Don’t give up old investment standards to try new ideas

May 16, 2019 by admin

You missed out on hearing the smart people talking the latest in money-management at the Morningstar Investment Conference in Chicago last week, but you’re no worse off for staying away from the cutting edge in investment ideas.

That conclusion was unavoidable as I attended Morningstar’s three-day fund-fest in Chicago last week for the 21^st time since 1995.

For as much as the investment world has evolved over the last few decades, the overwhelming truth drawn from an event like this – where top experts talk about their latest, greatest ideas — is that average investors can achieve all of their financial goals without buying into anything new that promises to be different.

To see why that is, let’s answer the three burning questions individual investors would have had if they had come to the Morningstar conference.

“What if your mousetrap is good enough, and if the ‘better one’ you’re being offered might snap off your fingers or poison your pets?”

Every few years, the investment world comes up with some approach that purports to be better than simply buying and holding a well-diversified portfolio.

It’s the proverbial better mousetrap, and it ignores the idea that the old mousetraps work just fine for most people.

A few years ago at the conference, “alternative investments” were all the rage. Featuring either assets that represent something besides stocks, bonds or real estate or investment styles built to move forward in any/all market conditions, alternatives were supposed to be the next great way for investors to smooth out investing performance and feel better during downturns and slow times.

The problem was that most alternative funds posted mediocre to lousy performance – especially when the market was rising — and investors lost interest.

This year, it was easy to see a similar course shaping up for “factor investing,” where investors are pitched strategies that minimize volatility, maximize “quality” or focus on specific criteria.

Academic studies certainly make these approaches look smart, but there are a lot of questions to be answered on how well these strategies work.

Moreover, investors buy funds like these in order to get a certain type of performance – a move upward with less volatility, for example – but then abandon ship if the specialized investment can’t keep pace in all market conditions.

The result is that investors flail around from one strategy to the next, hurting their results rather than enhancing them.

At Morningstar, I talked with a number of financial advisers who believe in the new strategies, but who recognize that they have to sell these ideas to clients who are most comfortable with a classic buy-and-hold plan.

They should skip the sales pitch.

When investors move out of their comfort zones, overall performance tends to suffer; make these moves with appropriate caution and care.

“What if ‘new and improved’ is just ‘new,’ and if achieving improvement requires you to react to unpredictable events in an orderly and predictable fashion?”

Few people read the instruction manual – the prospectus – that comes with their funds. As a result, there’s a real question of whether they will invest with good intentions but short-circuit their own plans due to poor self-control.

Consider, for example, low-volatility funds, which generally are designed to suffer only 50 percent of any stock market decline, while capturing 80 to 90 percent of any gain.

For someone worried about volatility, it’s a sensible option.

But studies and empirical data show that investors routinely bail out of investments once losses reach 15 percent.

So say that the market were to fall by 30 percent, and the low-vol fund does its job and loses half that amount.

If that loss triggers an investor’s flight mechanism, they are out of the fund, even though the fund did its job and protected them from a much larger decline.

Had they just held a standard mutual fund, their flight mechanism would have been triggered sooner, but their loss would have been the same 15 percent because that was their get-out point.

Meanwhile, the low-vol fund did not capture all of the market’s upside, while the standard fund did.

In other words, it’s entirely possible for the low-volatility fund to do its jobs, but for investors to still be better off without them simply because their own impulses negate most or all of the benefits.

“Many of these new strategies are about ways to mitigate risk, but the investors would be better off sticking with traditional investments if they understand the risks they’re taking,” said Karl Mills of Jurika, Mills & Kiefer in San Francisco. “These new fund types encourage you to be very sensitive and aware of short-term happenings when your time horizons are long. … Most people would be better off accepting the risk, but developing the patience to stick with their long-term plans.”

“Why is ‘simplification’ never simple?”

The fund industry has developed tremendous one-size-fits-all products like life-cycle and target-date funds, where investors get an appropriate allocation based on age and perceived ability to accept risk.

They’re an appropriate default choice for people who don’t know what to go with, but they’re also an acceptable portfolio for anyone who wants to spend their time focused on something other than building and managing investments.

The problem is that financial advisers and money managers don’t really earn their fees telling clients to use these basic choices, and to fund them as hard as possible.

Stuffing them with savings is the best way for average investors to meet goals, but not the best way for advisers to earn their keep.

As a result, every great and better idea that purports to give consumers “more control” and a simple way to take charge is likely to move the investor from simplicity toward complexity.

Yes, complex portfolio permutations can work; experts showed it repeatedly at Morningstar’s conference.

But investors can get by with more blunt instruments, with less active strategies and by sticking to their guns rather than changing what they use every time the industry introduces new weaponry.

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Chuck Jaffe is a nationally syndicated financial columnist and the host of “MoneyLife with Chuck Jaffe.” You can reach him at itschuckjaffe@gmail.com and tune in at moneylifeshow.com.