The multitudes at the Tower of Babel are a loud distraction today. They agree on nothing, but they have a common theme.
The election is important! It is becoming more important every passing second!
You should (insert action here: buy, sell) your investments now!
In fact, elections are a lot less important than the residents of Babel would have us believe. Investment manager David Bahnsen recently noted these findings:
· Energy was the best-performing sector under Obama — despite attacks.
· Technology was the best-performing sector under Trump — also despite attacks.
· The equity market rose in all eight years under Obama.
· The equity market rose 70% under Trump despite COVID-19.
· Markets generally (but not always) rise under both parties.
And here’s another fact that neither political party will be talking about. Government spending and debt rise under both parties. We conclude they are both good. Both bad. Or equally irrelevant, when it comes to our investment decisions.
The facts tell us that the sloth and indecision most of us are prone to is a good thing. A very good thing.
You would expect to see an eager slothful public devour an idea like this — save, buy and hold. But it hasn’t.
Earlier this year, Morningstar columnist John Rekenthaler noted index funds now account for half of all fund assets. They removed hundreds of billions from active asset management.
This didn’t happen overnight. The change has taken half a century.
Scholars tend to choose Charles Ellis’ “The Losers Game” as the starting point. In it, he observed that professionals were the market.
I was fascinated by something else: The statistics in “Portfolios Without Management” in The Wall Street Journal in the early 1970s. Same period, different media.
- Yes, index investing is a “slow idea.” You can’t use “index investing” and “viral” in the same sentence. To put a sharper point on “slow,” consider the halftimes of a few consumer products.
- Homes with TV sets rose from nearly nothing in 1946 to half of all homes by 1955, less than a decade.
- Homes with electricity rose from 8% in 1907 to 50% in 1925, a period of 18 years.
- About 8.4% of households owned a home computer in 1984. The figure rose to 56.3% by 2001 (17 years) and 69.7% by 2003 (19 years).
- Henry Ford started producing the Model T in 1908. By 1920, 20% of households owned cars, by 1929, 60%.
Was anything slower than index investing? Yes. Let’s give thanks to the InSinkErator Manufacturing Company. It was the first kitchen disposal maker, established in 1938. Household ownership reached 50% in 2007, a period of 69 years.
There are big reasons index investing has been slow. My favorite is a well-known quote from writer Upton Sinclair:
“It is difficult to get a man to understand something when his salary depends on his not understanding it.”
That’s how we hear celebrated professional investors saying:
- “It’s a stock picker’s market.”
- “It’s not a buy and hold market.”
- “There’s danger ahead.”
- “Do you really want to be just average?”
Transactions are the lifeblood of the financial services industry. It needs the regular flow of mind-changes. Re-evaluations. Shifts in strategy or any other “reason” to buy or sell. Threaten transactions and you are the enemy of high living without heavy lifting. Sadly, there is a natural alliance between financial services and media.
Financial services need transactions to feed revenue. Media needs change to appear relevant. Skeptics should compare books to magazines and newspapers. Then compare magazines and newspapers to television. And, finally, compare television to, say, Instagram. It’s a paired spiral of diminishing substance and rising stimulus.
The financial services industry has another way to impede low-cost index investing. I call it “blazing new trails of confusion.” A primary example is index funds themselves. While index funds were slow to grow in number, when Wall Street realized people wanted them, a light went on.
“Let them have index funds, lots of them.” We now have more index funds than the church has saints. All purport to provide easy access to one thing or another. It’s as though Wall Street took a page from the way big law firms defeat small law firms: Bury them in discovery.
But the financial services industry went well beyond a plethora of index funds. It also created and sold products that blur lines or “justify” new and special higher fees. Here are some examples:
- Life cycle funds
- Wrap accounts
- Equity index funds from insurance companies
- Alternative asset classes in pension funds
- Alternative asset classes in 401(k) funds
- Direct indexing
- Life annuities in 401(k) and 403(b) plans
Index funds have been a slow idea for another reason. Our desire for a simple, binary answer to our financial questions. Please just say “yes” or “no.” Any sociopath will delight in providing the answer we want. But truthful answers tend to come out as mushy probabilities. Our predisposition feeds the financial service industry and starves us.
I like to tell a story that’s called “the missing bullets problem.” During World War II, military officers and mathematicians gathered. Their mission? To figure out what to do about the number of downed planes. They examined returned planes. They recorded the density and location of bullet holes. They thought those areas could use more armor.
Abraham Wald, a leading mathematician, disagreed. He asked where the missing bullet holes were — the ones they’d see if bullets were equally distributed. That’s where the bullet holes were on the planes that didn’t return.
Most mutual fund performance figures use surviving funds as their sample. They don’t count merged or closed funds. So managed fund performance “improves” because the embarrassments are not counted. Statistics fans call this “survivor bias.”
The SPIVA reports now have a 23-year history. SPIVA is a report by Standard & Poor’s. It tells us how managed accounts fare versus their appointed index. Year after year it shows managed funds fail to beat their index. And their level of failure increases with time.
For the year ending 2023, for instance, large-cap managed funds trailed the S&P 500 index 59.68% of the time. Over the three- and five- year periods the percentage rose to 80%. By 20 years the fail rate rose to 93%.
International equity funds show similar figures. For example, 63.3% of emerging markets funds failed over the last year. But 95.24% failed over the last 20 years.
Fixed-income funds have a glimmer of light in the short term. Several categories had superior performance over a single year. But at the 10-year investing period the fails range from 53.66% to 100%.
Believe it or not, it gets worse. The probability a single managed fund will beat its index is low. The odds are worse when managers build portfolios with many funds. Complexity only increases the odds of failure.
In “How a Second Grader Beats Wall Street,” Allan S. Roth put managed fund portfolios against comparable index fund portfolios. He found that over one year, 42% of single managed fund portfolios beat index portfolios. But the beat rate went down to 25% if the portfolio had 10 funds.
But we’re not done. It got worse the longer the holding period. At 10 years, only 6% of managed fund portfolios with 10 funds beat comparable index fund portfolios.
We’d all love to have a yes or no answer to our retirement security questions. But the evidence against managed fund investing comes down to a single question.
“Do you want to bet your retirement on a low-probability event?”
I don’t and didn’t.
The other problem we face is even bigger than the constant threat from the financial services industry. It’s wealth addiction.
In his book Enough, John Bogle tells an anecdote. Novelists Kurt Vonnegut and Joseph Heller attended a wealthy hedge fund manager’s party.
Vonnegut told Heller their host had made more money in a single day than Heller had made from Catch-22.
Heller said, “Yes, but I have something he will never have … enough.”
One of the best things we can do has nothing to do with investing. We can examine ourselves for signs of wealth addiction. It is real enough that sociologist Philip Slater wrote a book about it by that title in 1983.
A sign of the times: It is out of print.
