Good reads from around the Web.
There are many reasons to be a passive investor [1], but guaranteed returns is not one of them.
Is passive investing most people’s best chance of capturing the expected returns [2]?
Definitely.
But you can’t bank [3] on expected returns.
This was illustrated nicely by Motley Fool columnist Morgan Housel in an article this week [4] on how long it takes to prove yourself as an active investor.
Morgan was discussing how some lauded active investors might just have been born at the start of a good run for their asset class – and wondering how long you’d have to invest for in order to know your returns weren’t simply down to luck.
But the graph that illustrates his piece might interest passive investors, too.
It shows how US stocks did over various 20-year periods, which Morgan suggests would reflect the key years in an investor’s life (35-55, he says):
[5]Source: Motley Fool [4]
From eyeballing the graph we can see that, for instance, the 20 years following 1910 were an awful lot easier to find gains in than the 20 years from 1930.
Lies and statistics
Now before anyone in any particular camp starts having a go in the comments, this is just one way of looking at a particular slice of data and it’s designed to make a particular point.
So yes, plenty of caveats.
For a start we nearly all invest regularly over many years, not just in a one-off lump sum.
Also, sensible passive portfolios are diversified [6] – rather than just being all-in US stocks or any other asset class.
Indeed, rather than being pessimistic or misleading, Housel’s graph of US stock market returns reminds us why geographical diversification is important.
The evidence [7] is that a wide variety of very simple well-diversified and rebalanced passive portfolios will deliver solid positive returns over the long-term (though nothing [8] is ever certain!)
Finally, active investing is always a zero sum game [9]. So to extend on Morgan’s comments, this means that an active investor in a good market may find it easier to put up impressive sounding numbers, but on average they will still lag tracker funds that follow the same benchmark.
Careful what lessons you learn
I suspect we will all take what we want to find from such graphs.
Passive investing skeptics will ignore my points about geographic diversification and regularly investing over a lifetime – and Morgan’s point about lucky fund managers – and say this is why you can’t rely on trackers for your returns.
And before I scoff at them too loudly, I must admit I did think to myself that this data shouldn’t really scare me, because as an active investor – for my sins – I flit about territories and individual stocks like a butterfly on a buddleia bush.
But it would be wrong (and ironic) to take away the message that passive investing is a flawed strategy from an article that is trying to show how the perception of an active manager’s success could just be down to when their parents happened to get jiggy with it.
(Again, read my zero sum game [9] article if you don’t understand why.)
The active fund industry will always use the fact that shares go up and down and markets sometimes disappoint to play on people’s feeling that passive investing feels wrong [10].
But those feelings are not a good guide to the reality.
Certainly we need to be alert to the potential pitfalls, such as not being diversified or falling prey to sequence of returns risk [11].
And I do still hear too many new-ish passive investors saying things like “I can expect to get 5% from shares over the next few years”.
No you can’t, not over five-years.
You can hope to – but remember that average returns are not normal [12].
You know what you’ve got to do
I know these warnings and caveats are all a bit relentless, particularly if you’re new to investing.
I’m tempted to write that investing is like an onion, and that every time you peel away a layer you find a new layer and another complication.
But really it’s more like a childhood cut that turns into a scab.
You know what is happening and what you need to do – which is leave it alone – but you can’t resist picking and poking at it.
And if you do it may just start to bleed again!
The principles of investing – regular savings, compound interest, diversification, rebalancing, time horizons – were all worked out long ago.
Investors will experience very different markets depending on when they were born, but the principles don’t change.
Make sure you understand them before deciding to break them.
(And remember they are there for a reason before deciding you know better.)
From the blogs
Making good use of the things that we find…
Passive investing
- When supermodel advice means ugly returns – Points of Few [13]
- Watch Comedy Central instead of CNBC – Evidence Based Investor [14]
- In defence of long-term strategies – A Wealth of Common Sense [15]
- 6 things to consider when investing a lump sum – Rick Ferri [16]
- More on ETF liquidity issues [US focused, nerdy, but interesting] – Kitces [17]
Active investing
- Memo to David Einhorn: Gold miners suck – The Reformed Broker [18]
- 6 reasons for David Swensen’s success at Yale – A.W.O.C.S. [19]
- Black Swans and Unicorns – Points and Figures [20]
- September was most volatile month bar Oct ’08 and The Great Depression – Twitter [21]
Other articles
- Spending your pennies – SexHealthMoneyDeath [22]
- Great news! Dog ownership is optional! – Mr Money Mustache [23]
- Learning personal finance is like learning to swim – ERG [24]
- Honey, I fired the financial adviser – The Escape Artist [25]
- Trouble with pensions – Keeper of the Cauldron [26]
- A self-publishing FAQ – Oblivious Investor [27]
- A wide-ranging rant about house prices and debt – SLIS [28]
Product of the week: The era of record low mortgage rates may be ending, warns ThisIsMoney [29]. While average mortgage rates are at all-time lows, the absolute lowest rates are disappearing. For instance a borrower with a 40% deposit could get 1.99% in May but now the cheapest equivalent is 2.29%.
Mainstream media money
Some links are Google search results – in PC/desktop view these enable you to click through to read the piece without being a paid subscriber of that site.1 [30]
Passive investing
- Constant mayhem amid long prosperity – Motley Fool [31]
- Most hedge funds are – effectively – costly passive funds – ETF.com [32]
Active investing
- Lloyds 2010 issue the first UK retail bond to mature – Telegraph [33]
- Are hedge funds still for suckers? – Bloomberg [34]
- Defensive shares of yesteryear take a haircut [Search result] – FT [35]
- A primer on investing in quality companies – ThisIsMoney [36]
- Volatility is becoming more volatile – Bloomberg [37]
Other stuff worth reading
- State pensions and the “healthy life expectancy” gap – Telegraph [38]
- [Tragicomic] mismatch of hope and UK property prices – Telegraph [39]
- 5 common inheritance tax myths – The Guardian [40]
- The banks’ secret cash withdrawal limits – The Guardian [41]
- Equity release for the kids’ deposits Vs inheritance tax – ThisIsMoney [42]
- House prices jump £5,000 in a month – ThisIsMoney [43]
- The argument about time diversification [Academic] – Morningstar [44]
- Steve Jobs a hero? It’s complicated – New Yorker [45]
Product of the week: I learned how to make coffee using a commercial espresso machine a few weeks ago. Most of the other pupils in my class were City bankers, pretending to be hipsters. There were many clues (not least their interest in the coffee trade business cycle) but the clincher was they all recommended the Sage by Heston Blumenthal [46]
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- Note some articles can only be accessed through the search results if you’re using PC/desktop view (from mobile/tablet view they bring up the firewall/subscription page). To circumvent, switch your mobile browser to use the desktop view. On Chrome for Android: press the menu button followed by “Request Desktop Site”. [↩ [51]]