Recently I watched an ad for a mutual fund on television that scoffed at the notions of investing for a retirement lifestyle that was popular a decade ago. Investors used to be teased with the notion of investing with the goal of “buying a vineyard” but now its a matter of “get real” as if the vineyard could never happen. While I’m not saying the vineyard is realistic, can we settle for enough discretionary income to buy the vintage of your choice, as often as you choose?
Call me stubborn or merely persistent as hell. Your dreams shouldn’t die easily, persistence is critically important. But, you may have the sense that there are so few options available that could bring new life to those dreams. If you walk into your local bank or stock broker you’ll be fed the standard line to expect 6% to 8% along with a shrug of the shoulders. Seriously, why bother with the aggravation of investing when you could just settle for the 3-4% being offered by annuities, is it really worth the headache? If you’re going to take the risk of equities it better be damned worth it, yes?
Personally speaking, I’ve never met an individual who’s significant wealth can be attributed to the ownership of mutual funds whereas I know of many who’s wealth can be attributed to ownership of individual equities.
For example, the Dalbar study measure the results of individual investor performance versus the market indices. While the S&P 500 grew at an 8.2% rate from 1990 to 2009 individual investors only made 2.3% on average.
The chart below highlights the Dalbar study with a hypothetical $100,000 investment:
Quantitative Analysis of Investor Behavior
Why such a large discrepancy between potential investment returns and reality? The truth be told for Socially Responsible Investors and the public at large is primarily due to emotionally based decision making aka “Buy High / Sell Low”, buying when confidence is high and selling when confidence is low.
Investors must keep in mind that mutual funds are first and foremost a business designed to run profitably, well…. so are we for that matter. But the difference is they are subject to group behavior and primarily will only invest in popular growth stocks with very large size like Apple, Exxon, Pfizer, which allows the fund to grow almost indefinitely in size. I’m always amazed at how few Small Cap Value Funds exist. In addition, if you look at portfolio composition you’ll frequently see many of the same holdings, in my opinion this is primarily due to more of a fear of failure than desire to excel.
But is there really a sensible solution that bridges the gap between the mundane and conflicted mutual fund industry and your dreams of a worry free retirement?
Yes there is. What surprised me the most over the last three years of research and development into Quantitative Investing is that there was actually no great revelations in terms of investment technique and philosophy. The correlations between academic research of individual stock performance holds up quite well under scrutiny. Value Investing paired with Small Cap investing remains the titan of performance that it has been for decades.
Based on my three years immersed in financial geekdom is that the method in which stock data is processed and utilized into real time actionable decisions had to change. In addition, it was shocking to see how poorly the mutual fund industry was with these discoveries. Quant theory and development had been the primary space for the Hedge Fund industry, with good reason as the data forthcoming will show. But nary was there any alignment with SRI, Socially Responsible Investing or the Green Investing universe.
The solutions will likely have to come from smaller entrepreneurial investment firms without entrenched management that insists on existing methods or subjective decision making.
While its impossible to predict exactly how the Quantitative strategies will be reviewed 10 years from now, we do know that a repeat of the last decade is simply unacceptable.
More to come.
Be careful out there,
Brad Pappas