Future Focus: Are you better than average?
And do you need to be?
There’s not many pursuits in life where you’d be ecstatic to be average. As investors, we’re often told to chase ‘alpha’ – to beat the market. Mark and I often see this chase as a declaration made with pride by many investors that listen to our podcast and read our articles. It’s an appealing story, but the truth is being average is more than enough to build wealth over the long-term.
Howard Marks is most famous for being the co-founder of Oaktree Capital but he is also known for his writing. His reflections on the market and investing are widely consumed and his books are revered. He has become a wealthy man by buying distressed investments.
Given a career spent seeking and making active bets it is surprising and credible that Marks believes most investors should be doing the exact opposite. He believed that consistent mediocrity beat being an inconsistent top performer.
Marks likes to tell a story an investor named David VanBenschoten who was the head of the General Mills pension fund. He recounts a story when he was told by David that over 14 years his pension fund was never ranked about the 27th percentile of the pension fund universe. But at the same time it was never ranked below the 47th percentile. The results after 14 years? The pension fund was ranked in the 4th percentile.
This became Marks mantra. Making sure that he never blew up his investment results.
What turns this mediocre investor it a spectacular one is time. Time is what allows those earning an ‘average’ return to build wealth. What prevents average results from turning into great results is investors getting in their own way.
This is the key to my investment strategy. Many of us do not start with a large capital base but I was lucky to learn early that time was the secret to building wealth. I saw a pathway where I could achieve my goals by investing small parcels over time.
I’m not the only investor that knows this secret.
Sylvia Bloom was an American legal secretary. She copied her boss’s investment portfolio, using time to accumulate a hefty portfolio of over $8 million USD starting in the 1920s. Her family and friends were unaware of her wealth as she maintained the same lifestyle throughout her life. She donated the funds upon her death.
She was able to amass such wealth on a legal secretary’s salary because she had over 60 years of runway for the small amounts she invested to compound and grow. My colleague John Reckenthaler has done the maths. Today, it would involve investing around $7,000 a year and earning the average return of the S&P500.
Grace Groner was also a secretary. She invested in her company’s shares over 43 years. The shares did well, and staying invested over the long-term meant she had $7 million USD at the time of her death in 2010. She donated it to a college where 1,300 students will benefit from her bequest.
One last investor. Ronald Read. He was a janitor for 17 years and a petrol station attendant for 25 years. Growing up in relative poverty he died with $8 million USD by investing in dividend paying stocks and avoiding investments that he didn’t understand.
These individuals had low to middle income salaries and no formal investing experience or education. Their secret was to invest over the long-term and not get in the way of the market. The bought investments they understood. They had simple portfolios and didn’t get caught up in over-researching and overcomplicating their decisions.
All of these investors lived in a different time to us but there is nothing stopping anyone from replicating their success. The same principles apply in the current market environment.
What does getting the average return mean?
An average return is the modern equivalent of investing in a passive fund that captures the market return. It is choosing a fund that tracks a broad market index which provides investors with some additional advantages that help to build wealth, including:
- Low cost, resulting in a higher total return.
- Low turnover, resulting in less tax consequences.
- Less complexity and volatility, which lends itself to better investor behaviour.
When it doesn’t suit being average
Being average doesn’t suit every investor. Getting the average market return is not the right strategy if your investment portfolio requires specific outcomes from your investments to achieve your goals. For example, if your goal is to create a portfolio that generates passive income for travel. Your goal requires investment in assets that generate sustainable income. Investing in a broad market passive investment is not going to be the right fit.
This might also be the case in retirement. There is added complexity of managing withdrawals and maintaining cash reserves to manage volatility. Your portfolio needs to reflect these additional needs.
Where you have to be better than average
While average returns build wealth, average investor behaviour can destroy it.
The investors I highlighted earlier all stayed invested over the long term without trying to time the market or make tactical allocations.
Morningstar’s Mind the Gap study highlights this reality. The study measures the difference between the returns of investment funds and the returns actually earned by investors in those funds. The gap exists because investors tend to buy after strong performance and sell after downturns. This poor behaviour costs investors about 1.2% per year over the previous decade in our latest report. This equates to 15% of the funds’ aggregate return.
That might not sound like much but over decades it creates a huge shortfall. An investor who simply held onto their investments captured the ‘average’ return. The one who tried to outsmart the market or succombed to anxiety caused by volatility, switching in and out, ended up with far less.
Final thoughts
At a recent conference, attendees shared that many of their friends spent the equivalent time of a full-time job to look for investing opportunities and manage their portfolio. Investing is a hobby for some investors. They enjoy the pursuit of opportunities and managing their portfolios. The irony is that the more time that is spent on your portfolio the higher the chance you will be tempted to tinker with your portfolio. This increases your chance of a poor outcome. The behaviours that we commonly associate with professional or sophisticated investors can often be detrimental to your return outcomes.
Being average can make you one of the most successful investors in your generation. The only thing standing in your way is time and your own behaviour.
Invest Your Way
For the past five years, Mark and I have released a weekly podcast and written on morningstar.com.au to arm you with the tools to invest successfully. We’ve always strived to provide independent, thoughtful analysis, backed by the work of hundreds of researchers and professionals at Morningstar.
We’ve shared our journeys with you, and you’ve shared back. We’ve listened to what you’re after and created a companion for your investing journey – Invest Your Way. Invest Your Way is a book that focuses on the investor, instead of the investments. It is a guide to successful investing, with actionable insights and practical applications.
The book is currently in presale which is an important time to build momentum. If anyone would like to support this project you can buy the book now. Thanks in advance!
