8th December 2021 - Sean Banks

Investing: Fact vs Fiction

The world of investing can be a traitorous place. It’s rife with its own language and jargon developed over decades by sales and marketing people to make it too confusing for the average person to understand. Even as professional advisers, it can be difficult to keep up with new words and phrases in an ever-changing environment.

Active vs Passive Investing

For inexperienced investors researching their options, it is easy to fall into the labyrinth of investment ‘strategies’, ‘approaches’ and ‘philosophies’. With proponents of each declaring theirs to be the best and only way. You will most likely come across as many advocates of low-cost, passive investing achieved by tracking a market index, as those who claim to be able to ‘beat the market’ with their active approach to selecting individual stocks (one assumes, by using computer algorithms able to see into the future).

But what does the evidence tell us? That, sadly, is a question asked all to infrequently in a world of ‘what’s working now’. Fortunately, there are some brave souls among us willing to push the envelope in search of a better investment experience, based on empirical, indisputable evidence.

At Herbert Scott, we have a core investment philosophy based on these principles with the aim of delivering positive outcomes for our clients. We are not interested in the ‘latest hot stocks’ or ‘best investment picks for tomorrow’ and refuse to be drawn into the debate on active vs passive investing. We are only interested in what the evidence tells us is the smartest way for our clients to invest their money, so they may spend less time worrying about markets and more time living their best lives.

Why evidence matters

Today, there are more equity funds in operation than there are stocks for them to invest in. I will repeat that again for it to really sink in. More funds available than individual stocks. A lot of them sold to investors on the premise of outperformance and, ultimately, most likely doomed to failure.

Research from Dimensional Fund Advisors shows that in the 20 years up to 31st December 2019, of all US equity funds available at the beginning of the period, only 41% survived while just 22% outperformed their benchmark.

So, less than half of these funds were still available 20 years later. And less than a quarter achieved what they had initially promised investors. Yikes. As a long-term investor in these funds, you are being asked to risk your life savings in something that has a 59% chance of complete failure and a 78% probability of underperformance. And you had to know in advance? I’d sooner take my chances on Squid Game!

Making sense of the noise

Investing doesn’t have to be a guessing game. By researching and understanding the evidence, we choose to take luck out of the equation. By doing so, we can ensure our clients’ financial plans a) aren’t built on sand and b) their chances of success are based on more than the whim of a stock picker. When the evidence is stacked in your favour, you can’t help but make wise choices with your invested wealth.

You should have a strategic asset allocation that assumes you don’t know what the future is going to hold.’ – Ray Dalio

The first step is understanding the fundamentals of portfolio construction. As we have seen, trying to predict which funds will provide the returns we seek ahead of time is a real shot in the dark. Active fund management is closer to fortune-telling than it is to science.

Ultimately, having the right blend of investments within your portfolio will be the key determinant of its performance over your lifetime. Why bother with the added cost and risk involved in hiring an active fund manager who won’t consistently outperform the market you’re investing in? You don’t need a city skyscraper to make intelligent investment decisions.

Managing risk

Diversification is, no doubt, another box ticked on your financial services lingo-bingo card. Diversification is managing the risk of your portfolio by not having all your eggs in one basket. By spreading your investments widely, you benefit from long-term market trends and protect your portfolio against the risk of steep single-market declines.

The evidence again tells us that small companies outperform large companies over the long term. Small companies carry higher investment risk than large, stable companies. While bonds with a short duration and high credit rating give you better protection than lower-rated bonds (although typically, with a lower return). We include a tilt to smaller companies in our growth engine and highly rated, short-term bonds as our defence mechanism. Simple, not easy.

The cost of ignoring costs

Charges are an unavoidable part of investing. They have a habit of eating away at your returns and can have a major impact on your long-term financial outlook. Here’s a brief hypothetical to illustrate the impact of a 1% difference in fees, over time.

Lucy, aged 28, invested a £100,000 inheritance into a fund with an annual charge of 0.3%. Her twin brother, Peter, also received £100,000 and invested his inheritance into a fund with a 1.3% annual charge. Both funds achieve an investment return of 6% a year. After 30 years, Lucy ends up with £143,000 more than Peter.

Same returns, yet a huge difference in the eventual outcome. We believe these numbers speak for themselves and highlight the compounding effect lower charges have over time.

Controlling emotions

Investing our lifelong wealth can be a constant battle of fear, greed, and the emotional attachment we attribute towards gains and losses. These emotions often lead us to make poor choices in times of market turbulence. Investors, clouded by uncertainty and swept up in the 24/7 news cycle are prone to ‘panic-selling’ their investments after markets fall. Only to then buy back in once the market has recovered and things appear more stable. As Carl Richards, author of The Behavior Gap would say… repeat until broke!

At Herbert Scott we believe a disciplined, systematic, and easy to understand investment process is key to one’s success as an investor. By having a meaningful financial plan and sticking with this, it becomes easier to keep your eyes on the longer-term prize when markets get scary.

Measuring Success

The Herbert Scott way of investing places our financial planners as experienced guides in an unpredictable landscape. As opposed to performance prophets in suits. With a true understanding of how markets behave in the long run based on solid evidence and research, coupled with a real appreciation for where our clients want to be in life, we can make confident decisions to maximise our clients’ chances of success.

Do you want to know more?

Why not contact us to discover more about Herbert Scott’s investment philosophy. Let’s see how it could work for you and your family.

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