The #1 thing investors need to do to improve returns in 2020 [plus a money-back guarantee if it doesn't work for you]
More has been written on the active versus passive debate than probably any other issue facing investors.
Every day people are coming up with different theories as to why one is better than the other.
Depending who you speak to, people are passionately for one and against the other.
So which approach is right for you?
The case for investing passively is, ultimately, nothing to do with theory at all.
Jack Bogle, the founder of Vanguard and one of the most famous champions of index investing, summed it up as follows:
“The index fund relies on a simple arithmetic, a mathematical tautology that could be calculated by a second grader: gross return in the stock market, minus the frictional costs of investing, equals the net return that is shared by all investors as a group.”
It’s very short, and well worth reading, but in a nutshell it says:
- The investing community is divided into active and passive investors.
- Before costs, the return on the average actively managed pound/euro/dollar will equal the return on the average passively managed dollar.
- After costs, the return on the average actively managed pound/euro/dollar will be less than the return on the average passively managed dollar.
Therefore, the average active investor must — no ifs or maybes, must — underperform the average passive investor.
To quote Professor Sharpe:
“These assertions will hold for any time period. Moreover, they depend only on the laws of addition, subtraction, multiplication and division. Nothing else is required.”
The investing industry is essentially an intermediator.
Fund managers, stockbrokers, consultants and so on all need paying for the service they provide.
Financial mediation is extremely lucrative, and yet the industry is very clever at disguising the fees and charges investors pay.
These costs aren’t just the annual management charge.
Platform charges, custody and administration costs, and the fees entailed with buying and selling stocks should also be counted.
Often the total amount you end up paying is two or three times the figure advertised.
Few people, even investment professionals, fully appreciate the huge long-term impact of compounded costs on investment returns.
Internationally, the effect of costs can typically reduce your potential returns by two-thirds or more.
The reason why investors find this basic arithmetic so hard to grasp is that it seems counter-intuitive.
We’re so used to the idea that the more you pay for a product or service, the better it is.
But with investing, it’s the other way around.
The more you pay to invest, the smaller your net returns will be.
The industry doesn’t like to talk about cost, preferring instead to emphasise fund manager “skill”.
But, over the long term, most fund managers are unable to provide consistent outperformance net of the fees they charge.
Time and again, research has shown that the costs are the most reliable predictor of future returns.
Of course, you cannot eradicate costs altogether.
There are still fees to pay to invest in index funds, albeit very much smaller than the costs entailed in active investing.
Also, for most people with substantial wealth, it’s well worth paying for a good financial adviser.
But costs are the one thing that you as investor can control.
It’s not often you hear ‘guaranteed’ in financial services but here is one I am happy to give.
If I can’t reduce the all-in cost of your investment – I’ll give you $50 – guaranteed.
Why not try me out today?
After all, it’s simple arithmetic.