Not too long ago, I was wondering on the internet, going from one blog to another until I get to this very interesting article telling me that I can’t beat the market… that nobody can: Why I can’t pick winning stocks, and you can’t either by Mr. Collins. While the article is dated 2011, the author makes some valid points. Academic studies across ages prove that you can’t beat the house. Still, I’m standing with my flag in the air claiming my righteous right to fail beat the market. If you are reading my blog, you and I are probably part of the same army. Can you beat the market? And is it that relevant to beat it?
A few points from Mr. Collins’ article to start with
Collin’s article is very interesting as it highlights the main reason why you could not technically beat the street as an individual (and SMALL) investor.
First, where do you come from? Do you think you can beat CFA’s and MBA’s at their game? Chances are that most DIY investors are not coming from a financial background. Therefore, how could this be possible to invest better than a team of well-trained CFA’s? That totally makes sense; I wouldn’t try to be a better mechanic than a professional garage either.
Second, predicting the market is impossible. I totally agree with him on this point. He discusses a funny story about how a company goes back and down in their job ladder to make-up sales guidance that would make sense for them and for investors as well. In the end, if a company can’t really predict their own sales, how could you possibly analyze the business and make your own assumptions and predict where the stock is heading?
Third, if pro’s can’t beat the market (most of the time), how could you? When you think about it, professional fund managers have a hard time beating the market. They have all the money and the manpower in the world to cover any companies. They are so plugged in some companies that they know everybody there from the CEO down to the receptionist. Yet, they can’t find a way to predict the future, how could you?
Why pro’s have a hard time to beat the street
You can pull out pretty much any research about active vs passive investments and most of them will tell you that most portfolio managers are… well…. Human! CNBC claims in a recent article that over 90% of portfolio managers don’t beat their benchmark over a 15 year period (including a full economic cycle).
“But the latest report on active management performance, in the closely watched SPIVA U.S. Scorecard from S&P, paints an even bleaker picture over the long term.
For the first time, the scorecard tracked 15-year performance to capture what it considers a “complete market cycle.”
In that period, 92.2 percent of large-cap managers missed their marks, while the number was 95.4 percent for mid-caps and 93.2 percent for small-caps. It’s probably no wonder, then, that more than 58 percent of U.S. equity funds either folded or merged during the 15-year time frame.”
I will not argue with facts here; portfolio managers don’t do their job… or do they? Most shocking articles telling you how you should sell everything you have in your portfolio and put it in an index fund often miss several obvious points. Here are the real reasons why pro’s can beat the market, but can’t make it happen for you:
First, there are fees. I know, this is the obvious reason, but trust me; it’s not the only one. Still, asking a guy you pay 2% (from the money invested) to beat the market is like asking Usain Bolt to win a 100m race, but he must start 2 meters behind everybody else. Chances are that he will lose even if he is the best sprinter in the world.
Second, the size of the fund. You are comfortably sitting by the window with a coffee in hand and you finish your thoughts about buying Apple (AAPL) as it is a wonderful company (really, it is). You place your order, click the “confirm” button and then, BAM! You just purchase 100 shares of AAPL at $157.50 each for a total volume transaction of $15.75K. Now, imagine if you had to purchase 834,854 shares of AAPL for $131.5M total volume transaction. This is a relatively small amount for the largest mutual funds. in fact, this is just one of the transactions Berkshire Hathaway Inc. (BRK.B) did over the latest quarter. But you can imagine that moving larger sums of money like this make it harder to beat the market.
Third, the index obsession. Many fund managers are required to almost replicate an index and then beat it. The logic from a sales perspective is simple; when the market goes down and you go down, nobody is going to blame you. Same thing when you go up along the rest of investors. What hurts mutual fund sales is when you go down when the market goes up. Therefore, many funds are required to follow an index (e.g. having a similar asset allocation) and then, beat it through superior stock picking skills (minus the fees and minus the large amount to trade).
Fourth, portfolio managers are humans. We rarely discuss this matter in the financial world where everybody should be efficient and trade without bias, but this is BS. How do you think most portfolio managers handled the last crisis in 2008? Most of them traded “not to lose more money” instead of following their course of action. They wanted to keep their job and the best way to do it was to finish at -20% where others were at -25%. Then, it doesn’t matter if they lag during the recovery of 2009, they were heroes who saved money to investors last year. The others got fired and the “safe guy” kept his job. However, the only way to make a solid investment return is to keep being invested and stick to your plan.
Unfortunately, the industry has been built in a way that most portfolio managers can beat the market, but won’t do it for the shareholders. However, you can now see that you weren’t that dumb to think you beat the market… it is probably easier for smaller investors to do it than for professionals!
Where am I standing over the past 5 years?
After reading Collins’ article, I thought; “oh… it’s been a while I didn’t check my own performance!.” I seldom do spot checks on my performance from time to time, but I thought it was a good opportunity to look at the past 5 years. I took this period because my broker gives me the numbers with all the calculations, not because it gives me an edge in the comparison game. For the past 5 years, I show a total annualized return of 12.80%. This return includes dividend payment and also convert my USD investments into CAD. Therefore, depending on the timing I look at my return, it may be greatly influenced. For example, you can imagine how my return was better in May, before the Bank of Canada increased their rate!
Unfortunately, comparing my return with indexes isn’t easy. Depending on the time I invest over the past 5 years, my geographic asset allocation changed from about 40%-60% (CDN-US) to 25%-75% now (including my latest trade of selling a Canadian company (SNC.TO) to buy a U.S. company (AMZN)). For the time being, I’ve used a 35%-65% comparison. I also calculated an exchange rate of 27.95% as follow:
However, it is obvious I didn’t put all my money in 2013 and enjoyed a nearly +30% ride on my US money. In fact, over the past 5 years, I’ve added $12,000 in contribution and $8,000 was added through dividend payments. This portfolio worth about $70,000 CAD today, $20K of it (28.5%) was added at various exchange rates during that time. Nonetheless, I rather pick the worst exchange rate (higher value of CAD) for my comparison with the markets.
So here are the results after 5 years (source Ycharts):
XDV: 7.71% CAGR
VIG: 11.90% CAGR, in CAD = 14.47%
SP 500: 14.07% CAGR, in CAD = 16.99%
TSX: 4.80% CAGR
If I use the combination of 35% CAD and 65% USD, I get total annualized returned of:
ETF Benchmark: 12.10%
Stock Market: 12.72%
My portfolio: 12.80%
Yeah! I win both against the dividend ETFs and against the market in general. Plus, if I use a currency exchange movement of 20% instead of 27.95% (which would be closer to the reality), the ETF benchmarks show 10.87% and the markets 12.20%.
It’s obviously not an incredible win, but still, it shows that it’s worth it for me to manage my own money instead of buying ETFs. I must also consider that I was building my portfolio during this period and most of my successful holdings weren’t even there back in 2012 (my portfolio worth about $27,700 back then). Therefore, I expect my return in the next 5 years a lot better compared to the index if I continue to post such performance.
Here’s my secret recipe
Now, I think the reason I beat the market over the past 5 years is related to two factors.
#1 I’ve built a solid investing strategy (read my 7 dividend growth investing rules).
#2 I never moved away from my strategy
While I think it is very important to have a solid investing process to pick the right companies, it’s even more important to not go from one strategy to another or try to time the market thinking a crash is imminent (thinking of any moment in particular?). This is the real secret of a successful investors.
This recipe has been applied to all Dividend Stocks Rock portfolios. Here’s my latest performance as at August 17th 2017:
In the end is it that relevant to beat the market? Hum…. Hell YEAH!
Some will tell you that it’s not relevant as long as you meet your financial goals. I partly agree with this statement. It is true the most important thing about your investment is to reach your goal. It doesn’t matter if you invest your money in CD’s paying 1.50% if in the end, you retire wealthy due to their high saving capacity or if your invest in penny stocks making 200% return each year (ok…I doubt you can achieve this). In the end, what matters is to reach your financial goal.
However, if you spend lots of time on your portfolio, this must be rewarded by something. I personally manage my portfolio as I really enjoy it. This is a hobby where I’m getting paid to have fun. Now that I have my own investing membership, I’m actually living to manage my portfolio and research the market. That’s the perfect life for me! However, my past 5 years would have shown a 8-9% annualized returned, I would have been better off investing my money in a few ETFs. All the time and energy wasted to not even meet markets’ return… this doesn’t make sense to me. It’s like doing repairs on my car and eventually having to hand it over to the garage to repair what I did.
Readers, do you track your returns? Are you satisfied with them?