If You Are Still Paying For Investment Advice, You Are Not An Investor, You Are A Philanthropist!
There are many worthy charities you should consider contributing to besides your investment advisor. Giving does make us feel better even though we know we will receive no economic benefit. In this article, I will prove to you that paying for investment advice meets that criteria. I will also show you why you only need three investments to have a fully diversified portfolio, regardless of your risk tolerance.
It is an established fact that the overwhelming majority of professional portfolio managers have not outperformed their respective indexes. The machinery known as Wall Street has thrived for a long time on a myth. The myth is the propagation of a false presumption that you need them in order to achieve above-average returns. This myth is and has been propagated by billions in advertising and the media. The brokerage and money management business is a giant cash-consuming monster that demands to be fed – continuously.
We propose that the average investor, with little experience can achieve better than average results without paying any advisory fees. If after reading this you decide you just really like your advisor, I suggest you fire them and start sending gift cards instead.
I realize that plenty of people reading this already know they could do better than their advisor but will continue to do it anyway. This group of investors are called “donors” and they are good for the financial ecosystem. In this article, we are going to break down the primary reasons stock pickers cannot outpick the universe (the broad market) from which they are picking. At the end of this article, we will outline simple steps you can take to get the same results as those sitting in the ivory towers. Here is a short list of reasons for this sad reality.
- The Market is Efficient – This has to be the biggest reason most managers fail to beat the S&P 500 over time. One would think that offices filled with analysts, strategists and expensive Ivy League MBA’s surely this brain trust could find 50 or so stocks that have better prospects than the other 450. Well, it ain’t so. Today, more than ever information is made available to everyone at the same time, leaving no one with an advantage (not legally anyway). On a given day, a portfolio manager buys stock X from someone selling it. Obviously, the manager thinks he knows something the seller doesn’t. Does that even sound reasonable?
- Fees, Trading Costs – Ever since the NYSE and NASDAQ switched from fractions to decimals, spreads have narrowed. For example, prior to this switch 1/8 of a point was 12 ½ cents per share. Decimalization lowered that to a few cents on most widely traded stocks. Still, this change did not result in any real improvement in returns. When portfolio managers and mutual funds place a buy or a sell order, the order itself can cause market movement, depending on its size. In addition, brokers charge commissions even to huge institutions and those commissions add up. Lastly, we have management fees.
- Managers, advisers and mutual funds don’t work for free. Even the giant Fidelity Contra fund ($100 Billion) charges .55% per year according to Morningstar. That fee amounts to $550,000,000 per year. That’s just one fund! So what did investors receive for their half Billion dollars in fees? According to Morningstar the “best fit” index actually outperformed Contra by .56% compounded over the last fifteen years, almost exactly the same as the management fee.
- In defense of advisers: Having been an adviser for over three decades and most of that as a fee charging money manager, I believe there is still a role for the right professional. My three fund, set it and forget it, couch potato portfolio is the SPY, QQQ and VFINX. This gives you 550 stocks that are the most successful in the country and short term government bonds to dampen the risk. An adviser’s role is to help those who need it determine how much risk they can tolerate, how much return they actually need. This can only be done via calculation and consultation. If you feel comfortable doing that yourself, go for it. The bottom line is regardless of how you wind up with whatever asset mix you choose, you will not outperform the indexes that match your portfolio by layering on investment advice.