Tim Slattery, an advisor friend of ours, starts out a meeting with a prospective client by stating the following:
“Our investment philosophy is 100% driven by logic, with one exception. We’re asking you to take one thing on faith: capitalism will make us money over time. If you don’t believe that, you shouldn’t hire us and you should not own stocks. Because if you don’t believe capitalism will make you money over time, then the stock market is just a gambling casino. It’s purely a speculative venture.”
Capitalism creates wealth in many different ways. For example, you can assess all the risks and then invest your time, money, and brains into opening a local coffee shop. Or you can invest in the global public securities market and rely on others to assess the unique risks of their businesses and build wealth that is reflected in rising stock prices and, hopefully, dividends. How you “invest” in these securities markets is the critical issue.
Most investors purchase mutual funds run by money managers who buy and sell a concentrated portfolio of, say, 50 stocks. It’s considered good diversification if you own many of these actively managed funds with different investment styles. Welcome to the gambling casino.
The table below shows that over the past 15 years, only 42% of U.S. actively managed stock funds have survived. Would you consider a 58% chance that your fund either merges with another one or is liquidated (almost always to hide poor performance) a gamble on the viability of active management?
Over the past 15 years, only 39% of actively managed funds stayed true to their investment style. If, as the empirical evidence suggests, returns are driven by style, shouldn’t this 61% failure rate considered a gamble?
Over the past 15 years, only 15% of all U.S. stocks funds managed to outperform the market. Shouldn’t an 85% failure rate be considered a gamble?
Finally (not shown), only 10% of funds that were in the top 25% in performance at the end of 2013 remained in that top quartile a year later. Four years later, only .87% were still top-quartile. Is this lack of performance persistence not a gamble?*
For these reasons, traditional active management should be considered an uncompensated risk by investment fiduciaries. Some risks are worth taking, and others aren’t. Capitalism creates the opportunity. You need to decide the best way to capitalize on the opportunity.
With so much empirical evidence supporting the efficient market theory, the availability of highly diversified index and asset class funds, and a better understanding of investment risk (as well as how emotion and behavior affect decisions), investors can invest in capitalism rather than gamble with it. Asset class investing is the answer.
According to the Ad Council, since the “Friends Don’t Let Friends Drive Drunk” advertising campaign in 1983, “more than 70% of Americans exposed to the advertising have acted to prevent someone from driving drunk. As a result of the campaign, the term ‘designated driver’ is part of American culture.”
Maybe you should be the financial designated driver for family, friends, and colleagues by steering them away from active management. After all, after you rejected the low odds and uncertainty of that addiction, aren’t you less stressed and more confident about your financial future?