Money Saver magazine claims in the Sept issue to 'prove' that the 'buy-and-hold' strategy outperforms. It does not specify what exactly is outperforms, but the counterpart of buy-and-hold is active management that involves market-timing of both the asset mix and the individual holdings.
Like many MoneySaver articles it sets out to prove a predetermined point, and does not care how it does so. The points I give below are simple common sense. The editor's choice to publish the article strengthens my long-time position that beginner investors should NOT take their information from this publication.
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The overall error made was to confuse the 'buy-and-hold vs active' issue with two other issues; 1) indexes vs active mutual funds and 2) buy-and-hold stock portfolios vs indexes. Most of the article in fact focuses on the third issue. Factors from the second issue were used to distort the conclusions regarding the first issue purportedly being discussed.
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The author chose the performance results from US actively managed mutual funds to represent the 'active' side of the issue. This is not a valid representation with the following problems.
1) The fund results used were net of the (say) 2% management fees (that do not include transaction costs). While management fees are a factor in the "indexes vs active mutual funds" issue, they must be removed from an analysis of the investing process only.
2) Funds do not represent active portfolio management because of the constraints on their managers. Most do not allow short-selling, or hedging currency exposure with derivatives (or anything else), or even cashing out during market down-drafts. These disallowed behaviours are a huge part of 'active' management.
3) Fund managers must contend with cash in/outflows that are reported to happen at the worst possible times. E.g. investors pile out of funds AFTER poor returns, just when the manager's luck is about to turn.
You can make the argument that this investor behavior itself proves that active timing of the markets does not work. But that is not a totally valid presumption. The MF investor is working once-removed from the market. They respond to the manger's performance which they expect to protect them from losses. The issue supposedly being discussed in the article is not investors' success in picking managers, but the managers' success in investing.
4) The data presented on MF returns only compares 5-year returns for US funds vs the index return. The data should have removed the 2% management fees. It should have covered the same time period as the other analysis (14.5 years) and it should have documented Canadian funds.
GlobeInvest has a mutual fund page called "15-year results". It does not take long to look up the 15 yr returns of all the surviving funds. I agree this result has a lot of survivor bias in it ... but so does the author's analysis of stock portfolio returns.
5) When the 2% management fees are added back to the funds' 15-yr returns, it turns out that 35 of the 55 funds OUTPERFORM the index (64%). The conclusion they reached was wrong. Active management outperforms.
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The author represents the 'buy-and-hold' side of the issue with both the passive TSX index and also with a portfolio of individual stock bought 14.5 years ago and held non-stop.
1) He made a choice to present the returns in the form of 'cumulative % growth over the entire period', instead of annualized yearly returns. This is a common ploy when trying to impress the reader with how HUGE a difference results from even a small difference in yearly returns. Unfortunately the metric is meaningless except in comparison.
2) If his results are converted into annualized returns they show the index earning only 6.1% over the 14.5 years. That number should seem VERY low to people and would have set off alarm bells in the readers (but of course the number was not published). In fact the index's total return was about 8.5%, a number that can be verified in many places.
3) So his data is incorrect. If he erred in the index's data, which is easy to come by and calculate, it can only be presumed that his data for the individual stocks within his portfolio are also wrong.
He claims that his portfolio returned 14.2% yearly. Does that seem at all possible to you? Of course all the reader was presented with was the 586.6% cumultive return, which is meaningless. So no alarm bells went off.
4) Lastly there is the issue of the author's supposedly 'random' choice of stocks to put into his buy-and-hold portfolio. He starts with the CURRENT list of DJ40 Titans, not the Big40 in existence 14 years ago.
Big companies do not get that way without better than average growth. They are by definition the survivors who has a successful past performance. The author is using perfect hind-sight to choose the winners.
He augments the survivor bias by ignoring the 15 (of 40) stocks not yet in existence 14 years ago. That proportion (more than 1/3) confirms the author's error in presuming that today's Big40 are the same as the Big40 14 years ago.
Like many MoneySaver articles it sets out to prove a predetermined point, and does not care how it does so. The points I give below are simple common sense. The editor's choice to publish the article strengthens my long-time position that beginner investors should NOT take their information from this publication.
---------------------
The overall error made was to confuse the 'buy-and-hold vs active' issue with two other issues; 1) indexes vs active mutual funds and 2) buy-and-hold stock portfolios vs indexes. Most of the article in fact focuses on the third issue. Factors from the second issue were used to distort the conclusions regarding the first issue purportedly being discussed.
--------------------
The author chose the performance results from US actively managed mutual funds to represent the 'active' side of the issue. This is not a valid representation with the following problems.
1) The fund results used were net of the (say) 2% management fees (that do not include transaction costs). While management fees are a factor in the "indexes vs active mutual funds" issue, they must be removed from an analysis of the investing process only.
2) Funds do not represent active portfolio management because of the constraints on their managers. Most do not allow short-selling, or hedging currency exposure with derivatives (or anything else), or even cashing out during market down-drafts. These disallowed behaviours are a huge part of 'active' management.
3) Fund managers must contend with cash in/outflows that are reported to happen at the worst possible times. E.g. investors pile out of funds AFTER poor returns, just when the manager's luck is about to turn.
You can make the argument that this investor behavior itself proves that active timing of the markets does not work. But that is not a totally valid presumption. The MF investor is working once-removed from the market. They respond to the manger's performance which they expect to protect them from losses. The issue supposedly being discussed in the article is not investors' success in picking managers, but the managers' success in investing.
4) The data presented on MF returns only compares 5-year returns for US funds vs the index return. The data should have removed the 2% management fees. It should have covered the same time period as the other analysis (14.5 years) and it should have documented Canadian funds.
GlobeInvest has a mutual fund page called "15-year results". It does not take long to look up the 15 yr returns of all the surviving funds. I agree this result has a lot of survivor bias in it ... but so does the author's analysis of stock portfolio returns.
5) When the 2% management fees are added back to the funds' 15-yr returns, it turns out that 35 of the 55 funds OUTPERFORM the index (64%). The conclusion they reached was wrong. Active management outperforms.
-------------------------------
The author represents the 'buy-and-hold' side of the issue with both the passive TSX index and also with a portfolio of individual stock bought 14.5 years ago and held non-stop.
1) He made a choice to present the returns in the form of 'cumulative % growth over the entire period', instead of annualized yearly returns. This is a common ploy when trying to impress the reader with how HUGE a difference results from even a small difference in yearly returns. Unfortunately the metric is meaningless except in comparison.
2) If his results are converted into annualized returns they show the index earning only 6.1% over the 14.5 years. That number should seem VERY low to people and would have set off alarm bells in the readers (but of course the number was not published). In fact the index's total return was about 8.5%, a number that can be verified in many places.
3) So his data is incorrect. If he erred in the index's data, which is easy to come by and calculate, it can only be presumed that his data for the individual stocks within his portfolio are also wrong.
He claims that his portfolio returned 14.2% yearly. Does that seem at all possible to you? Of course all the reader was presented with was the 586.6% cumultive return, which is meaningless. So no alarm bells went off.
4) Lastly there is the issue of the author's supposedly 'random' choice of stocks to put into his buy-and-hold portfolio. He starts with the CURRENT list of DJ40 Titans, not the Big40 in existence 14 years ago.
Big companies do not get that way without better than average growth. They are by definition the survivors who has a successful past performance. The author is using perfect hind-sight to choose the winners.
He augments the survivor bias by ignoring the 15 (of 40) stocks not yet in existence 14 years ago. That proportion (more than 1/3) confirms the author's error in presuming that today's Big40 are the same as the Big40 14 years ago.
