We’ve said it before, and we’ll say it again: Individual investors become their own worst enemies when they choose to play in financial markets instead of investing in them.
But here’s an interesting wrinkle. In one of his recent posts, Wall Street Journal columnist Jason Zweig shared a seemingly contradictory stat on that, in which do-it-yourself investors came out ahead of their advisor-assisted counterparts.
What’s up with that? Are we wrong??
Let’s take a closer look at the case. Zweig’s illustration compares investor experience in two virtually identical Fidelity biotech funds – except one is designed for direct investment and the other caters to investors being served by financial advisors.
You’d expect those who invested directly would engage in ill-advised market-timing and more severely underperform what the fund actually returned, compared to those who were advised to patiently buy and hold. Instead, investors in the advisor-tailored fund did worse in Zweig’s illustration. How come?
The illustration Zweig used may well have been a case of some market-timing investors getting lucky during a specific timeframe. But another culprit to consider may be the “advisors” recommending the advisor-tilted fund.
Zweig describes: “Not all advisers chase performance, but all too many still do. Buying what’s hot and dumping what’s not, they are no less human than their clients.”
In describing what a good advisor should be doing for you, Zweig quotes Dimensional Fund Advisors’ co-CEO Dave Butler: “Advisers [should] provide a human element that gives clients confidence and comfort in not deviating from a plan.”
“[Y]ou should hire an adviser not for his or her investing prowess, but to help organize your finances, prioritize your goals, minimize your taxes, and navigate the shoals of retirement and estate planning. Done right, those services can make you far richer — and happier — than the pipe dream of investment outperformance is likely to.”
In short, we believe a good advisor should help you avoid, not enable, your “worst enemy” tendencies. Plus, they should be even more disciplined than you are at ignoring any market-timing habits and stock-picking cravings to which they themselves may be vulnerable.
The defense rests.
There’s never a lack of news in the financial press: new studies, new reporting, new crises, new opportunities … it never ends.
Some of it is worth heeding; most of it is just noise. One of our roles at Hill Investment Group is to help you find the hidden gems in all that “new news.” Here are two worthy reminders that trying to pick individual stocks or forecast the market’s many moods remains as ill-advised as ever.
On the Dangers of Stock-Picking …
In his recently published piece, “Hot Stocks Can Make You Rich. But They Probably Won’t,” Jeff Sommer of The New York Times reflects on how investors may be tempted to chase surging stocks in hot markets. “But,” he cautions (emphasis ours), “before you jump headlong into stock picking, you may want to consider the odds … [O]ver the long run, while the total stock market has prospered, most individual stocks have not.”
This may seem counterintuitive, but for supporting evidence, Sommer cites a new study by Hendrik Bessembinder of Arizona State University’s business school (my own alma mater). Sommer points out two remarkable findings from the study, often overlooked in all the excitement:
- “58 percent of individual stocks since 1926 have failed to outperform one-month Treasury bills over their lifetimes.”
- “[A] mere 4 percent of the stocks in the entire market … accounted for all of the net market returns from 1926 through 2015.”
Professor Bessembinder’s study concludes that individual stock picks are like lottery tickets. A stock picker may beat the odds and win big, but if you’d rather focus on winning sustainably while managing the risks, you’re better off accepting wider market returns.
On the Dangers of Market-Timing …
On the same day Sommer’s article appeared, The Wall Street Journal’s Jason Zweig published a nicely paired piece, “Sorry, Stock Pickers: History Shows You Underperform in Bad Markets, Too.”
You may need a subscription to read the entire article, but the title says a lot. Based on data points going back to the 1960s, Zweig notes: “The odds of finding a stock picker who can do better in down markets have long been less than 50/50.” Not only are the odds against those who try to beat the market, the costs tend to be high in every market, up or down. So, while stock pickers often tout their ability to shine the brightest when the markets are at their darkest, the evidence again suggests otherwise.
So, What’s New?
Bottom line, a traditional active investor faces hurdles that are simply too tall to be enticing, especially when there is a more logical, evidence-based strategy to lead the way. This may not be breaking news to anyone who’s been following our work for a while, but I’d say it’s still as fresh and relevant as ever.
When we talk about evidence-based investing, we often mention the importance of going global.
Global diversification ensures that you aren’t placing all of your financial faith in the fate of any one country’s concentrated risks. It also helps you combat your natural tendency to bulk up on investments closer to home, where you imagine you’ll be safer or better off over the long haul.
That’s known in behavioral finance as “familiarity” or “home-town” bias, and it’s premised on false assumptions. We’re as patriotic as the next Americans. But the evidence still informs us that human commerce knows few borders, so neither should our investments.
That’s the long view on global diversification. But have you ever wondered about some of the details?
Say, for example, you were to invest half of your portfolio in a U.S. equity index fund, and the other half in an international index fund, “ex-U.S.” In terms of number of stocks as well as market cap (the total dollar value of a public company’s outstanding shares), how diversified are you, really? Are you still at a 50/50 split?
Dimensional Fund Advisors recently published “Going Global: A Look at Public Company Listings,” to explore some of these underlying questions. Some of its findings:
- Worldwide, there are more publicly traded stocks than their used to be, increasing from about 23,000 to 33,000 between 1995 and year-end 2016.
- In the U.S., there are fewer publicly traded stocks than their used to be. Using the Wilshire 5000 Total Market Index as a benchmark, U.S. stocks declined from about 5,000 to 3,600 companies between 2005 and year-end 2016. (That’s right, the “Wilshire 5000” actually only tracks about 3,600 stocks these days.)
- As measured by market cap, the U.S. still dominates global markets – by far, at 54% of the world’s market cap. That’s also an increase from 40% in 1995. The next biggest contender? Japan at 8%. (See our accompanying “Illustration of the Month.”)
- Many index funds only expose their shareholders to a fraction of these total available stocks. From Dimensional’s report: “For example, one well-known global benchmark, the MSCI All Country World Index Investable Market Index (MSCI ACWI IMI) contains between 8,000 and 9,000 stocks. … For comparison, the Dimensional investable universe, at around 13,000 stocks, is broader.”
What can you draw from these insights besides trivia to share at your next social gathering? Zooming back to our favorite vantage point – the Long View – there are still plenty of opportunities in plenty of places to maintain your efficient, effective, globally diversified investment strategy.