In his latest column in Report on Business, sleuth investor Avner Mandelman asks DIY investors: “you don’t wear suits you sewed yourself, or shoes you cobbled yourself, or feed your family bread you baked yourself, so why would you try to invest your family’s assets by yourself?” and somewhat self-servingly suggests hiring a professional:
So once again, how much of your investing should you do yourself? I had better step carefully here because it would sound self-serving - I am, after all, in the biz of managing OPM (other people’s money) - but I’ll say it plain: Just as you occasionally can bake your own bread for fun but would not think of doing it on a regular basis (not if you want to have time for work), so you should not think of investing all your funds yourself.
Let’s assume you can earn 2 to 3 per cent a year better than the pros, long term. It is very difficult, but let’s assume. On a $100,000 investment, that’s $2,000 to $3,000 a year. For the same amount of time you put in, couldn’t you make more in your own business?
While you can easily counter that with – you brush your own teeth, take out your own garbage or pay your own bills, so why not invest your own money – there is an excellent reason: the consistent failure of professional money management in providing market beating returns to retail investors. A 2000 paper titled How well have taxable investors been served in the 1980s and 1990s? shows the magnitude of this failure – over the ten-year period ending in 1998, only 14% of mutual funds outperformed the Vanguard 500 before taxes. Only 5% outperformed over fifteen years and a more respectable 22% beat the index fund over twenty years. These figures do not reflect survivorship bias.
Canadian fans of active funds contend that the U.S. market is “more efficient” and the Canadian experience is different (without any studies to back their claim). The S&P Indices versus Active Fund Scorecard (SPIVA) record shows how flimsy the claim is: the percentage of mutual funds beating the TSX Composite index over a 5-year period was 42% in 2004, 31% in 2005, 11% in 2006 and 8.5% in 2007. The early record looks better than it actually is due to the massive weighting of Nortel. Compared to the TSX Capped Composite index (which an investor can easily track using XIC) the record over the same time periods is 23%, 26%, 10% and 8.5% respectively.
A more apt question a DIY investor could ask a professional money manager would be: if I visited my barber, asked for a haircut and came away with a shaved head and lost my shirt in the process and paid for the privilege nonetheless, why wouldn’t I cut my own hair?
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31 responses so far ↓
1 Jon D. // Jul 22, 2008 at 10:45 pm
Same argument is used for real estate agents to protect their ridiculous commissions. Those stupid TV commercials really boil my blood….
2 Jim Somerville // Jul 22, 2008 at 10:47 pm
I completely agree with you. Why use fund managers that can’t do better than you in your sleep (ie. index funds)? I also like your haircut example…..not only is your head shaved, it is nicked and bleeding….lol.
3 Chuck // Jul 22, 2008 at 11:14 pm
I love how these salespeople put forth these arguements about hiring a specialist.
In context, Avner is trying to appeal to business owners, by telling them that if they let him do the 2 hours per week of investing that they do, then they could use the time to generate more than enough money in their business to justify his fees.
Though I understand the reasoning behind his arguement, the average person is not a small business owner who faces significant economic opportunity costs associated with his time allocation.
CC, you’re making me think everyone should use your sleepy portfolio.
4 Dillon // Jul 23, 2008 at 12:38 am
“Let’s assume you can earn 2 to 3 per cent a year better than the pros, long term. It is very difficult, but let’s assume. On a $100,000 investment, that’s $2,000 to $3,000 a year. For the same amount of time you put in, couldn’t you make more in your own business?”
Well,
1) I don’t have to beat the pros by 2-3% a year. All investors as a group must necessarily earn precisely the market return, by definition. By investing on my own with an indexing strategy, designed to earn the market return while minimizing costs, I am virtually guaranteed to beat the average managed mutual fund over a reasonable time horizon. This is because my costs will be lower.
2) Saving even 1% a year on management fees and expenses is huge, due to the nature of compound interest and the long investment horizons involved. $10,000 compounded at 5% over 30 years will grow to $43,200. If you increase that return to 6%, the sum after 30 years is $57,400, or about 33% more at the end of 30 years.
3) The time it takes to invest on your own is minimal if you are pursuing a strategy of just trying to match market returns. No market timing, no stock picking, just identifying appropriate ETF’s or index mutual funds and buying them when you have money available.
DIY investing isn’t for everybody, but for those with the interest and the aptitude to do so, it’s certainly worth doing.
5 NN // Jul 23, 2008 at 12:42 am
I am not surprised that an asset manager is encouraging people to use the services of an asset managers. However, I am surprised that the article was written with such a shallow intellectual appeal - this man takes his readers for fools.
6 Michael James // Jul 23, 2008 at 3:14 am
I couldn’t agree with you more. I liked the following quote: “Let’s assume you can earn 2 to 3 per cent a year better than the pros, long term. It is very difficult, but let’s assume.” In fact, you can beat the pros by just buying a low-cost index fund and going to sleep for a decade or two. This isn’t very difficult, despite what Avner Mandelman says.
7 Four Pillars // Jul 23, 2008 at 8:28 am
What an idiot - I’m not going to read his column anymore.
Passive investing takes almost no time so his argument about “time” isn’t that relevant.
8 Al // Jul 23, 2008 at 8:58 am
What’s Mandelman talking about? It doesn’t take me that long to throw my darts at the financials page. He also fails to mention all the financial managers that got their clients in ABCP or loaded up on tech stocks before the crash. They’re not just costly due to fees, but can be dangerous as well.
Why do I invest myself? The same reason I rotate my own tires, fix my own plumbing and paint my own walls. Because I can, it’s cheaper than hiring someone, and I enjoy it (less so the painting).
9 Andrew Baechler // Jul 23, 2008 at 10:14 am
Full disclosure before I comment. I am an investment advisor with a fee based firm. On the equity side, we invest exclusively through ETFs and DFA (Dimensional) funds.
I agree with the points made above, but there is one significant point that is being overlooked and that is emotional discipline. Many of the Dalbar studies have concluded that not only do the vast majority of mutual funds underperform their benchmark index; the vast majority of investors underperform the mutual funds in which they invest. The chief reason for this is performance chasing. Buying into funds or sectors when they’re hot and selling out when they’re cold. A do-it-yourself investor who uses ETFs can still fall prey to this mistake.
Dr. William Bernstein, who was once a strong advocate for do-it-yourself investing, wrote an excellent piece about the four aptitudes he believes someone must possess in order to be a competent investor.
The article is available here: http://www.efficientfrontier.com/ef/103/probable.htm
10 Canadian Capitalist // Jul 23, 2008 at 11:13 am
Andrew: It is clear that emotions (through performance chasing or panic selling) are clearly more costly than expenses as the DALBAR study and time weighted studies on mutual fund returns show. But I’m not so sure that the average advisor is any better at controlling their emotions than the average investor.
11 torbjorn rive // Jul 23, 2008 at 11:32 am
what a gooney article. he DOES take his readers for fools! it’s like when I go see my “mutual fund” manager at my bank who has a tiny % of my investments, she always wants me to invest in a variety of funds - yea so I can give you up to 5% a year in management fees…
…if I had gone with the average mutual since January 2007 I would only be breaking even around now, then eventually lose more when we hit the fan again. Instead, research and self-management is fun, and I’m up against the market average.
GO SELF, read lots!
12 Andrew Baechler // Jul 23, 2008 at 12:12 pm
I agree with the point that many advisors also succumb to their emotions. Dr. Bernstein’s article is just as applicable to advisors as it is to do-it-yourself investors. As a minimum competency, any advisor you choose to work with should possess the four faculties he describes.
13 Rob // Jul 23, 2008 at 12:50 pm
CC - I loved your post here because your writing style differed - you are far more passionate here than in most posts…. a little edgier here too which is cool. And I will say your counter-points are well thought out, and sarcastically written to boot. A great response to the article and post.
I saw the article, and like the author and read him regularly in a world where it is tough to find good investment information sources.
For disclosure, I am an investment advisor and consider myself a to be very good one. That said, I have many critisisms about my own industry and think it has lots of room for improvement. That said, there are good advisors out there - and part of what makes the good advisors good is their ability to control their emotions in both good and bad markets.
I think the disconnect here is that Avner Mandelman is talking about doing active management yourself vs. having a professional money manager do active management for you. In this case, i would definitely agree with his article.
I don’t read him saying you shouldn’t index, or in any way comparing the active vs passive routes. However given the fact that many DIYs (but certainly not all) do invest passively, his article would have been far stronger had he made the point about doing it yourself picking stocks as opposed to a sleepy portfolio.
Finally, I believe it is hard for strong DIYs, and many readers of this great blog, to realize that most people simply do not successfully invest on their own - whether they try to index and get distracted by stocks or market volatility, or add money when it feels good because markets are “high”, or they simply do not follow a plan like a sleepy portfolio as religiousy as they need to for it to be successful.
Readers of this blog are interested in finance, they enjoy thinking about it, and learning about it. Most investors - rightly or wrongly - are not. That is a fact.
I am not debating active versus passive issue here, but I am suggesting that - for all the above reasons - the AVERAGE investor will probably acheive better results with Avner managing their money, than on their own. At the same time, however, I am going to bet that CC, and people who EXACTLY follow CC’s strategies - as well as I believe he does now and will continue to do in the future - will probably do better than Avner.
14 venter // Jul 23, 2008 at 1:52 pm
Well put Rob. Most of my clients have no interest in doing it themselves and really don’t care to listen to my explanations about how they are invested.
15 ThickenMyWallet // Jul 23, 2008 at 2:08 pm
Having previously been in the “out-sourced” camp as a lawyer, I agree with Rob that the audience in which you write to is a minority rather than a majority. Most people don’t “manage” their money at all. They let it sit there in bank accounts and under their mattress.
Should they let an under-preforming manager or a commission/trailer based advisor manage it for them? No, no and no. The system encourages activity for the sake of activity in order to yield commission. The system is structured to squeeze every dollar out an investor. Why? Not enough of us take the time and attention to understand it and stand up for a change.
I don’t agree with the columnist because, as others have pointed out, his assumptions on expected rate of return cite exceptions rather than the rule.
Having said that, if you have been a DIY investor and returning below the pros than maybe hiring a pro is a step in the right direction since you are going from terrible to bad on the assumption you learn enough yourself to fire the advisor and go from bad to good. But to ask someone to go from terrible to good is a big step.
16 Four Pillars // Jul 23, 2008 at 2:39 pm
Andrew, that Bernstein article is priceless - thanks for the link.
Unfortunately he’s probably right.
Mike
17 Advisor user // Jul 23, 2008 at 5:20 pm
A bit of a counterpoint. I (somewhat grumpily) use an advisor to invest on my behalf. He’s pretty good, does things in the right systematic way. Fee based (1.5% per year approx), no commissions or trailers. We’re in a mixture of ETFs, bonds, a few preferred stocks, and a few funds primarily for international exposure.
I’m somewhat grumpy about it, since 1.5% is a drag on performance and I know I could do equally well if I tried. But every time I evaluate it, I decide to stick with it. Here is why, it’s sort of similar to Avner’s argument:
- Sure I could passively invest myself, but my portfolio is split between me and my spouse and registered and nonregistered accounts. The time it would take me to figure out how to make the right tax optimization choices and other tradeoffs (ETF vs fund, ladder of bonds vs bond funds) is far longer than it takes him. He does my tax returns too, so I don’t need to worry about ACB calculations etc.
- He keeps track and updates me about things like TFSA, RESPs, etc - again, he’s much more efficient about it (and less likely to miss things) than I am
- I work 65-70 hour weeks in a managerial position. Every hour I would spend managing my finances is an hour less of sleep, social, or hobby time. That’s worth paying a premium for - though I’m somewhat inconsistent since I cheerfully relatively frequently take the time to read this blog!
I’m pretty convinced the 1.5% cost is generally worth it to me, at least on part of my portfolio. I am somewhat leveraged (flip-type situation) and I do worry somewhat to what extent the 1.5% drag on performance is destructive to the expected returns of a leveraged portfolio (means almost all of the expected gain is from tax arbitrage with much less of a pure expected return - loan cost spread).
18 Al // Jul 24, 2008 at 9:17 am
The Bernstein article is interesting in two ways. It does outline that the majority of people don’t have the right combination of skills to invest soundly. It seems reasonable enough.
However, that same pool of people are the source for financial advisors. The skill sets, with a bit of tweaking, are the same that those commanding the nation’s airliners, nuclear power plants, and military hardware should have. Is it reasonable to believe, with all the competition, that most financial advisors actually have all these qualities?
19 Canadian Capitalist // Jul 24, 2008 at 10:52 am
Rob: Thanks for your comment. I don’t think it’s a great advertisement for professional money management if all they can say is we can do better than amateur stock pickers (even this claim isn’t backed up by any studies I’m aware of). The benchmark for professional managers is their index because investors (or their advisors) can implement portfolios based on these indexes for a rock-bottom cost and keep the fee they pay for the pros in their pockets.
venter: The point I’m making is that professional money management is a giant scam. I’m not questioning why a know-little investor should pay for an advisor. If an advisor provides a valuable service, everyone understands that they deserve a fee in return. But what value does professional money management add?
Advisor user: I totally understand that not everyone wants (or is able) to manage their money. A good advisor is valuable in that situation and the client to be prepared to fairly compensate the advisor in return. The client gets value for which he is willing to pay. But, what value does money managers (as a group) provide? Other than low odds that you *might* do better than an index, not much.
Al: I agree with you. There is very little evidence that advisors (as a group) are any different from investors (as a group) in avoiding negative behaviour.
20 Advisor user // Jul 24, 2008 at 12:33 pm
CC: Let’s try to push the peanut…you asked “what value do money managers provide”? If you frame it as “how often will they do better than an index”, I agree with your answer. I think if you frame it more broadly, the value equation goes like this
- Value due to fees/expenses
Generally - Value through active management, though on occasion some managers for some period of time overperform.
+ Value on process efficiency (that’s the key benefit for me, may not be for others)
+ Value on customized structuring (e.g. tax optimization) and financial planning, assuming it is included in the package
+ Value on (generally) less emotionally-driven response to market trends
How this value equation stacks up (+ or -) depends on your individual situation.
21 Philip S // Jul 24, 2008 at 4:46 pm
I find it interesting that Avner used the argument of Economic Specialization but then didn’t prove that Financial Planning requires specialization. The three advantages to specialization are time between tasks is lowered, learning curve becomes efficient (spread over more tasks), and the product quality increases. The question is, by how much? Do the gains justify the cost? If I drop 2.5% in MER, is that cost worth the savings in specialization?
Let’s look at the disadvantages of specialization: lack of motivation, repetitive tasks. How do you ensure your financial advisor stays motivated? If you have a vested interest in your plans, will you stay motivated? For $2-3,000 a year, is that motivation enough?
Just like I’m not a renovation expert, I will lay tile in my front hallway. Or I may put in my own back deck. Specialization is not supposed to limit other opportunities.
22 florch // Jul 24, 2008 at 6:09 pm
I get the point, maybe a few hours of OT a month would seem a more productive use of time, but how do you know if your managed portfolio is measuring up? For only a slightly higher investment of time, wouldn’t your entire nest egg be worthy of some attention? It’s a little late to take a look at it on your 65th birthday and say, “How’d we do?”
After your monthly bills are paid, it’s the only reason you go to work, period. After a lot of reading and thought, I believe in passive investing, but I’m thankful that I have at least that level of interest and ability.
23 Noel // Jul 24, 2008 at 6:42 pm
I can’t stand Avner. His columns have very little meat in them. Anyway, just what have his firm’s year-by-year returns been over the years for the various individual and pooled funds he manages? What has the average holding period been? What have been the year-by-year sizes of the funds? Does anyone know?
I remember all the mystique and hype about Kiki Delaney in the 90’s. Then the Globe & Mail ROB published an expose article around the year 2000 on the returns her firm produced. She didn’t even come close to beating the index!
I also remember all the mystique and hype about the exclusive boutique investment firm I worked for as an ICPM. Once I joined I found that most of the funds were being closet-indexed (ie should we overweight or underweight Nortel compared to the TSE Index?) You can do that your own by just buying the damn index as well all know (Sorry had to beat that dead horse one more time!)
24 Canadian Capitalist // Jul 24, 2008 at 9:25 pm
Advisor user: Sounds to me that the positives you are pointing out are services provided by your advisor, not a professional stock picker. There is so much evidence that active management after expenses and taxes is a tough game with low odds of doing better than the benchmarks.
25 Phil S // Jul 26, 2008 at 8:11 pm
You forgot one more category of DIY investors, which is the category into which I fall… Crusty investors who have already been ripped off by bad investment advisors in the past who were just looking to stuff your money into their pockets by pushing the product that yields them the most commission return. If I hadn’t had such a bad experience with investment advisors, then perhaps I wouldn’t be such an adamant DIY investor.
Just like the joke goes (which was originally created for lawyers), it’s just the 95% of them out there that makes the rest all look bad…
26 Old Dude // Jul 27, 2008 at 11:18 am
CC
I am always sceptical of studies that use 5yr time frames ,that is not a long enough time frame in which to draw a solid conclusion. They tend to smell of cherry picking stats. Here is something to ponder ,if an investor had purchased shares in the i60 in July of 2000 his annual rate of return to July 2008 would have been about 5%. A no-load low mer bank fund would have produced about a 10% rate of return. Even during this time the active fund still outdistanced the sp/tsx total return index. Yes this is also cherry picking stats. To me 10yrs and beyond is more meaningful with regards to any studies. Don’t be to hasty to jump to conclusions with regards to active funds in Canada. No I don’t have proof that they are better than index products ,my views come from 30yrs of experience and that with regards to Canada I still prefer to hedge my bets , index and active (No Load, Low Mer).I agree index products for the most part are the way to go in the US and International.
27 Phil S // Jul 27, 2008 at 4:32 pm
Regardless of whether you go with a managed large cap equity fund or a TSX index fund, if you look at the top 10 holdings, they are usually quite similar. Big 5 banks, Manulife & Sun Life insurance, BCE (in the past, maybe Rogers or Telus in the future), maybe Encana / Imperial Oil, a couple of “rocks & trees” companies and those make up the index as well as most large cap equity funds.
The TSX, on a market-weighted basis, is so UN-diversified that the top 10 holdings makes up the majority of our holdings anyways. So, if you’re a buy & hold investor such as in your RSP account, then why use a mutual fund or ETF at all? Just buy the top 10 biggest companies on the TSX and you’ll mimic the index anyways. Aside from the trading commissions, it will cost you a 0% MER. That’s zero. Nothing, nada. And those large caps are so liquid that you can buy or sell them at any time without having to worry about the bid/ask spread.
28 squawkfox » Welcomes, Link Love, and Carnivals Oh My! // Jul 27, 2008 at 5:09 pm
[...] Canadian Capitalist is Loving the Bear Market and questions Why invest your own money? [...]
29 Cathy // Aug 5, 2008 at 8:39 am
This article made me so angry! One small point - when did we get to the point where baking a loaf of bread, a staple, got to be a specialized endeavor that takes so much time you couldn’t possibly do that and hold down a job? Last time I checked, hands-on time for baking bread was about 15 minutes in total, the rest of the time is totally hands-off. And let me tell you something, after a few attempts, you will find fresh bread you bake yourself is easy and WAY better than store-bought. And as for my last “financial advisor”/fund salesperson, I could have more fun standing on my roof and throwing twenties into the wind all by myself while ignoring my small portfolio that didn’t seem to warrant any attention whatsoever. Now I’m on E*Trade, matching the index and keeping my fees.
30 Canadian Business Blog » Blog Archive » DIY investing under attack // Aug 22, 2008 at 11:07 am
[...] Canadian Capitalist took Mr. Mandelman to task on this point in his July 22 post; what CC said also seems applicable to Mr. West’s thesis. And as the creators of MoneySense’s [...]
31 Trevor Wilson // Sep 26, 2008 at 8:16 pm
If investment managers are as good as they say they are why don’t they do like other business and back it up with a gaurantee? or is that a dirty word to them. I trust them about as much as I would a car salesman or horse trader. Caveat emptor. My pappy taught me a very important investment lesson early n my investment life. He said that nobody but nobody will look after your hard earned money better that you provided you work just as hard investing it as you did to earn it. Only an incompetent, foolish or socialist leaning person would rely on someone to manage their affairs. Do your homework, learn from your mistakes and have courage in your own self-reliance and take responsibility for your own life.
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