Investing your money can be a daunting prospect. You may have read about and be deterred by high fees, underperforming funds and opaque investment strategies, Or you may be attracted to the next big shiny exciting thing that everybody’s talking about (insert latest meme stock, cryptocurrency, loss making tech firm here).
Maybe you want to chase returns from the latest star fund manager, or have heard that it’s time to allocate more to value stocks, or have high weightings to the UK, your home market, since you live there even though it represents less than 10% of the global stock market turnover. Or maybe it’s finally Japan’s time to shine. Or Gold’s. Or bonds’. Or small companies’.
If this is you, it‘s time to rethink your approach to investment management.
Here is the truth. Investing is simple but not easy. It’s also in our view a problem that has largely been solved. At Thera we believe in certain investing truths- for example that costs matter (and we keep them as low as we have found, industry-wide). We also appreciate that consistent outperformance versus a benchmark (alpha) is rare, and that many of our peers still inflate the importance of the small UK market in their portfolios. Most importantly though we never invest your money without first building your financial plan.
The plan, and of course your tolerance to volatility (or the bounciness of your investments) will determine the returns that you need, your time horizon and how much to invest in equities (the great companies of the world) and how much in bonds. You invest so you can reach your financial goals- whether they are retirement, a legacy for your children or saving for a holiday home. The plan dictates the portfolio. If the goal is the destination, the portfolio is the vehicle you use to get there. And our role as planners and advisers is to ensure you remain inside the vehicle at all times!
So once we know where we are going, let’s now talk about how we get there.
Successful investing- The evidence
We did not come to our set of investment beliefs by accident or lightly. We have done so by looking at the evidence, and thankfully we have years of historical data to fall back on. Here is what we have found.
The significant majority of active managers underperform
Unfortunately, some investors continue to chase that pot of gold at the end of the rainbow, that elusive individual, the fund manager that consistently outperforms.
Here is the evidence. In Standard & Poor’s latest Global SPIVA scorecard through 2023,
- 73% of active fund managers underperformed their indexes after 1 year
- At the five-year horizon, 95,5% of active stock fund managers lagged their indexes
- After 15 years there were “no categories in which the majority of active managers outperformed” across domestic and international equities. Similar shortcomings were uncovered in bond funds.
Performance inconsistencies: Forget the stats and technical jargon – consistently outperforming your benchmark often requires taking undue risk. This approach eventually leads to underperformance due to unexpected events, overexposure, or overconfidence. Even top fund managers can’t maintain year-on-year outperformance; their results generally regress to the mean.
Investors will always be able to point to those managers who outperform. You can find them at any time. But their excess returns ‘decay’ predictably and quickly, and managers usually fail to spot this before it’s all given back. Finding the managers that will outperform many years into the future is extremely difficult. As is determining whether any outperformance is due to skill or luck.
One eye on costs: Active fund managers – chasing outperformance – often trade more frequently than required, leading to higher fees and expenses than passive strategies. Their salaries and bonuses also cost more than running banks of computers. These costs steadily erode returns, affecting short-term performance and long-term compound growth.
Market efficiency: With today’s technology and widespread information, finding undervalued securities is more challenging than ever. Fewer and fewer people can point to having a real edge. The market is an effective information processing machine and billions of dollars change hands between buyers and sellers daily using real time information to set prices. Prices react immediately to any new information , faster than ever before. Efficient markets force those seeking outperformance to take on more and more concentrated bets and more risk. The evidence suggests that they very rarely outperform.
Behavioural biases: Like any other investor, active fund managers are also prone to behavioural biases, affecting their decision-making, especially in tough times. Short-term underperformance can quickly become a long-term problem if these biases aren’t addressed.
Global diversification is the way to go
You will undoubtedly have seen the comments that more than 80% of FTSE 100 company revenues come from overseas operations. Consequently, you are probably ready to tick the global diversification box for a fund invested in the UK. Maybe we should take a more in-depth look?
Diversification is the key: Is investing in funds allocated across various markets better than sticking to a one-size-fits-all approach like the FTSE 100? Absolutely. UK-based funds face unique challenges such as taxation, currency movements, and a different market composition than the US.
The Dow Jones Industrial Average, which includes giants like Apple, Johnson & Johnson, and Procter & Gamble, benefits from focusing on tech and financial services. In contrast, the FTSE 100, while diversified, doesn’t have the same sector weightings (but is probably more defensive). The NASDAQ, dominated by eight major companies, and the S&P 500, where the top 10 firms account for 20% of the index, highlight the importance of sector balance.
How to achieve it: True global diversification can be achieved through an index or a set of indices mirroring the underlying strategy and investments. For example, the FTSE All World Index . This index includes approximately 3900 companies in almost 50 countries, including the US, UK, Japan, Germany, but also smaller markets like Indonesia and Belgium. Unsurprisingly, the US dominates with 63% of the index. But embracing market prices and market efficiency means accepting the relative size or market capitalisations of these companies in the index. Like it or not, the biggest, most profitable and most successful companies in the world are American. This may not always be true (and there have been decades where the US has underperformed) which is why we invest internationally.
Economic cycles: Although the FTSE All World Index has a high US weighting, it spans a range of developed, developing, and emerging markets. This diversification mitigates risks and smooths out the impact of localised downturns, economic cycles, and geopolitical events, providing a robust buffer for your portfolio. You also have access to different markets which have a range of different valuations providing a counter to the higher valuations in the technology sector.
Index investing makes sense
Even the best-performing fund managers are susceptible to behavioural biases., These include overconfidence, confirmation bias, anchoring, following the herd, and, with a more confident manager, going against the market. In 2007, famously. Warren Buffet made a $1M bet that an S&P 500 index fund would beat the returns of an actively managed hedge fund over 10 years- and he won in a landslide.
A disciplined, structured approach to investment removes much of the emotional decision-making process and biases and helps arrive at more rational investment decisions.
Discipline and consistency: Passive low cost investment strategies rely on data and clear methodology to make investment decisions. Importantly they embrace market pricing, market capitalisation and have set out clear rules as to when each index is rebalanced and when companies are added or deleted from the index. This means that the index is c0nstantly being refreshed and evolving and at any point in time truly represents the biggest and most successful companies in the world
Transparency: Passive investing also offers transparency. The rules and methodologies behind each decision are clear, and changes are communicated promptly. This allows investors to understand the rationale behind the formulation of the index, even though not every decision will be perfect. Your index fund does not decide suddenly to change its investment style on a whim.
Low cost- All index funds have professional fund managers. What they don’t have is the need to pay more for the expertise and time it takes to hand-select stocks or bonds for each fund. While the initial savings, up to 1% a year can seem small they can contribute meaningfully to portfolio growth in the long run. The adage you get what you pay for does not apply to your investments.
How do we put our beliefs into practice- The investment process
So let’s summarise our investment beliefs.
- Global capital markets are, on the whole, efficient. Embrace market pricing
- Global diversification is essential
- Consistent outperformance is rare
- Investment costs matter
- Investment discipline protects investors
How do we make this work in practice?
Keep things simple – Invest in just three asset classes. Equities, bonds and cash,. Equities drive long term growth , government bonds offer a yield currently in excess of inflation and protection against a market crash or a recession, and a small cash buffer provides ready liquidity. We will agree on the relative allocation between bonds and equities by understanding at what stage you are in your financial plan, and your willingness to accept investment volatility. Every other asset class can be safely ignored- gold, oil, commodities provide no cashflows so their price is purely dependent on how much somebody is willing to pay for them. Real estate or your home is primarily where you live and as an investment is illiquid and should only be undertaken as a business by full time professional investors.
Transparent ,Liquid and low cost – At any point in time you know the exact composition of our portfolios. And they can be bought and sold at any time. Weird illiquid structured products and hedge funds with complex fee structures have no place here. We avoid market timing, style investing or past performance chasing,. You never know which market segments will outperform from year to year. By diversifying globally you are well positioned to seek returns wherever they occur.
Rebalance- Regular rebalancing according to Vanguard has shown over time to contribute up to 14 basis points per annum to investor returns. In effect this means trimming your winning positions when they have gone up too much (more than 10% from your original allocation) and using the money to add to your underperformers. Our portfolios do this automatically.
Regular fund reviews and monitoring – Index funds are not all the same even if they mirror the same index. Their returns can differ sometimes quite dramatically over long periods. You will need to keep an eye on their costs, how closely they mirror the index, how big and established the fund is and also the way in which they replicate the index. And you need to refresh this research making changes if necessary. It’s called due diligence and we do it every year.
Patience – Arguably this is the most important part of the process. Numerous studies have shown that the return of an investment is usually higher than the return of the investor. The difference is in a term coined by Carl Richards- The behaviour gap. Market corrections and crashes are incredibly stressful times for investors. During these times we focus on the long term, show you how the moves have affected your plans and ensure you don’t make any rash decisions like selling at the wrong time. We help you also look beyond the headlines as daily market news and commentary can challenge your investment discipline.
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What next?
We hope in this article we have outlined some of the beliefs, the mindset and the tools you need to invest successfully. The underlying theme behind successful investment is humility. You understand that current prices in the world’s financial markets provide the final decisions of billions of dollars of trades between some of the world’s smartest and most informed investors. You accept that individuals including you rarely know better than the collective and over time cannot beat the market. And by accepting market prices, you also understand why you need to diversify your investments globally because in this way you can seek returns wherever they occur in the world.
Many people can and should do this on their own especially if they are starting out, and have limited funds. Investing has become easier with the accessibility of global index funds and ETFs and low cost investment platforms.
Sometimes though it makes sense to ask for some help. Because getting your investments right is just part of the story, As you grow your wealth the stakes tend to get higher because you have more to lose and you want to protect your wealth from inflation but also from volatility. Or there is a big life event coming up- such as an inheritance or divorce. Sometimes life forces your hand and you need to seek outside counsel. Or you don’t have the time or the bandwidth to deal with all these decisions. Or your tax affairs are getting more complex. Or you want to delegate the money stresses to somebody else. Or you want somebody else on board in case something happens to the primary money decision maker in the family.
Usually though people engage with advisers because they want to create a bespoke financial plan which will ensure they can retire or at least make work a choice by a specific time. And then they want to hire someone to take responsibility for the implementation and success of this plan and ensure that it’s invested with this goal in mind.
Because investing without a plan is like driving a car without a destination.
If any of this resonates, please get in touch,
- This blog is for information purposes and does not constitute financial advice , which should be based on your individual circumstances
- The value of investments may go down as well as up and you may get back less than you invest.
- Any rates of investment growth shown, are intended as a guide only, they are not guaranteed, nor are they intended to be either minimums or maximums.
- Past performance is used as a guide only; it is no guarantee of future performance.
