Rule #2: The crystal ball is broken
They claim that, armed with the sharpest minds, the most up-to-the-minute investment research, and most expensive technology, they will pick the next Google and avoid the next HIH.
There is an enormous body of well documented academic research that proves the average fund manager, after fees, is unable to beat the market. Sure, there is a small group of fund managers who beat the market each year….but it’s a different group every year! There is no evidence proving active fund managers can consistently beat the market other than by pure luck.
Your life savings on the toss of a coin?
Consider this little experiment…
Let’s assume there are 5,000 fund managers in the country, all competing for your investment dollar. We’ll give each a coin and get them to flip it once a year. If they get ‘heads’ then they beat the market that year, tails and the market beat them.
After the first toss you’d expect half of the group to have come up with heads and the other half tails. Get rid of the tails (the market beat them) and we’ll keep the winning crowd, all 2500 of them, to test them next year.
They flip; 1250 are discarded and we keep the remaining 1250 who flipped heads; they have beat the market two years in a row – purely by chance.
And again and again and again.
By the end of our tenth year the original group of 5000 hopefuls has been whittled down to just 5 – only 0.1% of the group beat the market every single year. By chance, though, not by skill.
It takes a long time to rule out chance and prove that skill is the force at place here; statisticians tell us at least 20 years is needed as a minimum but preferably up to 115 years to categorically rule out dumb luck!
Active investing: an act of faith
The list of well-knowns who have beat the market consistently can be counted on one hand.
There’s Warren Buffett, naturally. Peter Lynch traded with stellar success for 13 years before retiring. There’s also Miller, Mario Gabelli and perhaps a few others. The trouble is in identifying them early in their careers – they are indistinguishable from the crowd of contenders beckoning you to their booth.
There is no established way of picking the stellar performers beforehand.
Investors who cast their lot with the empty promises of active fund managers are committing an act of faith. Why take bets on a manager’s purported skill, running the staggeringly high risk of them failing to deliver?
Even if they do have that rare skill… what if they retire? Get head hunted by another firm?
A passive approach to investment is not reliant on a manager’s ‘yet to be proven’ skill. Nor is it dependent on the team around them, their research, their technology, allegedly superior knowledge, nor any other of their supposed market-beating resources they claim they possess.
It’s a model that endures, day in and day out.