“Deserve's Got Nothin' To Do With It”
There are many paths to becoming a successful investor. On one end of the spectrum, some investors choose to delegate investment decisions to Mutual Fund Managers or Portfolio Managers. These professionals act on behalf of the investor and in turn charge for their services; usually on the basis of a percentage on assets managed. Sometimes these fees are very transparent and upfront. Sometimes they are hidden or embedded within the product itself; as is often the case with many kinds of mutual funds. Very soon legislation will take effect that will compel investment firms and advisors to fully disclose all fees including those embedded in their products (CRM II). -- I applaud this development because Investors will soon be able to assess what they are getting for what they pay.
At the other end of the spectrum are “do it yourself” investors who chose to minimize all forms of fees or charges and manage their own investments. Typically, they will invest their accounts with on-line discount (read ‘no service”) brokerages. This is an appropriate option for individuals who have the time, interest, expertise, and emotional control to manage their investments in a professional manner. The problem is that the number of investors that truly possess these traits are a vast minority.
Of particular importance is emotional control. The mainstream financial media regularly criticizes the mutual fund and investment firms for charging management expenses while the average fund frequently underperforms benchmark indices by 1%. They argue that investors should simply buy an index fund or Exchange Traded Fund (ETF), reduce their expenses, and read their news columns. Implicit in this reasoning is the assumption that by minimizing charges, investors can maximize their returns. However, studies from Dalbar and Morningstar have confirmed that time and time again, left to their own devices, do-it-yourselfers significantly underperform “the market”. For example, “for the twenty years ending 12/31/2015 the S&P 500 Index averaged 9.85% a year. A pretty attractive historical return. The average equity fund investor earned a market return of only 5.19%.” (“About Money: Why Average Investors Earn Below Average Returns”, August 15, 2015). This is commonly referred to as, “The Behavior Gap” (for a great primer read Carl Edwards’ “The Behavior Gap: Simple Ways to Stop Doing Dumb Things with Money”).
Why does this occur? I go back to emotion. While I have met some very smart and well qualified investors, most tend to fall prey to the impulse to want sell when markets fall (sell low), and buy in rising markets (buy high). It is a hardwired instinct to avoid pain and seek pleasure. And that is why, I would wager BIG, that you will never see advertisements from discount brokerage firms stating that, “Our average investor outperforms the market by X%!”. Why? Because most of their clients, no matter how well versed in the markets, are reacting emotionally and shooting themselves in the foot in a big way (but they are saving a bundle on commissions!).
In between the two extremes is a third option: working with a trusted Investment Advisor or Portfolio Manager (PM). While this is not the “cheapest” route, on an absolute basis, the significant value realized by working in concert with an Investment Advisor can more than recover the marginal increase in cost associated. Advisors/PMs typically have excellent access to research. They also provide a great sounding board for ideas. Most are qualified to produce a Financial or Retirement plan (providing a blueprint for financial success), and a good Advisor/PM will help you close the Behavior Gap in good times and bad.
No one is going to get market beating returns for free because they “deserve to”. It takes hard work, a good strategy, and steadfast emotional control. Unless you are one of the minority that have all of these abilities, you will get better value from working with a trusted Investment Advisor or Portfolio Manager.