For all of these reasons, and more, the act of comparing your portfolio to that of a "benchmark index" will ultimately lead you to taking on too much risk. Ultimately this will lead to emotionally based investment decision making. The index is a mythical creature, like the Unicorn, and chasing it takes your focus off of what is most important - your money and your specific goals.
There are many other very good articles to read in the "MUST READ" section of the website. I hope you will take some time and look through them. After all, the worst thing that can happen is that you might just understand your money a little better.
See you next week.
Disclaimer: All content in this newsletter, and on Streettalklive.com, is solely the view and opinion of Lance Roberts. Mr. Roberts is a member of STA Wealth Management; however, STA Wealth Management does not directly subscribe to, endorse or utilize the analysis provided in this newsletter or on Streettalklive.com in developing investment objectives or portfolios for its clients. Please read the full disclaimer here.