I’ll start with the complexities. The world stock markets make up a gigantic trading machine. During 2016, an average of 82 million trades occurred every day, with a daily trading volume of $346 billion (US).
Navigating such a high volume of trading, trying to outsmart the market with creative buy-low-sell-high strategies, seems a little far-fetched. No matter how complex the strategy.
But many mutual fund managers pride themselves on their attempt to outperform the underlying market they invest. Looking at the trading numbers, it’s hard to imagine anyone could have such a competitive advantage.
We have some interesting data from the U.S. showing mutual fund results for the 15 years ending in 2016. In 2002, there were slightly over 2,500 mutual funds. During the next 15 years, over half of those funds disappeared.
The mutual fund database from the University of Chicago shows a high correlation between underperforming funds and funds that are withdrawn from the market. Mutual funds with a bad track record are hard to sell, so they are usually eliminated. At the end of 15 years, only 17 per cent of the 2002 mutual funds managed to have returns higher than the underlying market.
Fixed income funds were similar. After 15 years, only 18 per cent of fixed incomes beat the underlying market they invested.
So, should investors only buy the top performing mutual funds? As it turns out, past performance has little to do with future results.
During this 15-year period, if you purchased one of the top 25 per cent performing equity funds during the previous five years, only 23 per cent of those top funds remained in the top quartile the following year.
The data for fixed income funds was only slightly better. Purchasing a top quartile fixed income fund over the past five years only resulted in 27 per cent of those funds remaining in the top quartile the following year.
In simpler terms: when investing, decide what your objectives are and then have an extremely diversified portfolio with the types of investments you want to own.
The two main investment options are owning stocks or bonds. Which ones you own makes a difference. If you invested one dollar in U.S. government bonds in 1926, that dollar would have grown to $134 by the end of 2016. An investment of one dollar over the same time in U.S. large stocks would be worth just over $6,000. A similar investment in U.S. small company stocks would be worth over $20,000.
Bonds are less volatile and therefore are considered safer. Safety in the short-term comes at a price of not achieving a stronger long-term return.
Stocks are the opposite. They are risky in the short-term as measured by volatility, however they are better long-term investments if you are looking for a higher return.
The portfolio that is right for you should be based on your tolerance for financial risk and your investing temperament —how well you handle the ups and downs. Those two elements should be considered when deciding whether you are a long-term or short-term investor.
For decades, trying to figure out the daily workings of the stock market has been elusive for many. My recommendation is to stop trying to outsmart the market by speculating on what investments to buy and when. Focus on what you can control.
Over complicating investing can lead to confusion and possible bad decisions. The clarity of a more simplified approach may inspire more comfortable decision making.
Build an investment portfolio that makes the most sense for you, your financial circumstances, and your timeframe.
Submitted by: Peter Watson. Peter Watson is an agent of, and securities products are provided by, Aligned Capital Partners Inc. (ACPI). ACPI is a member of the Investment Industry Regulatory Organization of Canada (IIROC) and the Canadian Investor Protection Fund (CIPF). The opinions expressed are those of the author and not necessarily those of ACPI. Peter Watson provides wealth management services through Peter Watson Investments.