Gallery:Step 1|Step 1: Active Investors

Are You an Active Investor?

Gallery:Step 1|Step 1: Active Investors

"The results of this study are not good news for investors who purchase actively managed mutual funds. No investment style generates positive abnormal returns over the 1965-1998 sample period. The sample includes 4,686 funds covering 26,564 fund-years."

- James L. Davis, Mutual Fund Performance and Manager Style, Financial Analysts Journal 57 (2001): 19-27

ARE YOU AN ACTIVE INVESTOR?

The first step on the index funds journey is to recognize active investor behavior. If all investors were lined up in a row, could the active investors be identified? Active investors actively engage in stock picking, time picking (market timing), manager picking, and style picking. They usually share the following thoughts and behaviors: 

  • Own or plan to own actively managed mutual funds. 
  • Select stocks they think can outperform a market. We call this stock picking
  • Think there are times to be in a market and times to be out of a market. We call this time picking, generally known as market timing
  • Think that active managers with the best track records are the ones to select to manage their investments. We call this manager picking
  • Shift in and out of styles or indexes in an effort to chase returns, e.g., from large cap to small value. We call this style picking
  • They think that now is the best time to be in a certain sector like healthcare, technology, large cap or small cap. 
  • They invest without considering their risk capacity or overall risk exposure. 
  • They invest without studying the academic research that explains how and why free markets work. 
  • Are primarily invested in the S&P 500, thinking this provides adequate diversification. 

If you are participating in these investing practices, I invite you to abandon your addiction to prediction and begin your 12-Step Journey to Tradeless Nirvana.

Our 12-Step Journey begins with acknowledging the patterns of behavior that result in wealth erosion rather than wealth accumulation. The erosive elements have been described above. True wealth accumulation can best be realized by abandoning the need to predict future market movements and to accept that we really do NOT know, and that is okay.

This acceptance frees our thoughts to focus on the long-term returns of the global markets. These returns have been there for the taking for those who have simply educated themselves enough to know that capitalism works over time, thus markets have a positive expected return. We may not see positive returns in every short-term period, but over time, Capitalism rewards long-term investors who remain steadfast – even when Capitalism seems under pressure for its very existence (as was bandied about in 2008). Take a look at what I call Capitalism, Inc.. Do we really think capitalism can just go away? Not likely.

How best can you earn your fair share of capitalism? You can buy, hold and rebalance a risk-appropriate, globally diversified portfolio of low-cost and style-pure index funds. Depending on your time horizon, you can pack that index portfolio with indexes that carry a tilt toward small and value companies because these have shown to deliver higher returns over longer time periods. These small and value companies are riskier in that they have higher highs and lower lows – making them really hard to hold for those who do not understand the true nature of their long-term returns or who will need the money in the short-term.

In sum, stock market returns come from taking stock market risk, not short-term speculation about whether the market will go up or down over the coming months. In fact, an investor who will need their invested money in less than four years should not be invested in stocks. An investor with a full-equity portfolio should have a time horizon of at least 12 years. This person should also possess a clear understanding of why they have the right to expect a return from their investments and that indexes which carry the highest expected returns also pack a lot of risk; this is the reason they carry higher expected returns.

My 12-Step Program for Active Investors will show you what doesn’t work in investing and what does work. I will lead you to an investing method that carries higher expected returns AND peace of mind. But, as always in life, “There ain’t no such things as a free lunch.” You have to LEARN before you can earn. So let’s get started with Step 1 of my 12-Step Program for Active Investors.