Tag: Indexing

Market Myth #2: It’s all about beating the market.

For many amateur investors the object is to beat the market.  They are abetted in this belief by the many magazines and newsletters that make the market the benchmark of what a successful investor should emulate.  People spend hours scouring the media looking for stock tips and investing ideas as if investing was a sport, like horse race, where the object is to beat the others to the finish line.

The fact is that “beating the market” does not address any individual’s actual financial goals.  It’s a meaningless statistic.  And it’s dangerous.

The fact is that most professional investors don’t beat the market on a consistent basis.  Even index funds, designed to replicate the market, don’t actually beat the market.  At best they provide market rates of return minus a fee.  Attempting to beat the market exposes the investor to more risk than is prudent.

Your portfolio should be built around your needs and consistent with your risk tolerance.

What does this mean?  Your portfolio should provide a return that’s keeping you ahead of the cost of living, that allows you to retire in comfort, and is conservative enough that you will not be scared out of the market during the inevitable corrections.

Want to create a portfolio that’s right for you?  Contact us.

How Great Advisors Search for Stand-Out Managers

In the bad old days, not that long ago, brokers for the “big box” stores recommended fund managers because

a) They were paid more or received benefits like trips or prizes.

b) They were trying to get their clients quantity discounts by using only one fund family.

c) They didn’t know any better.

So lots of unwary investors ended up with a hodge-podge of mutual funds, either all from the same fund family or a collection of funds that did not create a well diversified portfolio.  Many funds were not reviewed regularly and investors hung on to them for years because no one bothered to do any analysis.

Today a lot of the landscape still looks the same.  Even the “do it yourself” investor has a tendency to focus on things that may not really help them achieve their financial objectives.  For example, the focus on fees has a tendency to distract from issues that are more important.   Investors are constantly told that low expense index funds are the only way to go because they beat their actively managed cousins. Well, no, that’s not necessarily true.  Active managers can beat index funds, and have done so over long periods.  But managers need to be monitored.  A smart investor needs to keep track of how a manager is performing, be sure that he’s sticking to his discipline and, finally, make sure that he has not left the mutual fund to someone else to manage.

Well-chosen active funds can pull their weight during market downturns by cushioning portfolios from the full decline.  Since we can’t forecast the future with precision,  getting great returns on a risk-adjusted basis is the guiding principle for the selection of stand-out managers.  That’s why RIAs who are not part of one of the major firms and can give unbiased advice are so valuable.

What is an ETF?

Exchange Traded Funds, otherwise known as ETFs, are essentially index mutual funds that trade like stocks.  ETFs’ popularity is growing in part because some of the biggest names in the financial services industry are promoting them as alternatives to regular, or open-ended, mutual funds.

What’s the benefit of an ETF?  First, most have a low expense ratio.  An expense ratio is simply the amount of money that the fund charges in fees.  A second advantage is that an ETF can be traded (bought or sold) any time that the market is open.  For example, if you believed that the stock market was going to go up during the day, you could buy a stock market index ETF in the morning and sell it in the afternoon and capture the gain (or loss).  You can’t do this on an intra-day basis with a regular open-ended mutual fund.

What are the disadvantages?  Up till now the buyer or seller of an ETF incurred a commission, just like the individual who bought or sold a stock.  This is not the case with no-load mutual funds that don’t charge a fee for either buying or selling.  That is in the process of changing as some of the biggest names like Schwab and Fidelity are offering free trades on a growing number of ETFs.

The other disadvantage for the typical investor is that most ETFs are index funds rather than actively managed.  That means that there is no-one actually making a decision about what stock or bond to buy, sell or hold.  Buying an EFT requires your active participation and management or you risk putting your investments on auto-pilot and hoping that they don’t crash.

Passive investing vs. Active Investing

Comment from Oppenheimer Funds.

 Indexing clusters investment assets in securities which represent past success, are widely owned, and often fully valued.  Investing is about the future.  Good active investors are adept at uncovering future success.   Compounded over a long time horizons, the difference in so called “terminal wealth” can be very large between passive approaches, average active approaches, and above average active approaches.    

Translation: Most indexes, like the S&P 500, represent the best performing stocks of the past, not necessarily the best ones to own in the future.

© 2021 Korving & Company, LLC