Many of you may by now be sick of my harping on the idea of a “broader definition of alpha.” The idea being that individuals have a much richer opportunity set to add value to their personal net worth not through better investment strategies, but rather everything else that affects how much value flows down to your bottom line. Yesterday in a post I noted how this approach is to a large degree boring or “sensible people doing boring stuff.” Not exactly the stuff of viral blog posts or best-selling books.
Again today we came across data which showed that the approach many individual investors, and the media that cater to them, have things backward. Felix Salmon at Reuters looked at data which once again show that the majority of actively managed mutual funds trail their benchmark over any reasonable time frame. The data would look even worse if you took into account the poor-timing of fund flows. Salmon writes:
All of which is to say that picking an outperforming mutual fund is at least as hard as picking stocks. And while there are some famously successful stock-pickers out there, I’ve never heard of a very successful mutual-fund picker. So, don’t bother. Throw all your money in a Vanguard target-date fund, and forget about it. It’s much easier, and you’ll end up with more money when you finally need it.
Then again we should be all that surprised that mutual funds underperform. There that whole issue of fees one has to deal with. One could argue, like The Brooklyn Investor, that the industry isn’t really set up for end user performance. He writes:
When you really sit down to think about how the industry works, it is not really designed to perform well. It is designed to retain and grow assets under management. It’s much more profitable to run a $100 billion mutual fund that lags that market (but keeps accumulating assets due to intensive marketing) than to run a $2 billion fund that outperforms the S&P 500 index. So just as Buffett is stuck managing a huge portfolio for so-so returns when we know he can put up spectacular returns with $100 million, mutual fund firms tend to take their better managers and have them run the bigger funds (and give the smaller funds to young, next generation managers).
Despite all this the vast majority of investor money in collective vehicles still resides in open-end mutual funds. In the end, it is much easier to blame some high-paid portfolio manager in Boston or New York for your financial misdeeds than to take personal responsibility for them. However it is only through taking some responsibility for your decisions can you make some forward progress.
Self-improvement is difficult. It requires you to acknowledge that your current situation is not ideal. Most people don’t get beyond that step. This quote from Mortality Sucks drives home the point:
If you assume nothing is your fault, you forego any chance of improvement. Things you can control will be overlooked and your life will be a rudderless ship. On the other hand, if you assume you are responsible for everything that happens to you, no opportunities to improve your lot in life will be missed. It doesn’t mean you’ll be able to take advantage of them all, but you’ll always have the chance to try.
Actively managed mutual funds, or ETFs, are not going anywhere. Nor is an entire cottage industry for investment/trading advice. There is nothing wrong with taking on active risk in pursuit of financial gain provided you first take responsibility for “everything that happens to you.” No blaming some distant fund manager, high frequency algorithm or plain old bad luck. By venturing into active management you are taking on risk for which you, and you alone, are responsible.