Plenty of investors start out well. They build a diversified portfolio of low-cost index funds. But then an analyst on Bloomberg says bonds are going to crash. An expert on CNBC says U.S. stocks will fall. A financial magazine says Asian stocks will soar. The headline reads, “These Are The ETFs To Buy Right Now!” Suddenly, you have an itch that’s begging to be scratched. By tweaking your portfolio, you might gain a performance edge.
But here’s something to remember: your portfolio is much like a bar of soap. The more you mess with it, the smaller it’s likely to get. Many DIY investors can’t resist the urge to tinker. But they aren’t alone. Professionals also play with soap, and the results aren’t pretty.
Tactical Asset Allocation funds provide a great example. They differ from traditional mutual funds because their managers don’t have to stick to a consistent asset class. Their expertly trained analysts can pick U.S. stocks, developed international stocks or emerging market stocks. They can increase or decrease their U.S. or international bond market exposure as they see fit. These professionals keep their eyes on global interest rates. They monitor elections, pending tax cuts, corporate earnings projections and market valuations.
They often tilt their asset classes daily, weekly or monthly to provide their funds with the sharpest profit edge. But here’s the rub. If you can build a diversified portfolio of low-cost index funds (and leave it alone) you can whip these pros with a bathroom towel.
If you’re a low-cost index fund investor, I can hear what you’re thinking: “I can win because they charge high fees.” But let’s pretend they don’t charge fees. Their analysts work for free. Their companies’ mission statements say, “One hundred percent of our funds’ gains fuel your retirement.” That would mean no load fees. No expense ratio costs. Your index funds, by comparison, would look rather expensive.
But remember that bar of soap. These analysts trade to exploit tactical edges. Unfortunately, it rarely works. That’s why your portfolio of index funds, if you leave it alone, can beat them silly.
Morningstar tracks 308 Tactical Asset Allocation funds. Just 182 of them have five-year track records. Poor performing funds get delisted, or they get merged with more successful funds. That’s why the average listed performance of these 182 funds is overstated. It doesn’t include many of the worst performing funds. In other words, these are the cherry-picked survivors.
During the 5-year period ending June 13, 2018, these top survivors averaged a compound annual return of 4.74 percent. According to Morningstar, fees for Tactical Asset Allocation funds average 1.37 percent per year. If we pretended that these funds didn’t charge expenses, we would add 1.37 percent to the average fund’s return. That would give them a compound average return of 6.11 percent per year.
Compare that toOver the same time period, it averaged a compound annual return of 8.75 percent. A more diversified portfolio of indexes, including 40 percent U.S. bonds, 40 percent U.S. stocks and 20 percent international stocks would have averaged a compound annual return of 7.75 percent.
In other words, these professionals could have worked for free, but only a handful would have matched a diversified portfolio of low-cost index funds. If you’re invested in such a portfolio, you can trounce the pros. Just don’t fall victim to their hubris. If you’re working, add money every month. Rebalance once a year and resist the urge to tinker. Most pros can’t gain a strategic edge, so it’s best to learn from their mistakes.
If We Avoid The Urge To Tinker, It’s Easy To Beat The Pros
Compound Annual Returns To June 13, 2018
|5-Year Annual Returns|
|Average Tactical Asset Allocation Fund Performance||4.74%|
|Vanguard’s Balanced Index Fund||8.75%|
|40% U.S. bonds, 40% U.S. Stocks, 20% International Stocks||7.75%|
How Do The Tactical Asset Allocation Funds Stack Up?
Andrew Hallam is a Digital Nomad. He‚Äôs the author of the bestseller, Millionaire Teacher and Millionaire Expat: How To Build Wealth Living Overseas