Why Investors Cannot Outperform Benchmarks
Many investors believe the ticket to riches is a superior investing strategy. If they can just get their hands on the secret formulas the “pros” use, they can make money every month of every year with minimal downside.
Many different strategies work, but not many investors earn the returns these strategies produce. Buy-and-hold works; contrarian works; value works; as other alternatives. However, many investors, continue underperforming the strategy’s benchmark.
The reason? Lack of discipline.
Many different diets can get us lean and healthy, but not many stick with them long enough to work. We jump from one to the next never getting anywhere.
From Dec-94 to Dec-14, the S&P 500 produced an annualized return of ~10% while high grade corporate bonds earned ~7%.
The average investor? Slightly over 3% per year.
THREE PERCENT!!!
This is a travesty. As a manager, I’d feel extreme frustration and guilt if my investors underperformed my fund’s time-weighted returns. If I allowed them to indulge their emotions about short-term volatility, they’d make costly mistakes. They’d sell when they should be adding to their investment and buy when they should be sitting tight.
Buying and holding index funds is adored by passive investors everywhere, right? Nothing is better, right? So how is it possible that average investors don’t achieve the returns anywhere near the thing they love so so much?
How many buy-and-holders bailed out of equities during the Financial Crisis? Why would they do that? I thought they loved equities and index funds? Why would they then have trouble getting back in, thus missing out on the next bull market?
I know plenty. I wonder how many investors would’ve bailed out if they understood the risks better — namely, that indexes can decline 50% or more sometimes. Maybe they would’ve exited sooner, way before the Crisis picked up steam, or they would’ve sold some (not all) to lessen the pain. And then they would’ve been in a better position to get back in or hold through the entire decline.
All investment strategies work sometimes. Nothing works all the time.
Where investors and traders go wrong is not doing the work to understand how their strategy of choice works. Without this understanding, they won’t know what kind of returns and losses to expect, when it will perform well or when it will struggle or even how investment decisions are made in the first place.
The likely result of not doing this work? They’ll get emotional when performance isn’t to their liking and make rash decisions — bailing out near bottoms and leveraging up near tops.
Lack of preparation and discipline promotes performance-chasing and hurts returns.
I believe fund managers need to do a better job communicating with their investors about how their strategies work and what kind of returns and losses to expect. Investors can then decide whether the investment fits with their own philosophy and risk tolerance. This will tremendously improve the odds of them sticking with it through the inevitable ups and downs.
Disclosure:
Past Performance is Not Necessarily Indicative of Future Results. There is always a risk of loss in futures trading.
This communication is for information purposes only and should not be regarded as an offer to sell or as a solicitation of an offer to buy any financial product, an official confirmation of any transaction, or as an official statement of Melissinos Trading LLC. All information is subject to change without notice.
These charts show examples of trends. Inclusion of a chart as a trend example does not imply any kind of recommendation to buy, sell, hold or stay out.
