In most endeavors, there are things you can control and things you can't. That's true in life. That's true in business. That's true with investing. The good news about investing is that markets have rewarded investors over the long term. But over the short term—as anyone who has paid attention to markets knows—markets go up and markets go down. I thought it would be helpful to share some observations about the investment business and what it takes to have a good experience.
The Random Performance of Traditional Money Managers
Few things have been studied as extensively as the performance of professionally managed funds. While the results indicate that some managers have good track records, there are far fewer of them than you would expect by chance.
What does that mean to investors? It means that even after analyzing all the data, you can’t separate skilled money managers from lucky ones. And if you can’t identify superior managers after the fact, how can you identify them in advance? Based on the overwhelming evidence, there is no magic to investing.
Distribution of Luck vs. Skill in US Equity Mutual Fund Performance
3,870 US Equity actively managed mutual funds, 1984-2015
The Uncertainty of Markets
Throughout their lives, people must continually deal with uncertainty and make choices—what school to attend, what career to pursue, where to live, and so forth. You make these decisions without knowing the outcomes. You look at all the possibilities, and then you decide.
Much of the financial services industry is geared toward making people think they can eliminate uncertainty in investing. However, the future is unknowable. The best approach to dealing with uncertainty is to make informed choices, adjust as your needs and objectives change, and be comfortable with the range of possible outcomes.
Industry Mutual Fund Performance
US mutual funds over 15-year period ending December 31, 2017
Developing an Investment Philosophy You Can Stick With
A philosophy serves as a compass to guide you through turbulent times. When you’ve got a compass, it doesn’t take drastic directional changes to find your way. Small adjustments are all you need to stay on course.
In 2009, the US stock market was down more than 50%, which seems to happen about once every generation. A lot of people were stressed out by the uncertainty, so they cashed out. That locked in their losses. The market, as it turned out, rebounded and some of those people who got out of the market may have to wait decades to get back to where they were. It’s unfortunate they didn’t stick it out so that they could have better weathered the storm.
Trusting Your Strategy and Being Patient
Trust involves many different parts. To trust markets, you must understand how they work, which means having a source of reliable knowledge. The best source is scientific research, not opinions and hunches. You must also trust the professionals who are managing your investments, which should involve a clear understanding of what services and expertise you are buying and what you are paying in fees and costs.
Most people lack the knowledge to manage their own investment portfolio. A trusted financial advisor can help you figure out your goals, present different ways of forming portfolios, and ensure you understand the possible distribution of outcomes. This way, you can make informed choices about how to invest. Your advisor then keeps watch over what is happening, and together you revise your investment plan if needed.
Investing is a dynamic process and a lifelong journey. It’s having a philosophy you can stick with, considering the range of possibilities, and adjusting along the way. These are the keys to a better investment experience. Stay disciplined, control what you can control, and keep a long-term view on your destination so you can focus on what really matters and enjoy your life.