I may have mellowed over the years, but believe you me, this placid exterior masks a fiercely competitive temperament. I bang on at staff meetings about the need to keep our business ahead of the rest. I love to see my children win that dancing trophy or make that crucial penalty save. Heck, I even enjoy the looks on the faces of my fellow dog owners as my pride and joy Millie the whippet tears round our local fields like some canine Lewis Hamilton.
But I’ve learned there are certain areas of life in which competitiveness is counter-productive; where the harder we try, the more we want to succeed, the worse we do. There’s no better example of this than investing.
Many investors are hugely competitive. There’s no better motivator, particularly for us blokes, than hearing of a friend or colleague who’s made a fortune buying this or that. We love to be a winner.
In fact, as Charley Ellis famously asserted in the mid-1970s, investing as most people experience it is a losing game. Largely because of the explosion of funds in the intervening 40 years it’s even more of a losing game today. The only surefire winner is the industry itself.
Our competitiveness, in short, is how the industry makes its profits. That’s why it mercilessly plays on our competitive streak, constantly emphasising the need to beat the market or pick a winning fund. It gives us the impression that all we need to do is trust this “star” manager, or pick that multi-manager fund, and we’ll soon be on the winning side.
What the industry doesn’t tell us is that only a tiny fraction of funds provide anything like consistent outperformance, or that many of them are just expensive tracker funds or, to quote Professor Keith Cuthbertson from Cass Business School, that a fund which will outperform in the future is “harder to find than the Higgs boson”. Nor does it tell us that even if a manager does outperform the market year after year, the chances are they will recoup any value they add for themselves in the form of charges.
The good news is that this isn’t a game you need to play. In fact, the overwhelming likelihood is that you’ll end up far better off if you don’t.
Indeed the truth is that most investors don’t have to beat the market at all. Long-term stock market returns are remarkably generous anyway. You can earn those returns, or near enough, simply by having a stake in the market — preferably the whole market, via an index fund or portfolio of index funds — and staying there. It honestly is that simple.
There are two main reasons why the vast majority of people earn considerably less than the market return. The first is the accumulated cost they incur — fund charges, trading expenses, taxes and so on. The second is their behaviour, their tendency to give in to their emotions, particularly during periods of market turbulence. If you can keep your costs to a minimum and stay on course through thick and thin, bingo — you’ve done it.
What disciplined index investing offers is this: it provides a return that’s as close as possible to the market return. Nothing more, nothing less. Because of the much higher costs entailed with active investing, the average passive investor must — yes must — outperform the average active investor. Passive investing, done properly, guarantees that you will be one of the winners. That’s not a theory; it’s a mathematical fact.
It may be counter-intuitive but it’s true that, generally speaking, the more time and money you spend on getting the best investment results the worse those results will be. Yes, an active investor may end up as one of the winners; but the odds are heavily stacked against.
The industry, of course, is aware of this and will do all it can to discredit passive investing. I remember Jack Bogle telling me about the derision he faced when he launched the first index fund available to ordinary investors — “Bogle’s Folly” as it was known. He was told it was un-American. Fidelity said that investors wouldn’t settle for “average” returns. Vanguard, the firm that Bogle founded, is now the biggest fund manager in the world, with more than $3 trillion of assets under management, and Fidelity is now the world’s second largest provider of index funds.
Was he ever tempted, I asked him, to remind Fidelity of what it said 40 years ago? No, said Bogle. Now there’s a man who knows how to curb his competitive streak.