More and more I see articles from various financial professionals on how impossible it is to beat the market, and how fruitless it is to even try. These articles typically leave me with one of two reactions. My first is they must be a lousy money manager. The second is a sense of agenda – trying to get investors to give up and choose some passive index-based strategy they are likely pitching. I’ll concede most of these professionals are likely very bright, and I’m sure most are very passionate about their stance. But it doesn’t make sense to me.
I believe those who say you can’t beat the market probably can’t. But I believe you can.
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I believe in behavioral finance. I do not believe markets are efficient. I’ve lived through two major assets bubbles in both tech and housing which I believe have proved otherwise. I believe emotion influences investors to do wacky things at wacky times. I’ve seen it firsthand. I believe fear makes investors sell when markets are down, when they should instead be buying. I believe greed makes investors buy when markets are up, when they should instead be selling. I believe this cycle happens over, and over, and over again forcing investors to dramatically underperform the market. I believe investors eventually tire, and become enticed with the prospect of just getting full market return.
The benefits of these passive investment approaches are clear. You at least avoid underperforming the market. Many of them actually carry reasonably low fee structures. And if you are using broad-based index vehicles, you should get full diversification.
But you also get overexposed to the most expensive areas of the market at exactly the wrong time. If you owned the S&P 500 in the late 90s, you would have been dramatically over-concentrated in tech as a result of how the index works, right before the bursting of the tech bubble. The same applies to being vastly overweight financials in 2007, right before our financial system collapsed. In my view, there has to be a better way.
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For those who view the markets as I do, and are interested in long-term outperformance, I believe these are four keys to do so:
1.) Be greedy when others are fearful
Stolen right from Warren Buffett. When panic sets in, be aggressive. If the market is offering you a discount, take advantage. When valuations plummet, and prices are down, put cash to work. If you’re going to buy low and sell high, then you have to buy low first. It won’t make sense at the time. Headlines will be negative. People will be scared. But that is exactly when opportunity exists. Think 2002. Think 2009.
2.) Be fearful when others are greedy
Again, stolen directly from Warren Buffett. When markets are hitting all-time highs, be cautious. Take profits after huge market advances. Again, if you are to buy low and sell high, then you actually have to sell high. It won’t make sense, because everything will seem to be going so well, and everyone will be making money. But that’s exactly when you’ll want to start cashing out a bit. Raising cash is a savvy way to reduce downside risk, and book some profits. Save for a rainy day, when you may see fire sale prices again on those exact same companies. Think 1999. Think 2007.
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3.) Limit your fees
Any fees you pay will come at the cost of your overall return. Avoid paying huge commissions just to invest in the markets. You no longer need to pay someone 3%, 4%, 5%, or 6% just to get your money invested. There are far cheaper ways of doing so in today’s world which help you keep more of your money. Avoid investments that charge you for getting out. There’s no reason to be on the hook for a 10% or 9% or 8% fee just so you can get your money out. Avoid double billing. If you are paying your advisor a fee and then paying a fee to the funds your advisor is putting you in, then you are being charged twice. It all adds up. If you need to use funds, which can be a very effective method for many investors, insist on no-load and low-cost funds. If your advisor is pushing funds with heavy loads on them, I would question who’s best interest is really in mind. Remember, it’s either in your pocket or in someone else’s.
4.) Rebalance
One additional method is on the idea of rebalancing. Let’s assume you’ve set your overall asset mix to 50% in stocks and 50% in bonds – as a very simple analogy. As the value of stocks and bonds ebb and flow over time, you’ll notice the percentages of your total in each area will adjust as well. You may find after a major stock market rally that your new overall mix is 60% in stocks and 40% in bonds. So you would then take 10% out of stocks and put it back into bonds to get back to your target of 50% and 50%. Doing so helps force you to sell out of stocks after market rallies. The same is true if the stock market goes down. You may find that you are instead only 40% in stocks and 60% in bonds. You would then take 10% from bonds and move it over to stocks. That forces you to add more to stocks when prices are down. It’s a fairly basic concept – but one which should prove helpful over time to both limit your overall exposure as well as help capitalize on opportunity.
I’m sure there are other methods which can help lead to long-term outperformance, but these four stand out to me. Obviously no one can promise long-term outperformance, but I certainly believe it’s possible. And if it’s possible, I think it’s worth shooting for. Ask your advisor if they believe in efficient markets, or in behavioral finance. Ask if they use active or passive techniques. Your advisor should be able to tell you whether they believe markets can be beat or not. Put me on record as one who believes they can.
Source: https://tholansonnha.com
Category: Finance
