Almost every investing study tells us that buying stocks at a low price to anything results in market beating performance. Even just buying a S&P ETF and doing nothing else beats most investors and mutual funds. If out performance is a matter of doing a few simple things and nothing else then why is everyone acting so crazy? And if earning market matching, or market beating results are so simple then why don't investors earn those sorts of returns?
Fidelity released a study discussing a performance breakdown for their accounts. The clients that did the best were the ones who were dead. The second best performing set of clients forgot they had Fidelity accounts. It seems like a formula to beat the market is to start an account, forget about it, then die. Your heirs will thank you and marvel at your investing prowess.
How is it that investing is so "easy", yet so hard?
If in theory all one needs to do is follow a few simple formulas, or invest in a few ETF's why aren't more investors matching or beating the market?
It's often said that investors are their own worst enemy. Our own emotions get the best of us. When the market is roaring higher we get excited. When the market hits new lows we're too depressed to even open our account statements.
I believe investors fail for a number of reasons with the biggest being the lack of patience. There are many investing strategies that make sense on paper. The problem is few investors have the patience to see these strategies through to the finish. It is more exciting to watch a stock jump up and down 2-3% a day, or see a battle ground stock bantered about on CNBC compared to owning a company that trades in tenths of a percentage point most days. The thing is those tenths add up over time, especially for companies that continue to execute operationally.
Finding a reasonable investing strategy isn't an issue, it's sticking to it
It is very easy to find undervalued investments, but holding onto those undervalued investments for years can be difficult. For many investors it's fun to research and watch holdings, but it's no fun to watch a stock effectively do nothing for days, months, or years. If the excitement is in the research then we'll continually be researching new positions and throwing out the old ones.
Investors also fail if they do too many things at once
A few net-nets, a few growth stocks, some shorts, a turnaround or two etc. Their portfolio is a potpourri of strategies, many of them that are complex and require dedicated skills. Each investor needs to find their own style and stick to it. There is a reason there are so many funds with one focus. It's much easier to be a bankruptcy fund, or a turnaround fund compared to a general value fund. The same is true for individual investors. It's much easier to focus on a specific corner of the market rather than invest in any and all things cheap.
Related to doing too much is researching too much. Some investors fail because they can't see the forest through the trees. They are so caught up in the minutia of an investment that they miss the big picture.
I enjoy reading message board posts related to investments I'm researching. I'm always on the lookout for what I consider the obsessive investor. For some reason these obsessive investors often congregate in oil and gas or mining stocks. You've probably seen these posts. A few books worth of material detailing the pressure of well bores the company had in North Dakota in 1988. Excited posts about how rumors are swirling that carpeting is being replace at headquarters and maybe it's a sign of a buyout.
Buried within the pages of notes are usually a few nuggets of information useful to an investment thesis. But my feeling is that the author probably has no idea, they are too consumed with finding out everything related to the company to realize this. The ultimate irony is that the body of knowledge an obsessed investor can accumulate is about the minimum amount of knowledge every middle level employee at the company has. In other words outside investors are always at a significant informational disadvantage to almost any company insider, even the lowest level employees at times.
My favorite investments are ones where the value is obvious and the investment rests on what I consider a few pivot points. These are general assumptions. The larger the gap between the current price and fair value combined with a small number of pivot points makes for investment success. This is because each assumption, each estimation, and each guess adds uncertainty to a model. At some point endless research can blind an investor from realizing what truly matters from what they think matters.
Once I realized that I didn't need compile an exhaustive list of company information to make good investments I began to simplify my research. I only researched what was necessary to confirm or deny the pivot points I'd identified with an investment. By doing this I saved myself the endless research. Maybe the carpet color does matter in a merger. Small details can be exciting. But it's the boring details that matter, such as the age of the CEO, or the age of the Board. Companies with graying executives and graying boards are more likely to sell their company.
Investors also fail because they don't really know what they own, or why they initially invested
Cloning investments is a very popular strategy right now. And like all investment strategies cloning works well on paper, it generates market beating returns. Just buy what Buffett buys and sell what he sells and you'll do well the story goes. The problem is when we buy something on someone else's thesis it's hard to hold through thick and thin. If bad news starts to come out on a cloned investment it's easy to dump it and say "maybe this is one the guru messed up on."
Closely related is when investors purchase stocks on a story basis. That is they feel a given company will benefit from some larger trend at some point in the future. Many times when these story stocks are purchased investors aren't conducting true due diligence to see if the company will actually benefit from the trend.
Story stocks are a favorite of the news shows. There's a very specific reason for this. There are two types of stocks, stocks that are great stories, and stocks that are great investments. As someone who writes about stocks I can say that some of my best investments have been my worst posts. This is because there was nothing exciting to write about. There was no narrative or story around the stock. It was cheap, and all an investor needed to do was purchase and wait. Some of my best and entertaining posts have been about stocks that aren't necessarily great investments. But they make great stories. This is the same with the financial media. Companies that make great stories aren't usually great investments.
When we look in the mirror we're facing the enemy of our returns. The best course of action is to pick a strategy, stick to it and move on.
Mod Note (Andy): #TBT Throwback Thursday - this was originally posted on 6/11/15. To see all of our top content from the past, click here.
"Most" people fail because investing is a zero sum game. There are two sides to each transaction and only one eventual price for the security.
Add in the potentially non-investable ideal universe of each theoretical index (each has its own problems which can include too many securities to match, no transaction costs assumed, no tax assumptions, liquidity of positions, etc) and it is a zero sum game with the net ending somewhere below the index returns for each market. Then you add in active or passive fees.
"If in theory all one needs to do is follow a few simple formulas, or invest in a few ETF's why aren't more investors matching or beating the market?"
Because you don't buy an index to match or beat the market. You buy it to trail by a few bps in market with high liquidity like the S&P 500 or to trail within a broader range on a market with those investability issues (like in emerging markets).
A better topic would be "why do some investors fail miserably". There's gotta be some fat tails on the retail market return distribution.
""Most" people fail because investing is a zero sum game. There are two sides to each transaction and only one eventual price for the security." - Trading is a Zero Sum Game but Investing is definitly not.
They fail because the market accumulates and incorporates knowledge at a faster pace than any individual investor with the exception of those that have inside, i.e., illegal information. In other words, markets are efficient and here's another study supporting this proposition.
EDIT:
95% of finance is bullshit. It tries to convince investors that markets frequently misprice assets and that these champions of the universe (at an extremely high price, of course) can make you very wealthy with little-to-no effort on your end. Empirical study after empirical study shows that your best bet is to put your money into a portfolio of ETFs and focus your effort on other, more productive endeavors.
read David Dreman, he does regressions on this and finds that using as-reported earnings, the 2nd cheapest quintile of P/E, P/CF, and P/B stocks always outperforms the indices. his data go back to the 60s or 70s, can't remember, but it's pretty solid. the interesting thing is that it's not the cheapest of the cheap, it's the 2nd cheapest. he also tested dividend yield, but this was the weakest indicator. P/E was the strongest, PB not far behind.
also I completely disagree with the "doing too many things at once" (not with you Macro, OP). you need to be diversified, period. guys like you are like Ken Fisher, you recommend 100% US stocks for any type of investor, regardless of their comfort level, and one of 2 things will happen: they will bail out at the worst possible second because they can't stomach corrections, or they will never have a good night's sleep. no matter how irrational you think this is, this is how people are.