I know this might be hard to imagine for most of us golfers, but which of the following scenarios would you rather choose:
1. Shooting par every time you go out and play a round of golf.
2. Shooting below par 25% of the time you play and failing to reach par the remaining 75% of the time
It’s an easy decision, right?
The game of golf has many parallels to investing. A score of par is similar to a stock index. It is the base score everyone is trying to reach.
Continuously shooting par, similar to passive (index) investing, is what we do here at Rockbridge. We try to control costs, manage risk and get as much return as the markets allow. With index funds, you always get what you expect when it comes to returns and are left with no surprises. It’s much like going out and shooting par every time you golf. Basically, we help you avoid the double and triple bogeys that we are all too familiar with!
The other scenario is to strive for a score lower than par, which is similar to active investing. You incur additional costs – Wall Street “experts”– in an attempt to beat the return produced by an index. However, evidence shows that you will only be able to do so 25% of the time. The remaining 75% of the time you will underperform; and to make matters worse, you will underperform by a much bigger margin than you will ever outperform! This makes perfect sense. When active managers continuously strive for outperformance, they must take additional risks which lead to mistakes. No different than a golfer trying to make eagle on every hole. He will find himself shooting much worse with that constant added pressure!
The situation only gets worse with time as well. Just like shooting a score below par gets harder as we age, your chances of beating index returns goes down drastically when you look at longer time periods. Over extended periods of time, your probability of beating index returns falls into the single digits! Larry Swedroe, in a recent CBS News article, goes on to state that this value is lower than what we would expect by sheer chance! When most investors are saving for long-term goals, like retirement, those don’t seem like odds I would be willing to pay extra for!
So, if shooting consistent pars on the golf course sounds like the no-brainer choice, then why do so many people still engage in active management when it comes to investing? In golf, spending additional time/money to improve your game might pay off in a lower score, but unfortunately this does not hold true when it comes to investing. Control costs and shoot for par (index returns) and you will be much farther ahead in the long run. Sometimes it takes a simple analogy to help lead us to making wiser and more prudent life decisions!