Five ways individual investors can beat the pros at their own game
At our research company, 5i Research, we just passed an important milestone. In March, 2013, we offered clients our first Model Portfolio. Thus, we recently hit our five-year performance numbers. We are proud of our results, and in fact the portfolio has risen every year. In addition, our five-year compounded annualized return is more than any investment return I achieved at any of the mutual or hedge funds I managed during my long career on Bay Street.
So, ever the analyst, this got me thinking: “How come things went so much better than they did in my mutual fund world?” Well, I have come up with five reasons why. But these reasons are not really specific to our company. For individual, do-it-yourself investors, the same reasons certainly apply, and can highlight how you, the individual investor, has a big advantage over almost every mutual fund or hedge fund manager.
Not having a complete focus on calendar year performance
As a Bay Street fund manager, one’s bonus is almost entirely dependent on calendar-year fund performance. Have a good year, get a big bonus. Bonuses, in fact, were often multiples of your salary, so it was very important your fund has a good year. If performance was lagging in, say, October, it was time to add some ‘juice’ to the fund. This — adding some riskier positions — can work, or not, but it was certainly considered. Our model portfolio does not give us a bonus, and your own portfolio doesn’t either, so there is no need at all for you to even look at the calendar. This can encourage more longer-term investment thinking.
No fees
Of course, your own DIY investment portfolio has no management fees attached to it. Paying high — or any — fees is going to be a big drag on investment performance. According to the Wealth Game (www.wealthgame.com), $10,000 invested at 6 per cent for 45 years, with 2.25 per cent fees results in $85,230 lost to fees (you get to keep $42,416). Fund managers thus end up with more than two times what you make. Eliminating fees will seriously help your investment performance. Note, our clients do pay an annual membership fee. But it is minimal and certainly less than mutual fund fees.
No redemptions/purchases to worry about
As a fund manager, one of the biggest challenges is managing sales and redemptions, and how they can wreak havoc with fund performance. In 2007, my fund had a great year. Money poured in and had to be spent. Then, of course, 2008 happened, and all of that ‘hot money’ decided to leave with the market plunge. I remember October 2008 very well. I wanted to buy some stocks, but because of fund redemptions I had to instead sell stocks. There were no buyers. It was ugly. Do-it-yourself investors, on the other hand, are totally in control of cash flows going into and out of their investment account. Unless your house deposit is tied up in the market (a very bad idea) you do not have to sell stocks at the wrong time. This gives you a huge advantage over any fund manager.
Not tied to the TSX
As a fund manager, all investors want to know is how your fund fared against the TSX index. But, as we have discussed before, the TSX index is a bad index to follow, and our model portfolio could care less about it. Neither should you. By not following the index, you are free to see your portfolio far more diversified than the Canadian market, which is having a very painful year so far in 2018.
You do not have to ‘do’ anything
As a fund manager, it is very hard to do nothing. Not only do you need to justify your high salary, you also need to justify your existence to investors. The market is plunging? It is very hard to tell an investor you are ‘doing nothing.’ Plus, you are staring at a stock screen all day, and most managers have a ‘need’ to trade something, or do something. Our model portfolio, and your own portfolio, of course, have no such compelling need to do anything. Nothing says you have to buy that new issue, and doing nothing is often the exact very best course of action when the market experiences heightened volatility.
Keep these points in mind the next time someone wants to manage your money. You have the advantage, proven over time. Don’t let the investment industry take even more of your money.
Peter Hodson, CFA, is Founder and Head of Research of 5i Research Inc., an independent research network providing conflict-free advice to individual investors (http://www.5iresearch.ca).