Yet More Investing Lessons from 2017

Yet More Investing Lessons from 2017

By Larry Swedroe Every year, the markets offer lessons on the prudent investment strategy. So far, we’ve covered what they taught us last year in lessons one through three and four through seven. Today, we’ll finish off 2017’s list with lessons eight through 10. Lesson 8: Hedge funds are not investment vehicles, they are compensation schemes. This one has been appearing as regularly as the lesson that active management is a loser’s game. Hedge funds entered 2017 coming off their eighth-straight year of trailing U.S. stocks (as measured by the S&P 500 Index) by significant margins. And investors noticed. In 2016, poor performance and withdrawals led to the closing of 1,057 hedge funds, the most since 2008. However, even after withdrawals of about $70 billion, that still left about 9,900 hedge funds (729 new hedge funds were started) managing just more than $3 trillion as we entered last year. Unfortunately, the losing streak for hedge funds continued into a ninth year as the HFRX Global Hedge Fund Index returned just 6.0% in 2017, underperforming the S&P 500 Index by 15.8 percentage points. The following table shows the returns for various equity and fixed-income indexes. As you can see, the HFRX Global Hedge Fund Index underperformed the S&P 500 and nine of the 10 major equity asset classes, but managed to outperform two of the three bond indexes. An all-equity portfolio allocated 50% internationally and 50% domestically, equally weighted among the indexes within those broader categories, would have returned 21.3%, outperforming the hedge fund index by 15.3 percentage points. A 60% equity/40% bond portfolio with the same weighting methodology for the equity allocation would have...
More Investing Lessons from 2017

More Investing Lessons from 2017

By Larry Swedroe Earlier this week, we began discussing what the markets taught us in 2017 about prudent investment strategies. We tackled lessons one through three then, so today we’ll resume with lessons four through seven. Lesson 4: Don’t make the mistake of recency. Last year’s winners are just as likely to be this year’s dogs. The historical evidence demonstrates that individual investors are performance chasers—they buy yesterday’s winners (after the great performance) and sell yesterday’s losers (after the loss has already been incurred). This causes investors to buy high and sell low—not exactly a recipe for investment success. This behavior explains the findings from studies that show investors can actually underperform the very mutual funds in which they invest. Unfortunately, a good (poor) return in one year doesn’t predict a good (poor) return the next year. In fact, great returns lower future expected returns, and below-average returns raise future expected returns. Thus, the prudent strategy for investors is to act like a postage stamp. The lowly postage stamp does only one thing, but it does it exceedingly well—it adheres to its letter until it reaches its destination. Similarly, investors should adhere to their investment plan (asset allocation). Sticking to one’s plan doesn’t mean just buying and holding. It means buying, holding and rebalancing—the process of restoring your portfolio’s asset allocation to your plan’s targeted levels. Using DFA’s passive mutual funds, the following table compares the returns of various asset classes in 2016 and 2017. As you can see, sometimes the winners and losers repeated, but other times they changed places. For example, the best performer in 2016, U.S. small...
Investing Lessons from 2017

Investing Lessons from 2017

By Larry Swedroe Every year, the markets provide us with lessons on the prudent investment strategy. Many times, markets offer investors remedial courses, covering lessons it taught in previous years. That’s why one of my favorite sayings is that there’s nothing new in investing—only investment history you don’t yet know. Last year supplied 10 important lessons. As you may note, many of them are repeats. Unfortunately, too many investors fail to learn them—they keep making the same errors again and again. We’ll begin with my personal favorite, one that the market, if measured properly, teaches each and every year. Lesson 1: Active management is a loser’s game. Despite an overwhelming amount of academic research demonstrating that passive investing is far more likely to allow you to achieve your most important financial goals, the vast majority of individual investor assets are still held in active funds. Unfortunately, investors in active funds continue to pay for the triumph of hope over wisdom and experience. Last year was another in which the large majority of active funds underperformed, despite the great opportunity active managers had to generate alpha through the large dispersion in returns between 2017’s best-performing and worst-performing stocks. For example, while the S&P 500 returned 21.8% for the year, including dividends, in terms of price-only returns, 182 of the companies in the index were up more than 25%, 49 were up at least 50%, 10 were up at least 80.9%, and three more than doubled in value. The following table shows the 10 best returners: To outperform, all an active manager had to do was to overweight those big winners....
The Crucial Nature of Patience

The Crucial Nature of Patience

By Larry Swedroe “Success in investing doesn’t correlate with IQ. Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people in trouble investing.” — Warren Buffett In my more than 20 years as the director of research for Buckingham Strategic Wealth and The BAM ALLIANCE, I’ve learned that, while financial economists understand that even 10 or 20 years of investment performance can be nothing more than “noise,” the vast majority of investors believe three years is a long time, five years is a really long time and 10 years is an eternity. This is true even for institutional investors—who should know better—as evidenced by the fact that the typical horizon over which investment managers are judged is three years. The lesson I’ve taken from this knowledge is that investment discipline—the ability to adhere to a well-thought-out strategy (asset allocation)—is likely to prove far more important for helping investors meet their goals than the specific asset allocation decision itself. The reason is the well-documented tendency for individual investors to chase performance, buying what has done well recently (buying relatively high) and selling what has done poorly (selling relatively low)—not exactly a recipe for successful investing. In addition, once investors remove assets from the equity markets, it’s difficult to get back in, because there’s never a green flag letting them know it’s once again safe to enter. Odds of Negative Premiums In our book, “Your Complete Guide to Factor-Based Investing,” my co-author Andrew Berkin and I present the following table, which provides the historical odds of underperformance for six factors that have provided...
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