Sunday Morning Coffee
There was an opinion piece in Barron's that questioned a few tenets of portfolio management. It noted that many of the assumptions about correlations and diversification are backward looking and so there is no guarantee that, to use the example in the article, that oil and airline stocks will always have a low correlation.
The article raises valid issues with benchmarking including that many active benchmarkers will hug an index very closely so clients of those benchmarkers may not be getting their money's worth. These are valid questions but hasty conclusions in my opinion.
Be that as it may the most useful part of the article might be that it is a reminder for an important building block that I have talked about before.
A reasonably diversified index equity portfolio will likely average a 9-10% average annual return over some long period of time. This combined with a diligent savings rate and appropriate asset allocation can give someone a decent shot of having enough money when they need it. Poor emotional reactions and poor spending decisions are two big impediments to a positive outcome.
In this context any active strategy needs to be considered against just holding a portfolio of index funds. If an investor has to work 50 hours a week to add an average of 50 basis points annually to the result then that could compound out to be a difference maker but is the time spent worth it? The answer will be in the eye of the beholder.
It is also important to understand that an active strategy does not have to be about beating the market. I would describe what I am trying to do as capturing most of the upside while missing a big chunk of the downside aka smoothing out the ride. I believe this can yield a much better result over the course of the entire stock market cycle. This is what is right for me. Anyone else needs to do what is right for them but whatever that is what value are you adding and is it worth the effort?
To be clear I am not making the case for passive indexing but there are folks for whom this is the best thing and there are all sorts of reasons why this may be so but staying with the wrong, for you, strategy is going to create a very bad long term result.
One other point that the article made was the silliness in measuring performance in "90 day increments" because they "are coin flips that promote excessive trading and follow-the-leader strategies, which are the bane of investing success." I think this is consistent with a running joke I've made before in asking "quick, how'd you do in the third quarter of 2006?"
Be that as it may the most useful part of the article might be that it is a reminder for an important building block that I have talked about before.
A reasonably diversified index equity portfolio will likely average a 9-10% average annual return over some long period of time. This combined with a diligent savings rate and appropriate asset allocation can give someone a decent shot of having enough money when they need it. Poor emotional reactions and poor spending decisions are two big impediments to a positive outcome.In this context any active strategy needs to be considered against just holding a portfolio of index funds. If an investor has to work 50 hours a week to add an average of 50 basis points annually to the result then that could compound out to be a difference maker but is the time spent worth it? The answer will be in the eye of the beholder.
It is also important to understand that an active strategy does not have to be about beating the market. I would describe what I am trying to do as capturing most of the upside while missing a big chunk of the downside aka smoothing out the ride. I believe this can yield a much better result over the course of the entire stock market cycle. This is what is right for me. Anyone else needs to do what is right for them but whatever that is what value are you adding and is it worth the effort?
To be clear I am not making the case for passive indexing but there are folks for whom this is the best thing and there are all sorts of reasons why this may be so but staying with the wrong, for you, strategy is going to create a very bad long term result.
One other point that the article made was the silliness in measuring performance in "90 day increments" because they "are coin flips that promote excessive trading and follow-the-leader strategies, which are the bane of investing success." I think this is consistent with a running joke I've made before in asking "quick, how'd you do in the third quarter of 2006?"