Thursday, February 23, 2012

Think There is a Smart Investment Advisor Out There to Pick Winning Stocks for You – Think Again

You Cannot Beat the Market – So Join It

There are two major competing ideas in the investment world.  One is that there are a bunch of smart people out there who can pick stocks and put them into a portfolio that will consistently perform better than the market as a whole.  The way to find these smart people who manage mutual funds available to the public is to look at past performance and pick funds that did better in previous years.

The second theory is that it is impossible to consistently create a portfolio that will perform better than the market, that on average about half of the managed portfolios will do better than the market, about half will do worse, and that past performance is no indicator of future performance.  Under this theory it is impossible to determine in advance which funds will do better than the market.

The logic behind the second theory is compelling.  Since large managed portfolios like mutual funds are diversified, not only will they on average fail to beat the market, they will on average underperform the market average.  The reason is that these funds charge up to 2% of the portfolio as fees.  So in order to just equal the market they have to do 2% better than the market.

The statistics are clear on this, as this report shows.

According to James Bianco of Bianco Research, 2011 was a particularly rotten year for stock pickers: Only 17% of more than 4,000 funds that invest in large U.S. stocks beat their benchmark. In most years, fewer than half do.

What!!!  Only 17% of the people paid huge sums to pick the winning stocks did better than simply investing in the market as a whole, something that can be done by buying an index fund who performance matches the market.

Now you all know the basis of the (very) old joke, “If you want to make a small fortune by letting someone who is an “expert” invest your money, you need to start with a large fortune”.  Or as a statement attributed to Warren Buffet goes, “when a person with money meets a person with experience, the person with experience gets the money and the person with the money ends up with an experience”.

1 comment:

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