People have often told me there’s no point investing privately because it’s impossible to beat the professionals. But with only a few exceptions, that isn’t true — if you invest with a decades-long horizon and avoid simple mistakes, you’ll enjoy distinct advantages over most pros.
Short-termism is the pros’ biggest failure. Every year we see tables of the best-performing funds from the previous 12 months and previous three years. Is it any surprise that people almost always plump for those that have done the best? We see the “past performance is no guide to future performance” disclaimer, but how else do we judge?
The thing is, that disclaimer really is true — even if every investment manager picked shares randomly, one of them would be the best performer over 12 months, and one would be the best over three years! Competent investors (Warren Buffett and Neil Woodford spring to mind) eschew these annual rankings and leave it to investors to look to their longer-term performance — and superior performance only really counts when it comes to decades.
Trading costs money!
To get ahead in the annual race, too many managers trade their portfolios too often, trying to get into the next hot stock — if they miss this year’s big winner, they’ll gain fewer customers for next year. That incurs extra costs and would you be surprised to learn that around three-quarters of all managed funds have failed to even beat the FTSE average long term?
We have to look beyond current funds to see this shocking statistic, because these City institutions have an unsavoury habit of closing down the worst performers, transferring their assets to new funds, and starting again with a clean slate. That leads to a distortion called survivorship bias, which makes still-operating funds look better than they deserve as so many have gone the way of the dodo and aren’t included in the latest statistics.
One outcome of the race to be “this year’s best” is the distasteful practice known as window dressing. If you ran a fund that was holding a few 12-month losers, you might not look so good at the end of the year. So what many do, just before the end of their reporting period, is sell-off recent losers and buy into shares that have been flying so it looks like they’re holding winners.
That has two nasty effects. It increases trading costs purely for cosmetic purposes and with no real benefit. And selling shares that have fallen and buying ones that have risen is a pretty dumb strategy if that’s all you go on. It’s a way to lose out on undervalued shares with a recovery due in the near future, and a surefire way of finding overpriced junk that’s up there just because it’s part of the latest fad.
It’s easy to avoid
As private investors, we can avoid these mistakes. We should buy quality companies that we want to hold for the long term, and avoid whatever bandwagon fad-followers are jumping on. And it follows that we would be trading rarely and thus minimising costs. Plus we’ll have no need to make our portfolios look good over just the past 12 months or the past three years.
If you follow these principles, I think you’d be unlucky to not beat most of the professionals.
