The Secret to Successful Investing Is You
If a dish you order at a restaurant tastes better than what you prepare at home, it can be attributed to the skill of the chef. You don’t know how the chef does it, but it’s likely he or she follows a distinct recipe.
Similarly, some investors believe the key to success in the market is in the secret sauce, a unique investment strategy. Of course, some fund managers and investment advisers are eager to sell investors on the idea that they’ve got the best sauce available. In fact, the Consumer Financial Protection Bureau found close to 25 times more money is spent on financial industry marketing than is spent on financial education.
This disparity presents a challenge to the average investor. Investors may become so certain they have a successful strategy that they are fooled by overconfidence, believing their investment skill is better than their returns suggest. In one study, “Positive Illusions and Forecasting Errors in Mutual Fund Investment Decisions,” researchers found a third of participants thought they had beaten the market but had in fact underperformed it by at least 5% while over a fourth of participants actually fell short by 15%.
The delusion of skill seems to extend to professional investors as well. Consider that the average expense ratio for actively managed equity funds is about seven times higher than average expense ratio for equity index funds, according to the 2014 Investment Company Institute Fact Book. It’s reasonable to assume that high fees equal high performance. Actually, it creates a disadvantage as the fund must earn a return greater than the market plus its fees in order to outperform. This helps explain the results of a study from the Financial Analysts Journal that shows that most mutual fund managers fail to beat the market or their respective benchmarks and do not consistently exhibit superior performance over time.
What can be learned from research that indicates professionals — generally supported by high-powered technology and advanced finance degrees from Ivy League schools — underperform the market much like the average investor?
For one, when investing in actively managed mutual funds, you don’t get what you pay for. Or, as John Bogle is famous for saying, “You get what you don’t pay for” in the form of various marketing and administrative expenses that do not benefit your returns.
Additionally, you could invest in plain-vanilla, low-cost index funds – no magic tricks or algorithms – and beat the majority of active managers over the long run.
Most importantly, the secret to successful investing is that there is no secret. Rather, the secret to successful investing is you and your behavior. Educate yourself to see through the marketing hype and find an investment strategy that is prudent for your financial goals. Then, practice investment discipline and patience as you seek to capture the long-term performance of the market. For the rest of your portfolio needs, from managing retirement accounts to withdrawal strategies to taxes, seek help as you need it. Investing isn’t easy, but it needn’t be complicated.