Behavioural Finance

In my last video, I talked about some of the challenges that active managers face in outperforming the market. It boils down to their relatively high fees, and intense competition from other managers.

The data is in and, for fund managers who are still trying to “beat” the market, the numbers are still not on their side. As talented as active players often are at slicing and dicing the data, and as mightily as they may try, there’s considerable evidence that passive players continue to have the last laugh. Why is that? As usual, it has a lot to do with common sense.

Until recently, it was frustrating trying to convince you to become an evidence-based investor. Part of the problem was persuading you that brokers and self-appointed stock market gurus are emperors with no clothes. There’s no credible evidence anyone has the expertise to reliably and consistently pick outperforming stocks, tell you when to get in and out of the market or pick the next “hot” mutual fund manager.

Often, successful business owners think of their personal investments as simply another way to generate profits on their profits. For investing, I recommend an entirely different mindset, in which you shift the emphasis from venturing more of your money to preserving the profits you want to keep as your own.

Research has shown that small cap, value, and high profitability stocks have higher expected returns than the market. They also exhibit imperfect correlation with the market. Building a portfolio that tracks the market, and then increasing the portfolio weight of small cap, value, and high profitability stocks increases the expected return and diversification of that portfolio. From a human investor’s perspective, the problem with higher expected returns is that they are expected, not guaranteed. And that imperfect correlation?

I’m in Chicago as I write this, about to run another marathon. In the next couple of weeks, I’ll be launching my new book, Long Road to Boston, at a special event at Ottawa city hall.

Recently, I went shopping for a new car. I now understand why a survey from Edmunds.com found that a significant percentage of Americans consider the process of new car buying so distasteful they would give up sex, Facebook and their smartphones to avoid it.

When I started writing books about a decade ago, I took the position that no one should rely on a broker for financial advice. My reasoning was simple.

Of all the misinformation disseminated to investors, the most pernicious supports the belief that some “investment pro” or pundit has the skill to reliably pick outperforming stocks.

The data is irrefutable. There’s a direct correlation between low fees and higher expected returns. Two recent studies from Morningstar bring this point home in a powerful way.