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A parable for today's investor:
Diversify and hold steady against doom-saying.
(cont.)
The key is smart diversification ... and staying put.
Studies consistently show the only sure way to really lose money in the
long term is trying to beat the market by jumping around between sectors and funds. Over the last two decades – through the peso crisis, the Asian and Russian collapses, 9/11 and innumerable other events – the stock market as a whole returned an average annual return of 11.8%. But a typical "active" investor, according Dalbar Financial Services data, netted annualized gains of only 4.3% after expenses.
Incredible. And there's more. An extensive new study by the Dartmouth economist who helped invent the Fama-French model (widely used to calculate risk-adjusted performance) says investors "collectively spend [i.e., waste] $100 billion a year" trying to out-smart the market. Kenneth French took into consideration the expenses
and typically high management fees of domestic equity funds.
At that price tag, "active investing is a negative-sum game," wrote the New
York Times. "Even if you have compelling reasons to believe a particular trade
could beat the market, the odds are still probably against you."
But stock pickers (and their clients) persist.
Already this year we are seeing moves back into the pummeled financial
services sector. Why? Because some believe this group has bottomed out. Although
the average international fund earned 16% last year, and emerging-market funds posted a 36% return, the Wall Street Journal reports some funds actually trimming their overseas holdings for moves into the domestic market – betting on the Big Bounce.
And some hedge funds are borrowing into that bet.
Investing is not an act of faith.
Sustained, broadly-allocated investing
is the only rational approach to protecting
one's financial future.
It's true that we live in an Analysts Culture where quarterly corporate
earnings are forecast down to the decimal point – and to miss analysts' estimates,
even by a penny, is to tempt punishment in the market.
But this is a far cry from Apocalypse.
What investors learned from the sub-prime fiasco is that 1) nothing happens in isolation and 2) world markets will correct. Just as the insurance industry swiftly reacted with improved risk modeling and underwriting after Katrina, world financial markets collectively will stabilize and prosper – as they always have – over time.
Precisely when will this occur? Exactly where on the planet? In what sectors? For the broadly diversified index investor, who is invested in almost everything everywhere, in terms of investment approach it doesn't matter.
Risk of Ruin?
What has all this meant to the well-allocated, long-term investor?
It certainly has provided some heart-pounding reading. Perhaps it was
even cause for a long look out the kitchen window. (After all, no one is devoid of emotion!) But the well-diversified Holland investor – looking out that window – saw
an undisturbed long-term horizon.
"Because our portfolios are so exceptionally diversified, and because I don't use potentially dangerous strategies like leverage, the risk of ruin in what I do is virtually non-existent," said Jeffrey Holland, manager of Holland Portfolios, a family of proprietary "passive" index models.
(cont.)
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