The article raises valid issues with benchmarking including that many active benchmarkers will hug an index very closely so clients of those benchmarkers may not be getting their money's worth. These are valid questions but hasty conclusions in my opinion.
Be that as it may the most useful part of the article might be that it is a reminder for an important building block that I have talked about before.
A reasonably diversified index equity portfolio will likely average a 9-10% average annual return over some long period of time. This combined with a diligent savings rate and appropriate asset allocation can give someone a decent shot of having enough money when they need it. Poor emotional reactions and poor spending decisions are two big impediments to a positive outcome.In this context any active strategy needs to be considered against just holding a portfolio of index funds. If an investor has to work 50 hours a week to add an average of 50 basis points annually to the result then that could compound out to be a difference maker but is the time spent worth it? The answer will be in the eye of the beholder.
It is also important to understand that an active strategy does not have to be about beating the market. I would describe what I am trying to do as capturing most of the upside while missing a big chunk of the downside aka smoothing out the ride. I believe this can yield a much better result over the course of the entire stock market cycle. This is what is right for me. Anyone else needs to do what is right for them but whatever that is what value are you adding and is it worth the effort?
To be clear I am not making the case for passive indexing but there are folks for whom this is the best thing and there are all sorts of reasons why this may be so but staying with the wrong, for you, strategy is going to create a very bad long term result.
One other point that the article made was the silliness in measuring performance in "90 day increments" because they "are coin flips that promote excessive trading and follow-the-leader strategies, which are the bane of investing success." I think this is consistent with a running joke I've made before in asking "quick, how'd you do in the third quarter of 2006?"
6 comments:
Good morning, Roger.
I don't have any data to support this assertion, but I'd observe anecdotally that most folks probably fall somewhere between the extremes. That is, they buy a few stocks, neither benchmarked nor diversified, and hold onto them until they need the money. They don't trade nor do they index. Simple, unsophisticated, and probably dangerous. Of course, they're not reading your blog, either.
Personally, I find that the more I read, the more likely I am to deviate from my strategy. I'm not a Barron's subscriber, but it seems like there's always a better-performing strategy in the next article or blog I see. The arguments are all so convincing...
I take some comfort in Mebane Faber's semi-active approach--a few select index funds, traded only on the basis of the 200 dma, will outperform over the entire cycle. Mathematically, that is.
3rd Q 2006? Umm ... 4.8% in strategic accts (beta = .31), 13.7% in tactical accts (semi-decent vol that Q).
Just kidding, I ran a report query to check [lol]
More seriously, a cost benefit perspective is very useful when considering the match between lifestyle and investing style but investing in yourself first (education and training) and a focus on saving rather than trading can probably pay larger dividends for most people when they are building a career.
But it always makes sense to divide savings into that which you would rather not lose (capital preservation rules the roost) and that which you can afford to lose in the reach for greater return (not that you want to lose it of course but risk is what it is).
RW as my buddy Mike would say that was a nice piece of business
(that is not a sarcastic comment)
NESTURATDO YOU HAVE ANY CONTROL OVER THE SITES WHICH ARE TACKED ON TO THE BOTOM OF YOUR ARTICLES?
"It is also important to understand that an active strategy does not have to be about beating the market. I would describe what I am trying to do as capturing most of the upside while missing a big chunk of the downside aka smoothing out the ride. I believe this can yield a much better result over the course of the entire stock market cycle."
By doing this, you are lowering portfolio volatility intentionally to increase the Sharpe Ratio.
After many years in this business, this has been one of my best conclusions --- if you target a high Sharpe Ratio -- you will beat the market soundly in the long-run. If you target beating the market over short-term windows, you will get stuck with a high volatiliity portfolio at inopportune times, suffer large drawdowns and end up with poor long-term returns and an inferior sharpe ratio.
So, target the Sharpe Ratio, find good ideas and avoid benchmarking to an index the best you can --- good investments and a portfolio that keeps an eye on maintaining low volatility (and therefore low drawdowns) will beat the market in the end, soundly.
In the long-run, the S&P 500 will NOT have a strong sharpe ratio. 5-7% earnings growth and 14-20% volatility is just not going to get it done.
Hey Roger,
Do you do link exchanges? I'm the webmaster behind LearnGoldCoins.com, and I'm open to trading links with you...my site's only a few months old, but already has 10,000+ links pointing toward it, and has a PR of 4. If you want to trade, just let me know.
Thanks!
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