Podcast Episode 28 – Active vs. Passive Investing Example From 2000-2010

If someone told you he was able to get his clients 18.7% a year over the last 20 years would you give him your money to manage?

I hope not! As in this video I show you how people use, “misuse?”, investment models as a way to show their investment performance.

The problem with models is EVERYONE and their mom has a model they can backtest to “prove” anything. As someone once said, if you torture the data enough it will confess to anything.

So tell me…how is YOUR investment model going to generate positive alpha over ALL the other models, algorithms, PhDs, AI, etc.? You think you’ve found the magic solution that NOONE else can exploit?

What happens with investment models is that when they work for a bit they generate excess cash flows. And thus the model loses its ability for future outperformance. And many a money manager is left on the streets without shoes wondering what went wrong. “it always worked before,” they’ll say.

Yup, always does. Until it doesn’t. Just hope you weren’t leveraged when the markets caught up to you, as it certainly will.

Models also never take taxes into consideration. For instance, the guy I hammer in this video he simply says the way to generate excess return is to get out before the markets drop and back in before they go up.

Whoa! Who knew??? But even if you were able to do that, what’s the tax consequence of all that selling?


Yeah, I’m cynical. Been around too long not to be.

Hopefully, my cynicism can rub out on you too so you can protect you assets.

What’s the best way to get good returns??? Shhh…don’t tell this to anyone.

It’s to stay in the market, good times AND bad. Historically, the good times have outweighed the bad and thus you made money. Will that continue? Anyone’s guess.

But the alternative is what??? A 2.84% 10 Year Treasury bond. Oh, and that’s BEFORE tax and inflation. Not going to make much return there.

n this episode I break out an article I saved from the Journal of Indexes May/June 2011 edition.
The article is written by Richard Ferri who wrote the book “The Power Of Passive Investing: More Wealth With Less Work” with a forward by John Bogle.

I had never heard of Richard previously but if Bogle is writing his forward well, this may be a guy who has something to say. And sure enough he does.

In his article he takes 3 different investors. One is a market timer, one simply buys and holds and the last is a buy and hold BUT with annual rebalancing.

All three have the EXACT same portfolio but just have different strategies on how to invest. Who do you think outperforms during the 2000-2010 time frame?

The third investor. That investor beat the market timer by 135% and the buy and hold investor by 38%.

But wait, I thought active managers are supposed to do better in down markets and you can’t get much more down than that decade. At least that’s what we’ve been told all these years. Yet, it didn’t happen during this time period.

Can active managers outperform? Absolutely. But one must remember where their excess returns come from. “Tactical asset allocation is a zero-sum game. When someone underperforms the market it means someone MUST have outperformed..before fees and expenses.”(emphasis mine.)

Investors who lose with their tactical asset allocation strategies indirectly provide excess returns to investors who religiously rebalance their strategic allocation. This occurs because rebalancing naturally forces investors to sell some amount of their better-performing investments and buy more of their worse-performing ones.  Although it seems counter-intuitive to do this, rebalancing increases portfolio returns and lowers risk.

Remember, folks. Investing is not trying to beat the market.  Because inherently only a few people CAN do that after fees are factored in.  And unfortunately we do not know who those few people will be in advance, only after the fact.

But more importantly investing is actually hoping the COMPANY we invest in improves its financial situation by growing more, cutting costs, increasing revenue, increasing profits etc.

A company which does that will reward its investors with a higher share price. Active trading has absolutely NOTHING to do with that company’s financial health.  Active trading is literally a gamble that costs a lot of money.

Real investing is the farthest thing from that.

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