If you were considering eye surgery, chances are you’d do some research to raise the probability of a successful outcome. You’d likely want to know which procedures offer patients the most vision and clarity. You’d want to know which doctors perform that procedure and about their experience, success rate and overall cost. You’d want evidence to support your decision; you have one set of eyes and your vision is crucial.
Medical science continues to utilize research to raise the probability of success in patient outcomes, otherwise known as evidence-based medicine. If this approach applies to our physical well-being, doesn’t it make sense to apply the same rigor to our financial well-being?
Consider these trailing-period statistics for “active” fund managers (professional investors who employ a strategy of stock picking and market timing):
1-year period (2011): 59% of equity managers and 74% of bond managers failed to have a successful outcome (defined by outperforming the market or their stated benchmark AFTER fees).
5-year period (2006 – 2011): 67% of equity fund managers and 85% of bond managers failed to have a successful outcome.
10-year period (2001 – 2011): 80% of equity fund managers (see the breakdown by asset class below) and 89% of active bond managers failed to have a successful outcome.
The common thread among these managers who did not have successful outcomes? They all chose not to structure their investment portfolio to consistently simulate a market index or asset class. They failed to trust the efficiency of markets. They increased costs by trying to realize outcomes that are virtually impossible to achieve over long periods of time.
Ironically, nearly 80% of the $6.5 trillion of assets in mutual funds today are actively managed. Destined for a losing proposition, the overwhelming majority of investors still utilize an active approach. How can this be? If the medical community had overwhelming evidence showing a particular procedure or protocol consistently provided the highest probability of success, it would potentially be malpractice not to recommend that procedure for your patients.
The investing alternative, or “procedure,” known as asset class or index investing, is backed by rigorous research and overwhelming evidence from academia. Consider the simple math: The average return on the universe of actively managed assets, before fees, must equal market return since asset class and index investors are already accepting market return. Asset class and index investors experience lower costs than those fees borne by active investors, therefore, after fees, the return on the average asset class or index managed dollar will be higher than the return on the average actively managed dollar. Nothing to argue here folks! Like medicine, successful investing begins with paying attention to research, evidence, and results. Picking a few stocks or even a few professional managers from the universe of thousands is not a supportable evidence-based strategy, nor is trying to avoid a few bad days, months or even years in different markets. The evidence suggests that while this knowledge would be valuable, it does not reliably exist. Information moves too fast once it becomes public knowledge.
Evidence suggests investment success lies along the path of reliably capturing the return of entire markets, asset classes and indices, day in and day out. Through the best days and the worst days. Period.
The mix of asset classes an investor holds will vary with life circumstances and risk preferences (e.g., what percentages in stocks, bonds, and cash). That determination comes in the form of holistic financial planning. Yet, regardless of allocation, employing low-cost, globally-diversified portfolios that neither seek to time nor select against the market will provide you with the highest probability of success. That level of confidence is invaluable, both on the operating table and in the investment world.
Looking for another objective voice that summed up the argument very well?
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