Due Diligence

The Wall Street Journal and the financial community have been abuzz about passive investing.  I wrote about settling for average and outrunning a bear via active management previously.  The newest argument for choosing active management over passive is that investors should choose ‘good’ managers, not average or bad managers. Why didn’t anyone think of that before?  Choosing a good manager sounds like common sense, but really this is an attempted rebuttal of the fact that benchmarks outperform 70-80% of actively managed funds.  Capital Group (parent company of American Funds) even published a scorecard in a sort of homage to S&P’s SPIVA report that touts the performance of ‘good’ funds.  Tim Armour, chairman of Capital Group, asks why an investor would buy Blockbuster stock in the early 2000s when they could have bought Netflix – the assumption being that a good manager would have bought Netflix while an index would have been forced…

As a whisky (whiskey here in the States) matures, it loses about 2% of its volume to evaporation each year.  Distilleries call this The Angels’ Share.  They fill oak casks with a precious liquid knowing that each year part of their hard work will simply disappear.  I can’t help but think of the angels’ share when I look at expense ratios.  An investor sets aside a certain amount of money, let’s say $100,000.  They pay a money manager to invest that money – I’ll use the S&P 500 as an example.  When the investor looks at their statement, they should see that their investment returned the same amount as the index, less whatever the expense was, right?  Looking at the annualized returns, yes, that’s approximately right.  Looking at actual dollars, we see something different.  A portion of the returns evaporates, escaping the pockets of both investor and money manager. This chart…

We are all beholden to the tyranny of the calendar.  Monthly or quarterly account statements tie a nice bow on a period of time, but can lend false significance to a time period’s returns. If you’ve got a brokerage account or 401(k), you probably got a statement ending on 6/30/2016.  As of the quarter end, the S&P 500 was up 3.99% over the past 12 months and 12.09% annualized over the past 5 years (77.02% cumulative). What if we look at the same performance, but ending a month later on 7/31/2016?  As of the end of July, the S&P 500 was up 5.61% over the previous 12 months and 13.37% over the past 5 years (87.36% cumulative).  What a difference a month can make! If statements were cut on 8/5/2016 we’d see an even bigger leap.  As of Friday, the S&P 500 was up 6.29% over the last 12 months and 15.18% over the past 5 years…

Fear is an investor’s constant companion.  We are supposed to be greedy when others are fearful and fearful when others are greedy.  However, fear seems to loom largest when the markets are down and fades away when markets are up.  Pain of past losses gives birth to new fears that what happened in the past will happen again.  While fear was helpful to our ancient ancestors, it is less helpful in investing. One of the most insidious fears is fear of missing out – sometimes abbreviated as FOMO.  Fear of missing out is why everybody and their brother threw money at any stock with ‘.com’ in their name in 2000.  Fear of missing out is why your brother-in-law suddenly got into the house-flipping game in 2007.  Fear of missing out tells us that this is a once in a lifetime opportunity and if we get in on the ground floor, we…