The Temptation of Outperformance
Unfortunately, no advisor can consistently deliver “outperformance.” The difference between Intelligent Investing and other advisory firms is that we will not lie about that fact. However, we believe we offer more practical and reliable ways that hopefully will achieve superior long-term, real-life results.
We are planners, not prognosticators, and there is a big difference between the two.
All unsuccessful investing is market-oriented and performance-driven. All successful long-term investing is goal-oriented and therefore planning-driven.
Adam and Eve were goal-focused investors…until the serpent told them they could be–with just a little guidance from him–smart enough to “outperform.” Outperformance is the apple. Don’t bite into it. ~Nick Murray
Every year, Lipper and DALBAR, Inc. juxtaposition the 20-year average annual compound rate of return of the average large cap equity mutual fund in the U.S. and the average return realized by the average equity mutual fund investor. For the 20 years through 2007, the results were that the average equity fund produced 10.81%, and the average equity fund investor produced 4.48%. Although the two numbers will bounce around a lot from year to year, the relationship between them remains eerily constant: over 20 year periods, the average fund investor consistently manages to capture much less than half of the return of the average fund.
This behavioral gap (6.33% in the above example)–is the difference between the 10.81% the average investor would have gotten, and the 4.48% they actually (behaviorally) secured for themselves, either on their own or with the tender mercies of a string of selection-and-timing-oriented “advisors.” Intelligent Investing wants to close that behavioral gap between investment return and investor return by liberating the average investor from inappropriate behavioral proclivities. Remember, these inappropriate behavioral proclivities also apply to other financial advisors.
Thus, in a society that has made almost a secular religion out of “outperformance,” the average investor is not merely underperforming the markets– they are underperforming their own investments! The reason the average investor blows upwards of 60% of the return of the average fund over any given 20 year period is that he behaved inappropriately. Instead of buying a mediocre large cap equity fund, and allowing the dividends to reinvest (i.e., buying and holding), the average investor did something else–a whole lot of other things, which had three important characteristics in common:
- They were always the wrong thing to do.
- They were done at the wrong time.
- They were done for the wrong reasons.
Presented again and again is irrefutable evidence that the central problem is emotional/behavioral–that is housed in the investor’s emotions–advisors seek ever more complex intellectual/analytical remedies, on the bizarre assumption that the problem is housed in the intellect. Unfortunately, advisors are not immune to experience emotions/behavioral problems. However, the good news is that if you are aware of this built-in problem, you can mitigate it through discipline, transparency, and accountability.
Outperformance, while it may be desirable, can neither be consistently predicted nor controlled by Intelligent Investing or any other advisor. No one can scientifically assert that the portfolios will “outperform” some other advisor’s selections.
The dominant determinant of long-term, real-life returns will be the behavior of the client and advisor.
At Intelligent Investing, our value–the thing that we believe is worth multiples of what our clients pay–is that we act as prudent behavioral coaches. Everything else we do–asset allocation, investment selection, rebalancing, reporting, excellent customer service, –everything other than behavior modification pales in comparison.
Intelligent Investing cannot–and will not– guarantee that our clients won’t still figure out a way to steer around our advice and drive over a cliff. We can empathize, reason and encourage our clients not to panic out of a lifetime equity portfolio when it’s down 30% in a bear market. But we can’t actually stop the misbehaving. We will do our best, but some clients will cry, “This time is different.” In the end, behavioral investment counseling–like diet, exercise, and taking prescribed medication–only works if the patient does what the doctor advises. Intelligent Investing can only help people who are willing to be helped. A doctor doesn’t convince; he prescribes. He cannot flatten one’s abs, clean out one’s arteries or force-feed a patient his meds.
Can Intelligent Investing Outperform?
We certainly don’t rule out the possibility that our investments will “outperform” most of your neighbor’s investments. We just cannot promise it–nor can any other advisor. We are comfortable with this fact. However, using the principles we practice, you may end up with a far better lifetime return than do most of your neighbors.
If you are interested in learning more, consider watching some Behavioral Finance Videos.