#137 Part 3 – Who’s Flying


I’m a couple weeks behind on my writing right now. I knew I would come back from MDRT bursting with excitement; trying to implement all my new ideas while catching up from a week in New Orleans, but it’s still hard to just sit down and work when you’re trying to change the world! MDRT statistics show that the “MDRT high” typically wears off after three weeks, so they recommend implementing any ideas you have as soon as you get back. The conference was amazing, and I’m so excited to share what I’ve learned!


This column is the third piece in a four-part series on my investment philosophy. The first was fun and upbeat! Goals-based investing! Yeah! The second one was a bit heavy on the technical side, working through investment parameters and building systems to reduce risk. This column is going to be about what actually makes a good investment, which is a fun topic but also a wicked challenge. I’ve had a few cups of tea and a handful of the dropjes we picked up on the weekend, so I’m feeling ready to dive in! Let’s launch!


Here are my three rules for how to choose a good investment.


First rule: Nobody can predict the future. Wish I could, but I can’t. And neither can anyone else. So if you don’t have the skill, knowledge, or time to be a dedicated DIY investor, then don’t even try. There’s way too much at stake – the most important being your predisposition to investing itself. I didn’t build the plane, and I’m not paid to predict the weather – I’m paid to react to it. So find someone you trust and stick with them.


Do you want a pilot in your plane or are you comfortable relying on autopilot? Either answer is fine, but if you do want a pilot, you’re going to want to know the difference between a pilot who’s flying a plane and a pilot who’s just acting like it.


Studies have shown that mutual funds, on average, underperform the market as a whole. Mostly I find this information skewed into low-fee sales tactic, but it does actually have some merit to it. You just need to view in reference to value (what are you actually paying for?).


In order to determine value you’ll need to know a fund’s “active share” – a measurement of how unique a fund is. Typically, any fund with 60% or more unique holdings can be considered to have true active management. Some guy in the cockpit actually making decisions. All the other guys are considered closet indexers, to varying degrees. Pilots who use auto-pilot indexing in an effort to minimize underperformance while still charging active-pilot rates. This is where the fees matter –if you’re going to pay someone to do the job, they better be actually doing the job.


While using a true active-managed fund isn’t a guarantee of above-average performance, a very interesting Active Share paper by Vanguard separates active management from closet indexers. They find that “at no time during the analysis period did these less-active [closet-indexing] funds generate positive excess returns after costs”. Conversely, while not a guarantee, actively managed funds with low cost implementation (traditionally buy&hold mantras) did appear to be a predicator of above-average performance.


So if you’re happy with auto-pilot, that’s fine. If you want a live pilot, that’s find too. Just make sure he’s actually the one flying the plane. Closet indexers have been shown to make up more than a third of mutual funds, so cutting those guys out brings down eligible investments substantially.


Second rule: In most cases all of the micro-nuances of investment selection don’t friggin’ matter. Individual secures, exchange traded funds, mutual funds, strip bonds, whatever. Specific duration, alpha, beta, Sharpe ratios. All that stuff can be fun to look at, and somebody somewhere should definitely be aware of it, but in reality, in the real world, it really has very little to do with your success.


The problem is that everyone assumes they can think rationally, and all of the investment selection ratios and parameters are predicated on this assumption. Dalbar, a financial services research group, issued their 2014 report on investor behavior reiterating again, for the 20th year in a row, that “investor results are more dependent on investor behavior than on fund performance.”


Both investment turnover and market timing have been shown to dramatically reduce a retail investor’s chance of success. Even if you have the perfect analysis, the act of allowing past events to frame your future decision, media analysts thick with emotional triggers and personal emotional biases (such as the belief that you, or the markets themselves, are rational) will be the largest determinant of your results.  


So what can you do if you want to be successful? Buy something, get it at a discount, and don’t friggin’ touch it! Behavioral finance is going to be the topic of next weeks’ column, and that’s always a bunch of fun, so we won’t get into it too much now, but the don’t-touch-it rule goes for fund managers as well – if there is high turnover inside a fund, it probably means high fees, and that probably means lower long-term returns.


And finally the third rule: if you’re going to choose an investment, make sure you have a well-documented reason for choosing it. Each of your investments should be uniquely different from anything else you own while at the same time complimenting the rest of your portfolio. If you don’t know what you have, or don’t know why you have it, either find out or get rid of it. Your investment portfolio is not a place for hunches or second-best ideas. This is your life, and your money, and your future. Create a concentrated portfolio and stick to it with conviction.


The only reason to change an investment is if one of the fundamental reasons you purchased it has changed, or if it’s gone outside of the parameters you’ve set for it. So make sur you know who’s flying your plane, buy something and don’t touch it, and make sure everything in your portfolio has a purpose.


For more information on managing investments with a purpose, or if you have questions on the differences between active and passive management, speak with a CERTIFIED FINANCIAL PLANNER© today.

Written by Meagan S. Balaneski, CFP, R.F.P CERTIFIED FINANCIAL PLANNER®
Advantage Insurance & Investment Advisors

Investment Funds Representative
Manulife Securities Investment Services Inc.

The opinions expressed are those of Meagan S. Balaneski and may not necessarily reflect the views of Manulife Securities Investment Services Inc.

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