Jan 14
Two Types of Investors
Michael Edesess, in his “The Big Investment Lie” book lays out another step when it comes to explaining the simple facts about investment performance.
Step 2: “Investors in the U.S. stock market are of two types: professionals who are paid to invest their clients’ money and everybody else.”
Before we take on investing professionals, one must recognize the high percentage of individuals who find investing to be of little interest. They do not want to be involved in the day to day business of money management. Instead, they are willing to pay a fee to have someone else manage their money. Second, we need to concede some money managers do a better job for their clients than other managers.
Here is the key question asked by Edesess. “Is it worth the extremely high cost to pay a professional money manager and perhaps a professional advisor to find her, when the probability that the manager will enable you to outperform a market index (before all fees and taxes!) is no better than 50-50 and no better than you could do yourself at negligible cost? The answer should be no.”
I would add a second question. Is it possible for a professional money manager to outperform a total market index fund by a percentage that is greater than the percentage uncertainty of the portfolio? For example, it is not unusual for a portfolio to carry an uncertainty value of 10% to 15%. How many money managers do you know who can consistently outperform a benchmark such as the VTSMX by 12% annually? I don’t know any.
Investing on your own will likely drive you to the “Portfolio for Dummies” and I need to revisit that portfolio. Before taking that detour, there is at least one exception to the No answer.
If the client is a socially responsible investor and they are seeking a manager who will put them in investments in keeping with their social requirements, then an advisor or money manager servers a particular purpose. If one builds a portfolio through the use of index funds, there are going to be “sin” stocks buried inside those funds. There is no way to avoid this completely.
Six months to a year ago I spent time with a long list of banned stocks and an array of ETFs. What I found is that 2.5% to 3% of a portfolio will be made up of those banned stocks. Note that different investors will come up with a different list of banned stocks. If one wants to reduce the percentage of “sin” stocks, it is possible to do so by eliminating the Large-Cap Value asset class as that is where most of these questionable stocks reside. At least that is what I found from the list of stocks I was analyzing. To populate the Large-Cap asset class would require the investor to find individual stocks to populate this particular asset class or just eliminate it entirely. I recommend finding the individual stocks.
Lowell Herr
Photograph: Waterford, VA
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January 15th, 2009 at 12:01 pm
Lowell,
What makes a stock “banned” or considered a “sin stock”?
Thanks,
Joel
January 15th, 2009 at 12:35 pm
Joel,
The definition of a “sin stock” varies with different investors or institutions. Companies that participate or manufacture products related to defense, tobacco, alcohol, and gambling are some of the first to be eliminated from the portfolio. The catholic church will eliminate companies that put out birth control products. For other investors, they see birth control as essential. That is why I say, it varies from investor to investor.
Many Chinese companies are eliminated due to treatment of workers. Human rights is difficult to monitor, but there is an organization, KDL, that will build custom screens for institutions so they know which companies to include and which to exclude from the portfolio. Only a very wealthy private investor would subscribe to such a service.
One of the negatives, and about the only one I can think of, for investing in ETFs has to do with socially responsible investing. As I mentioned before, when I ran an analysis on “sin stocks” held in ETFs, most were in the Large-Cap Value ETF. The other place I found a large concentration was in the Chinese ETF, FXI. This was one reason why I sold my FXI holdings.
Lowell