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Why is personal investing unlike other skills?

Canadian author Margaret Atwood features on most lists of the best living writers. The worldwide success of the recent adaptation of The Handmaid’s Tale further enhanced her status. Atwood tells a story about a brain surgeon who she met at a party. On learning her identity, the surgeon said: “I've always wanted to be a writer, and when I retire, I'm going to become one.” Atwood replied: “Well, that’s a coincidence. When I retire, I'm planning to become a brain surgeon.”

It was Atwood’s way of saying that writing is a craft that takes years to master. Almost anyone can write, but few people can write well without years of practice honing their skills.

What about the skills required for investing, and in particular, assembling a portfolio of assets and selecting shares or funds to match or outperform the market?

Anyone can do their own investing

More than one million Australians are trustees of their own superannuation fund. They have all signed a 70-page trust deed which makes them legally responsible for their own retirement savings and investment strategy. According to the Australian Securities Exchange (ASX), almost 40% of adults hold ‘on-exchange investments’ outside of institutional super funds, making listed shares more popular than investment property and cash as a retail investment.

The vast majority of these people would not dream of fixing the engine on their car, playing a piano concerto or doing the dental work for their children. Those skills take years of dedicated study and practice to acquire.

What makes teachers or electricians or doctors believe they can assemble a portfolio and trade shares successfully when they retire, most of them with little or no training?

Even the experts struggle

I recently received two emails from different market experts within a couple of hours of each other. Both had analysed the shopping centre company, Scentre, owner of 40 Westfield malls. A broker warned revenue may be ‘deteriorating’ as specialty store rents were ‘going backwards’. The latest results were weak in the food and dining out areas. SELL! Then a fund manager said Scentre owns great real estate with huge barriers to entry with ‘an extraordinary diversity of sources of income’. It was as attractive as any property company. BUY!

Who’s right? I have no idea, but I know one thing – despite the days and months both these experts have spent analysing Scentre, flying around the country inspecting the properties, meeting management and dissecting the numbers, at least one of them will be wrong.

To become a professional share market analyst working for a fund manager, broker or research firm requires considerable training. After university, most attend specialist courses that are tough and take years of study to pass. Then they work in the finance industry for years more before being given portfolio responsibilities. Yet despite this intense training, most of these analysts managing active share portfolios cannot beat the market index consistently.

While there are criticisms of the methodology, the Standard & Poor’s (SP) scorecard of Index Versus Active (IVA) performance is at least a pointer to the number of active managers who struggle. Measured over 10 years, SPIVA says 85% of active global equity fund managers and 74% of active Australian equity fund managers fail to beat the index.

In fact, about half of all institutional share funds established do not survive longer than 15 years.

It’s a counter-intuitive result. Active managers need only pick a few winners and avoid a few losers, and they would perform better than the index.

No doubt, there are some special people with such a talent, but it's not easy to identify them among all the highly-qualified people who spend 12 hours a day sitting in their offices studying markets and stocks.

A recent report estimated there are almost 10,000 professional fund managers in the US. Rather than being poor investors, it’s more likely that most of them are good, making it difficult for anyone to outperform the market. After all, the market is simply the sum of all participants.

The problems with stock tips

Most stock tips from fund managers in the media or at conferences are buys, not sells. Relatively few investors short stocks (that is, sell stocks they do not own by borrowing them from a broker) and market analysis is buy-side dominated.

This ignores the fact that most listed companies will not survive in the long term. Amazingly, of the 2,300 companies currently listed on the ASX (which is 6% of all the companies ever listed), only 580 make a profit. Jason Orthman of Hyperion Asset Management told The Australian Financial Review on 25 January 2020 that Chief Investment Officer, Mark Arnold, thinks many companies are worthless:

"Mark thinks most small caps have zero intrinsic value in the long term as they don't have sustainable business models. This means they don't have sustainable earnings, which means the valuations will go down."

At conferences for retail investors, I always wonder what audience members achieve by filling pages with notes on share tips from stock-pickers on the stage. If people believe a fund manager has some special talent, attendees should simply invest in the relevant fund. Or do they plan to ring the company CEO for a private chat to check the numbers, or carry out more extensive research for additional clarifying insights?

Others watch business television, read daily newsletters or hear company gossip from mates. It’s easy to collect four or five great ideas every day. That’s 20 a week or 1,000 tips a year. How on earth is anyone supposed to filter all these bits of information?

Nikki Thomas, Portfolio Manager at Alphinity, told The Australian Financial Review on 12 January 2019: "I always told people who asked for a stock tip that unless they were prepared to ring me every week for the sell decision, a stock tip was worthless."

I once attended a conference where a high-profile fund manager recommended one stock from the thousands of listed companies available to him. Over the next six months, the stock fell heavily. When I next spoke to him, I asked him about it. "I was out of that months ago," he said.

One thing you can guarantee about fund manager stock tips. The person giving the tip already owns the stock and would like others to be convinced of its merits.

We all love stock stories but unless they form part of a regular update and rating process, including a sell signal, they are of dubious value.

What does Warren say?

The world’s most famous investor is Warren Buffet. Each year, he writes his famous letter to shareholders in his investment company, Berkshire Hathaway. He wrote this in 2013:

“Most investors, of course, have not made the study of business prospects a priority in their lives. If wise, they will conclude that they do not know enough about specific businesses to predict their future earning power. I have good news for these non-professionals: The typical investor doesn’t need this skill. In aggregate, American business has done wonderfully over time and will continue to do so (though, most assuredly, in unpredictable fits and starts). In the 20th Century, the Dow Jones Industrials index advanced from 66 to 11,497, paying a rising stream of dividends to boot. The 21st Century will witness further gains, almost certain to be substantial.

The goal of the non-professional should not be to pick winners – neither he nor his ‘helpers’ can do that – but should rather be to own a cross-section of businesses that in aggregate are bound to do well. A low-cost S&P 500 index fund will achieve this goal.”

So the good news is that investing is different from plumbing or dentistry. With some basic learning and understanding, most people can assemble an appropriate portfolio at little cost. A mix of inexpensive index funds across different asset types, supplemented by some active managers and quality direct shares, should perform well over time. Avoiding over-trading and sticking to a long-term strategy further minimises costs.    

Asset allocation matters most, not share selection

The second-largest fund manager in the world, Vanguard, estimates that 90% of the return from a portfolio comes from the mix of assets in a diversified portfolio, not the share selection. Even if someone has a special talent for picking shares, it matters little ultimately if the overall asset allocation between cash, property, bonds, domestic and global shares and other alternatives is inappropriate.

How do you construct a portfolio that meets your goals? That’s the subject for another day.

Of course, if you enjoy investing in shares, or you have skill and knowledge, or even if it’s just something to do in retirement, then go for it. It will help if you use detailed analysis from experienced researchers rather than going for a hot tip or rumour. Otherwise, pick some index funds or select a talented active fund manager if there is someone you especially admire. 

What will you do with all the extra time if you’re no longer pretending to be an expert stock-picker? You could follow Margaret Atwood’s advice and try something you've always wanted to do, such as brain surgery.

 

Graham Hand is Managing Editor of Firstlinks. This article is general information and does not consider the circumstances of any investor. Graham will be presenting on portfolio construction at the Australian Shareholders Association Conference in May 2020.

 

9 Comments
Wilbur
March 07, 2020

Great article as always, thanks Graham! Perhaps as there are more professional investors than before, there are no longer as many "easy wins" and markets become more efficient.

Lakshmi Krishnan
March 05, 2020

Graham's articles are priceless. What a great public service he does every week to all the investors. I don't have enough words to express my gratitude.
Thanks very much from the bottom of my heart.

Lakshmi

Graham
March 06, 2020

Thanks, Lakshmi, I'm honoured and humbled by your generous comment.

Ahjay
March 05, 2020

After some years of reasonable returns I started reading many investment books. John Bogle, The Little Book Of Common Sense Investing and Peter Thornhill, Motivated Money are the ones that changed things for me.
Such simplicity and my fair share of the market returns have set me up for a comfortable, worry free retirement. I am in my forth year of retirement, Have two years income in fixed interest and investment ready cash which I am investing on a monthly basis ending in fifteen months time. The current downturn, is good for me as I am still buying. I have a budget which caters well, for my "needs" with some left over for my "wants".

DougC
March 05, 2020

My wife and I have, together and separately, invested our savings over the past 25 years. Over the same time we also have Super/Pension accounts (managed by Fund Managers). There is little difference in the overall performance of the individual and managed investments over that timeframe, although neither of us had any background in finance or financial planning. On four occasions we have paid for financial advice. In one instance the advice simply reinforced the conclusions we had already reached and in three instances the advice was next to useless. If we have had any strategy it is simply to invest in products or commodities that sell sustainably and appear likely to continue to do so and choose a company that seems sound on the basis of established performance. It probably aligns with the Buffet advice and is closer to common sense (or just good luck) than to skill, expertise, training and analytics.

Jan
March 05, 2020

Graham: if, as you say "even the experts struggle" -- and there is no doubt they do, if you analyse their performance over time, then, in my opinion, your advice to invest in an index fund is not very sensible, especially given the fees. The individual investor can do quite, even very, well if they are prepared to study the subject, and do their own research. There are also many self-proclaimed "gurus" out there who charged dearly for their often trivial investment "advice". However, rather than wasting one's money on signing up to them, better to spend it on the many excellent books on investing that have been written over the years. Prior to the internet, the Melbourne Stock Exchange used to run free lunchtime lectures and had an excellent book shop. Now, there is no end of online resources, including the research available on the online broking sites, e.g. Commsec, Nabtrade, etc. And, of course, the company annual reports and their own websites are full of information. As for "tips": sometimes they are good and sometimes not. But, first it is essential to research the company to make one's own assessment before spending any money. Having said all this, of course, no one, not even the experts can be a winner all of the time. Along with the constant market volatility, come wins and losses. The goal, however, is to grow one's money over time, through a combination of capital growth and dividend income. As I learned many years ago at one ASX lunchtime lecture, never forget the power of compounding, It was an invaluable lesson.
i will finish with a little piece of humour. One financial guru says to the other:

"The economic forecast is difficult for an amateur to get right...but the professionals are reasonably confident that the markets will either go up or down in the long or short term."

Jeremy
March 05, 2020

Love the Buffett quote.
"I have good news for these non-professionals: The typical investor doesn’t need this skill. In aggregate, American business has done wonderfully over time and will continue to do so."

David
March 05, 2020

Great article Graham. I once knew an electrical engineer who did a weekend "course" that he claimed showed how to trade options with no risk........pity Buffet etc haven't heard of this course!

john
March 05, 2020

Great article


 

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