The markets had a great year. The benchmark S&P 500 Index was up 30%. Other averages were up almost as much. So why are some investors disappointed?
“Why am I paying you a fee to manage my money?” asked one disgruntled client recently.
His portfolio was up 28% this year, but still 2% shy of the benchmark’s performance.
“I could have invested all my money in just one fund and I would have made more. What do I need you for?”
Of course hindsight is always 100% accurate but his point is well taken.
What indeed does he need me for?
Money management is an art, not a science, despite efforts by Wall Street to convince you otherwise. Professionals would like you to think that investing is all about financial analysis, mathematical models, historical data extrapolation, and behavioral science. These buzz words reflect a fairly boring set of concepts, which few outside the industry care to study or understand.
What the pros rarely admit is that there is also a healthy amount of luck, timing and chance within the investment process. Most money managers I know are far more concerned with protecting your money against unforeseeable events than they are about matching or beating the benchmark index. As a result, any manager worth his or her salt is going to diversify your holdings.
That means that your portfolio should hold some investments that are less risky than others. Depending upon your personal risk tolerance, this could mean holding securities that could be termed “defensive.” When the markets go down, normally defensive investments go down less and some, like bonds, could actually rise. However, when markets go up, these securities go up less than the market overall.
So naturally, putting all of a client’s assets in one security, such as the S&P 500 Index, would be like betting your fortune on one number on a Las Vegas roulette wheel. In my opinion, it would be the height of irresponsibility. Insulating a client’s portfolio against risk is of the utmost importance. If that means losing some performance in exchange for some insurance against the downside, then I am all for it.
It is interesting to note that back in the Seventies, when over 75% of employee retirement plans in the U.S. consisted of pensions, no one expected that one’s yearly investment performance should match any equity index. The point of retirement savings was to take as little risk as possible while compounding small yearly gains into a comfortable nest egg for the future. Pension fund managers today continue to operate under that same philosophy and employees who are lucky enough to have one do not complain.
Yet, with the sea change in this country of making the individual rather than the employer responsible for retirement savings, something was lost in the transition. Today many investors care little about such things as risk or investment insurance. They hire managers for that but are disappointed when they do. So many investors still expect us to beat the market and, at the same time, invest in securities that are not subject to market risk.
The sad truth is that those who expect that kind of performance will be sorely disappointed the majority of the time. The secret to successful investing is to make consistent returns while avoiding the serious downdrafts that markets are subject to periodically. In other words, hit singles and doubles and if possible a homerun or two along the way. You will make more over the long run.