Morgan Stanley is arguably one of the best investment and brokerage companies in the world today and have at their disposal some of the best minds in the world when it comes to investment strategies. Recently one of their top people, a gentleman named Gerard Minack, announced that he was retiring, an announcement that was met with quite a bit of sadness as his work has always been extremely helpful as well as very articulate.
The good news however is that, as a parting gift to his thousands of clients, Mr. Minack whipped up a two-page note of farewell that contains what’s possibly the best investment advice that you’re ever going to hear. It’s only two pages and, as such, does not allow him to go into an explicit explanation of said advice but, in just a few sentences, he puts together a powerful argument against any other kind of investment strategy besides the one that he espouses. To wit;
· Don’t try to pick stocks
· Don’t try to time the market
· Only invest in a portfolio of low-cost, tax efficient index funds
Sounds simple enough doesn’t it? Below are going to elucidate his advice just a little bit more for you, our dear readers. (You’re welcome.)
One of the things that he points out is that, in any given year, actively managed funds actually underperform their benchmark nearly 60% of the time. So, when Mr. Minack advises that you shouldn’t try to pick stocks, he’s basically citing the fact that, in most years, you’ll have no better than a 40% chance of finding and picking a fund that will actually beat the market. Thus, if you try to pick stocks the odds are definitely against you.
What he also notes is that a whopping 80% of all funds were actually behind the market over the last three years through 2012, an incredibly high percentage of failure. Put into simple terms, what this means is that if you plan to hold your investments for three years or more there is only a 1 in 9 chance that you’re going to pick a fund that will actually beat the market, odds that are quite dismal to say the least.
Even worse is that, if you approach investing like most people, you’re also going to do your best to pick a time to be in the market and, like most, you won’t do a very good job of it. What this means is that you’ll no doubt be pulling money out of the market when you should be putting it in and vice versa.
If you think rich, sophisticated investors do any better because they invest in hedge funds instead of mutual funds, you’ll find that, to the contrary, their chances are actually even worse. The reason is that the actual cause of the lag in mutual and hedge funds is fees, not one’s lack of ability to pick stocks.
The reason for this is a combination of odds and simple mathematics. For example, since about 50% of all funds beat the market every year this means that, conversely, 50% don’t and, once cost and fees are subtracted, your odds of picking a winner get substantially worse. Since hedge funds generally charge much higher fees than mutual funds the odds that you’ll end up losing are quite high.
Basically, trying to pick stocks and funds as well as trying to time the market are, as Mr. Minack suggests, not very good ideas.
Now that we’ve hit you with all of that negativity, we have a bit of good news as well.
Simply put, if all you do is buy and hold on to low-cost index funds you’ll be, in the long haul, able to beat nearly 90% of funds.
The reason is that index funds generally have very low costs and very low fees whereas actively managed funds do not. The reason for this is that index funds, unlike actively managed funds, have very low fees and costs. While actively managed funds lose ground to these costs and fees, index funds instead track the market. Having a 100% chance of beating the majority of actively managed funds thus gives you great odds over the odds of picking a fund that will beat the market.
In our opinion Gerard Minack was incredibly generous in leaving these tips behind as he left. Now, if Morgan Stanley and the rest of their financial advisors can take his lead and help their clients to build low-cost, tax efficient portfolios, we’ll all be very happy.