To consistently produce better returns, evidence suggests that you should keep-it-simple and "Just Say, 'No.'"
Another calendar quarter has come to an end and already the airwaves are full of updates celebrating what investment fund has recently performed the best and with recommendations on how to win going forward.
My email inbox is also filling up rapidly with invitations to "register now before space closes" to hear Wall Street's latest hot debate on topics such as "Factor Alpha vs. Smart Beta -- How to Win" or to hear more about "This Year's Big Winner."
Why do we receive so many emotional pitches with implied promises of excellent returns from investment gurus when studies consistently show that following the Wall Street herd into the latest "New New Thing" often doesn't end well? Maybe it is because investment marketers know that, just like with drugs, our brains get fried on the stock market.
Does anyone remember the 1980s public service announcement run by the Partnership for a Drug-Free America titled, "This Is Your Brain On Drugs"? In the video, a man holds up an egg and says, "This is your brain." He then turns to a hot pan and says, "This is drugs." Next, cracks the egg, drops it to the pan says, "This is your brain on drugs. Any questions?"
Like with drugs, our brains get fried by money.
"I looked at studies that compared people who make money to those who are high on cocaine. Remarkably, the brain scans were almost identical," said Kabir Sehgal, and author of the book Coined, which presented research into how conversations about money can be a powerful mental stimulant.
"I also looked at brain scans of the people who are high looking at naked women, dead bodies and money. And what got the most activation? Money."
Keeping this in mind, it is no wonder that the average investor tends to chase performance while also significantly underperforming in the market due to emotional selling or buying at the wrong times.
According to research from Morningstar, the 10-year return of the average balanced fund (mix of stocks and bonds) for the period ending 12/31/13 was almost 7%.
What was the average return of investors in balanced funds over this same time period? Approximately 5%, which represents a gap of 2% on average per year for 10 years.
The gap for investors in sector funds, which tend to attract more active traders, was even higher at over 3% on average per year for 10 years.
This past Sunday the Wall Street Journal ran a story with updated data from Morningstar stating that "the gap over the past 15 years is negative 1.6%, implying that investors are getting worse at timing their trades."
Professional investors much be better though, correct? Nope.
As I've discussed in the past, unfortunately investment professionals often are off the mark as well.
CXO Advisory recently published a report based on over 6,500 predictions made by 68 investment gurus covering the time period 1998-to-2012. They found that the accuracy of well-known investment strategy professionals, including Jeremy Grantham and Abby Joseph Cohen, was only 47%, or worse than a coin toss.
So, what to do?
Here are two predictions:
- Sensational headlines that are designed to sell products, but that are often not conducive to good investing, will continue
- When volatility spikes again, which it will, Wall Street will not miss out on the opportunity to sell a trade or a product when anxiety is high
Back in the 80's, the "Just Say, 'No'" PSA took a lot of flak for not understanding just how hard it is to resist simulates and for not giving realistic thoughts on alternative courses of action.
I know it is not easy to avoid the excitement of the latest hot idea and get sold something based on the FOMO (fear of missing out).
So, if you find yourself yearning for a star recommendation, consider getting anchored on the following advice that investment star Warren Buffett recently gave on CNBC to the NBA star, LeBron James:
"Everybody's got an idea... [but] usually simplest is the best."
Buffett went on to say that stars are often approached with investment ideas, but that LeBron should "just make monthly investments in a low-cost index fund."
This might not sound exciting, but as with many things, in investing the boring tortoise often beats the hare.*
* For the latest stats on how active managers have performed as compared to index funds click here.
This article is commentary by Preston McSwain as an independent contributor and does not reflect the views of Fiduciary Wealth Partners.