When we review prospective client portfolios, it is almost guaranteed some portion of their money is invested in some sort of active management strategy. As you may know, active management is the strategy of attempting to beat a benchmark. This could be done through market timing (buying and selling at opportune times) or stock picking (buying winning stocks and selling ones that will underperform). The alternative strategy is often called passive management, though we like to call it "evidenced based" management. Essentially, you own the entire market and don't try to time when to buy or sell securities or pick one stock over another. The "evidence" suggests that this method of investing has a much higher probability of success.
As I was thinking about the idea of probabilities, I thought it might be fun to compare active management to another game that is all about probabilities…blackjack. First, let's look at the statistics on active management. Actual results* show us that 17% of stock mutual funds have beaten their benchmark over the last 15 years. Bond funds fared much worse, with only 7% beating their benchmark during the same period. If the goal of active management is to beat a benchmark, they are not doing a very good job.
So what about blackjack? The odds you will win one hand of blackjack (factoring out ties) is 46.36%. But we are measuring 15 years of whether an active manager can beat the benchmark. What is the chance you will win money at blackjack if you play 15 hands in a row? The answer: 17.5%.
Long story short- you have almost identical odds to walk away with more money after 15 hands of blackjack than you do trying to pick an active manager that will beat the market over 15 years. The odds are much worse trying to pick a bond fund that will beat the market. We all have heard that as long as you play for a long enough time, the house always wins. Maybe you should think about who the "House" is when you are investing and shift the odds more in your favor.
*The US Mutual Fund Landscape, 2016 Report
If you were thinking "What is Brazil?" you could claim victory over your opponents who might have scribbled down, "What is the U.S.?"
That might leave the audience scratching their heads as they recall some pretty negative news that came out of Brazil last year. Zika…Dilma Rousseff’s impeachment….favelas….deforestation….green swimming pools at the Olympics. Brazil had a tough year in many ways but its benchmark index was up over 65%.
What might be even more surprising is that the top 10 stock indexes in 2016 were all emerging or frontier markets. The MSCI Emerging Markets Index as a whole was up over 11% in 2016.
You might say 2016 was a crazy year and this could be just one more example of that. Actually, nine of the 10 best performing equity indexes over the past 20 years have been in developing nations. Before you bet the farm on Emerging Markets, you need to flip the coin and look at all the 2016 data. The markets with the worst losses were also dominated by emerging markets.
If some emerging markets can do really, really well but some can also do pretty badly, do they have a place in the portfolio? Greenspring thinks so.
We believe in a globally diversified portfolio that has exposure to US, Developed and Emerging Markets. Your individual risk profile then helps us structure how much of your portfolio each of these equity components should comprise.
Final Jeopardy Question: What is "the only free lunch in investing"*?
Answer: "What is diversification?"
*Harry Markowitz, founder Modern Portfolio Theory
If you called South Africa home, life would be very different….
There is at least one thing though that would be pretty similar- the approach you and your financial advisor take to develop your financial plan.
Greenspring recently had the privilege of hosting Bruce Fleming from the Financial Planning Institute of South Africa (FPI). Bruce won the FPI Financial Planner of the Year competition for 2016-17. This is a very prestigious award given to the most deserving recipient after three rounds of judging; the winner then serves as FPI's lead volunteer brand ambassador for one year. Bruce was attending conferences in Baltimore in September and he had time to sit down with us.
What was so striking when we met with Bruce was that despite all the differences in our countries-regulations, politics, language, currency, even the seasons- the fundamentals of financial planning are universal. First an advisor will help you examine and really think about your financial goals. Does your spouse or significant other share these goals or are there other things to consider? Next, we assess where you are today financially and where you want to go. After a thorough analysis, we develop a plan to get you where you want to go that incorporates risk management (what could derail my plan?), tax implications and strategies, and estate planning. The best laid plan is useless unless it is efficiently implemented (hint: let your advisor do the heavy lifting here!). After all the implementation items are checked off, you may think you can put the plan up on the shelf and go on about your way and all of your financial goals will come to fruition right on schedule. Not likely. Life happens, things change and so will your plan. You and your advisor need to meet as life changes, or at least annually, to monitor the plan and course correct when necessary.
As financial advisors we are dedicated to an ongoing relationship where we can help you achieve your financial goals. Whether you are meeting with Bruce in Cape Town or sitting down with us in Towson, we would all would be doing pretty much the same thing and following a similar process. Yes, Bruce has a much cooler accent, but at the end of the day your experience would be remarkably similar. As with many things in life, putting a clear plan and process in place is an integral component of achieving ultimate success, in whatever country you might call home.
Information contained herein has been obtained from sources considered reliable, but its accuracy and completeness are not guaranteed. It is not intended as the primary basis for financial planning or investment decisions and should not be construed as advice meeting the particular investment needs of any investor. This material has been prepared for information purposes only and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. Past performance is no guarantee of future results.