In July and August many traders and money managers will swap the stress of the office and staring into a Bloomberg terminal for relaxing on a beach staring across a glittering azul blue sea. Today’s stock market is a ‘frenetic’ trading machine lubricated and fuelled by a 24-hour entertainment cycle masquerading as news. Most will close their positions to go on holiday, carrying the ice box instead of risk in the market.
Money managers are paid to produce what the industry calls ‘Alpha’, a measure of the return that they can generate on a given amount of capital over and above ‘Beta’, a measure of return achieved by the market. In essence they are paid to ‘beat the market’ – to ‘beat the market is to win’. The question facing many investors is how to win? On their own or with professional advice? Data shows that the majority of professional active investment fund managers will lose to the market by on average the amount of the fees and costs. So it is not a question of if you will fail to achieve the market rate of return by yourself or the manager you hire, but when?
But what is winning all about for you, your family or institution? This has everything to do with you not the market. What is your financial position? How much capital can you allocate to invest? How much interest do you have in the markets? How knowledgeable are you? Do you become fearful when prices go up and down sometimes violently? Are you interested in a steady stream of income or a rate of return over the long term?
The most important decision you make as an investor is about time preference. For how long can you reasonably tie up your capital? The longer the time preference over which the capital may be invested, the greater the potential for growth and reward. What Albert Einstein referred to as the miracle of compounding – the steady compounding over time of growth from earnings and dividend income provided by businesses, and a steady stream of interest payments from bonds.
Rather than fail, most of us will ‘win’ and succeed well above the average active manager if we ‘index’. Match what the market is doing and then stay the course. It is a discipline which has now been developed well enough for us to be able to buy very low cost index funds. Provided that we stick with the plain vanilla broad-based, deeply liquid, very low-cost index funds with small tracking error, in a sensible diversified strategy, we will achieve a better investment outcome than we would otherwise have received. Allowing us to focus on what really matters in our lives and relax.
The author is an investment counsellor and member of the Society of Trustees and Estate Practitioners. The comments and observations by the author are a reflection of his opinion and do not constitute an offer to buy and hold securities, nor does he receive any remuneration of any kind from names referred to.