April 4, 2010
Control the Controllable, Ignore the Rest
Like most things in life, the simple approach to doing something almost always tends to be the best. This theory holds true when it comes to investing and is one of the cornerstones behind our investment philosophy.
“Gross return in the financial markets, minus the cost of financial intermediation, equals the net return actually delivered to investors.”
– John Bogle
At Rockbridge Investment Management, we feel that one of the main culprits of investment under performance is the cost associated with investing. It is because of this that we construct all investment portfolios using passively managed index funds, which are a fraction of the cost when compared to their actively managed counterparts.
Numerous studies have shown that only about 20% of active portfolio managers will outperform their respective portfolio benchmarks over a 20- or 30-year time period. This is not due to lack of intelligence by these money managers, but rather to the efficiency of capital markets.
To quote John Bogle again, investing “is a zero sum game before costs and a loser’s game after costs.” If a money manager charges a 1.5% fee, then he automatically must outperform the market by at least that before the investor sees any benefit. Since active management is run by individuals, this now adds another layer of risk to your portfolio. Human beings have a tendency of letting emotions dictate their investment decisions, and if they are already starting below market returns (-1.5%), then there might be the inclination to take on some unnecessary risk to make up for their high fees.
Below is a graph that shows how the additional costs of active management can greatly affect an investment portfolio. The graph portrays the difference an additional cost of 1% can have on a $350,000 portfolio earning an 8% real rate of return over a 30-year time horizon.
It is critical for any investor to control the factors that can be controlled, like costs, asset allocation and risk, while ignoring the rest. Contrary to what many people believe, proper investing should be simple and about taking calculated risks that will reward investors over time.
In conclusion, I would advise any investor to go out and enjoy their hobbies, channeling their emotions into their daily living, while leaving their simplified and disciplined investment portfolio to make them financially secure during retirement.