Investors who spend too much time in front of CNBC or Investor’s Business Daily can easily lose the forest for the trees. They get lost in minutia that can grip emotions, causing them to react impulsively and undo the long-term benefits of globally diversified capitalism.
March 2009 provides a fresh reminder of this truth. S&P 500 investors who were scared out of the market at the March low locked painful losses of 25.1% for the year. On the flip side, those investors who remained unshaken are now sitting on a gain of 12.3% for the year. Clearly, the cost of flinching is very high.
By simply understanding and adhering to a handful of investment truths, investors can maintain their confidence in the long-term returns of the market, and they can invest and relax.
To advance that end, here are my 16 principles that collectively define IFA’s Position on Investing:
1. On average, Capitalism earns a profit for its shareholders.
2. Companies have a cost of equity capital of about 10%, and that cost of capital is paid to the shareholders.
3. Nobody can see the future, and future prices are randomly moved by unpredictable news. Bad news results in lower prices and good news results in higher prices, all in an effort to keep expected returns essentially constant.
4. Free markets work best and current prices are the best estimate of a Fair Market Value. Fair prices result in a distribution of future returns that resemble a bell curve and are equally likely to be above or below the expected return.
5. Greater expected returns only come from greater risk. The expected return from speculation is zero and becomes negative after costs and taxes.
6. The expected annual returns for any of 20 risk calibrated IFA Index Portfolios are about 5% plus 1/2 the annualized standard deviation of returns over the last 50 years.
7. In a study of investor behavior over the 20 years ending 2008, the average equity mutual fund investor under performed the IFA Index Portfolio 100 by a 7.3% annualized return. The primary cause of the under performance was that investors chase past performance.
8. In a study of 2,100 stock pickers over 32 years, 99.4% of managers were shown not to have verifiable stock picking skill.
9. In a study of 15,000 predictions over 12 years from 237 Market Timers, there was no evidence of market timing skill.
10. In a study of 660 hiring and firing decisions of investment managers, the fired managers beat the hired managers.
11. In a study of 8,755 hired investment managers, the average hired manager out performed their benchmark by about 3% per year for the 3 years before hiring, however, they under performed their benchmarks by about 0.5% per year for the 3 years after hiring.
12. Over the 81 years ending 2008, the annualized return of a US small value index of equities beat large growth by 4.53% per year.
13. Save 10% of your annual income while you are working and spend only 5% per year of your savings in your retirement.
14. Buy a risk appropriate, globally diversified, small and value tilted portfolio of index funds anytime you have money to invest. Hold. Rebalance. Loss Harvest.
15. Only sell your investments when you need the money.
16. Hire a good passive investment advisor. Everybody will benefit from their expertise, teaching, coaching, service and independent advice. A study concluded that indexers with an advisor were 27% more successful at capturing the returns of index funds than those without good advice (see here).
I rest my case.
Mark T. Hebner
President and Founder, Index Funds Advisors