In a recent post, I provided an update on the performance of the Sleepy Mini Portfolio. The portfolio was started in August 2007 with an initial investment of $1,000 and $1,000 was added to the portfolio every quarter since then. As of May 31, 2010, the portfolio is slightly below book value. Some readers looked at the performance and expressed impatience at the slow growth in the value of the portfolio. “When will the fruits of index investing show its face?” asked one reader.

To be honest, I’m a bit surprised by such comments. A portfolio like the Sleepy Mini Portfolio is designed to provide satisfactory returns over the long-term by (a) keeping investing costs very low and (b) keeping emotions in check by putting money to work regularly. Over the long-term — an investment horizon of at least 20 years — the portfolio is highly likely to provide satisfactory results. By “satisfactory”, we mean returns that provide a healthy premium over the risk-free rate. The level of the premium would depend on how much is allocated to equities and the valuation level of equities over that time frame. The plan has a very good chance of achieving satisfactory results provided investors have the patience to stick to it through thick and thin.

It is the sticking-to-it part that some investors seem to be having trouble with. They are judging the final result of a long-term strategy based on a time frame of less than three years. It’s a bit like judging a team’s chances for the Stanley Cup based on the first five games. When an investing strategy encounters mediocre results — as any strategy, passive or not, that calls for investing in risky assets is likely to at one time or the other — investors get a hankering to throw out the play book and try something — anything — new. But, they have to ask themselves: how likely are they to stick with the new strategy when it runs into a rough patch in the future?

Studies such as DALBAR (see post Investors Behaving Badly ) consistently show that investors underperform their investments due to performance chasing. We can all become better investors simply by picking a reasonable investment strategy and sticking to it. The endless search for the perfect strategy is a big reason why the average investor experiences such poor returns.

This article has 26 comments

  1. For disclosure, I’m not a fan of passive investing, index investing or traditional mutual funds for my own portfolio. I’m a stock picker, bond trader, market timer and I switch from risk averse to risk hungry from time to time and I try as much as I can to be contrarian – as much as my own personal financial situation allows.

    But for people who aren’t interested in watching the market, I do believe that the passive investing model is good for them. With that being said, I think even in a passive situation, I think it is best for passive investors to first build a ladder of GICs that forms the foundation of their portfolio. In a rising interest rate environment, you don’t lose face value like you would in a bond fund. Only after they have that fixed income foundation, then they can should build equity on top of it, be it through index funds or whatever.

    Just one man’s opinion.

  2. Canadian Capitalist

    @Phil: Even the best active investors will occasionally trail the markets. When they do, they should be patient enough to stick to their strategy.

    A GIC ladder isn’t a bad idea. The only drawback might be liquidity. If an investor is looking to rebalance they may not be able to liquidate their GIC holdings. If this is an issue, a short-term bond fund or ETF might be a suitable alternative.

  3. Well said. Investing is an activity where trying harder usually leads to worse results.

  4. Patience is important, but most traders don’t know what they’re waiting for. Without defined rules for trades and management, patience could be indecision in hiding.

  5. @CC. Let’s say this is your RSP account and you buy 5-yr GICs once a year. Once you’ve constructed your ladder over a 5 yr time span, then you’d have a GIC maturing every year. That maturity would provide you with your liquidity.

  6. Good post CC!

    Nothing replaces a good (financial) plan and execution on that plan. Execution requires patience and seeing it through. All the cliches apply….
    -By failing to plan, you plan to fail.
    -Today’s preparation will create tomorrow’s achievement.
    -A good plan is like a road map: it shows the final destination and usually a good way to get there.

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  8. While I do not disagree with a passive investing approach (we use this strategy for 50% of our household investments) I wonder how long of a time frame is adequate to assess/evaluate the portfolio’s performance relative to other strategies? i.e. would you ever abandon the strategy?

    It almost seems like your “low-fee, no emotions” style of investing necessitates sticking to the plan whether it works out or not. We could obviously be investing in a period where the reward of the risk-premium trade never pans out (witnessed by the 10-year returns of cash vs. equities between 1999-2009).

    While I’m not proposing an active investing style, or a guaranteed return strategy, I wonder if after 20 years, and the IF the sleepy portfolio is still lagging, (a) is it time to give up on it? and (b) wouldn’t it already be too late?

    –Devil’s advocate

  9. @Sampson:When you ask about the Sleep Portfolio lagging after 20 years, we should clarify what that means. Lagging what? An indexed portfolio will always lag its benchmark indexes slightly because of costs, which is inevitable. However, if the indexing strategy proved to lag the average actively managed mutual fund (or stock picker’s portfolio) after 20 years, then I would be the first to abandon it. So far the data has shown that over periods of even five years it will beat the majority of active strategies.

    If your goal is to try to pick the best investing strategy every year, or even over three-year periods, don’t even think about indexing. A broad-based index fund will never be in the top 10 in any year, guaranteed. A diversified portfolio will always lag the asset class du jour, guaranteed. If this bothers you, turn the other way and run because indexing is the wrong strategy for you.

  10. Canadian Capitalist

    @Devil’s Advocate: By ‘lagging’, I think you mean that the Sleepy Mini Portfolio is still below book value at the end of 20 years. If it did, it would mean that all equities — Canadian, US and International — earned very poor returns over a 20 year period (money is regularly added to the Sleepy Mini Portfolio, so it’s not the same as starting off with ‘x’ dollars and examining it at the end of 20 years). It also means that active strategies invested in equities would, on average, have earned the same returns as the benchmarks. If passive investments in equities sucked, it follows that active investments in equities also sucked over the same time period. But that’s neither here nor there. A passive investor experiencing a shortfall will hardly be jumping with joy hearing the news that others did worse.

    We invest in equities fully aware that there is risk — the risk that realized returns are well short of expected returns. When that happens, Plan B comes into play. Plan B calls for (a) making up the shortfall through savings (b) delaying retirement by a few years (c) working part-time to supplement the portfolio income etc.

    Now equities also have upside risk — your realized returns could be more than your expected returns. Here too Plan B comes to play. Just retire early. Or splurge a bit more. Or leave a bit more for your heirs.

    The point is put the odds in your favour. If it still doesn’t work out, play with the hand we are dealt with. Planning for the future involves uncertainly of all kinds. A shortfall in returns is just one of them.

  11. Thanks for the response guys. Both of you caught my mistake on the use of lagging, although I believe I have seen studies showing active managers do better than the index in bear markets. So it is conceivable we could come to a time when professional managers are consistently beating the index.

    I guess CC your response is actually the only way to handle it. If you are approaching retirement, not enough? save more. Too much? retire early or buy a convertible.

    On a personal level, I wonder how long I will stick with stock picking for my 50%, or whether after 5-10 years of under performing, I’ll pack it in and go 100% passive. I suppose we compensate for added risk of under performing the index by increasing savings rates.

  12. @Sampson: The SPIVA scorecards, produced by Standard & Poor’s have showed that active management has no advantage in bear markets either:

    Active management, on average, cannot beat passive management after costs over the long term. See this key paper by William Sharpe:

  13. If I were a person with more time on my hands, I would actually go through the NHL standings after 5 games and compare them to the final standings just to see if you can judge a Stanley Cup winner after the first 5 games. Aside from having no time, I am also a Leaf fan and I remember their 0-9 slide to start this season. One of them should do it since they have LOTS of time on their hands at this point in the year.

    That aside, I agree entirely with the message of the post. Just like Mick Jagger said “time is on my side”.

  14. @CC: Thanks for quoting me in your post! You misquoted me though. I said “I’m waiting for the fruits of index investing to show their face.” That doesn’t mean that I want to see a big return right now. I am in it for the long run. So I am actually waiting “patiently” for the fruits of index investing to show their face (as in many years from now).

  15. Canadian Capitalist

    @index loser: Sorry, I did misunderstand your comment. I should have asked for a clarification. Having said that, there were other comments along the lines of “it is not making any money” here and in an earlier post.

    Good luck in your investing journey. I’m glad to hear that you are patiently sticking to your strategy. The fruits of it will (eventually) arrive.

  16. @ Michael,

    I think the leafs would be a biased example. Looking through their history and record of the first 5 games and success in winning the cup would only show that it is impossible to win the Stanley Cup, whether you go 0-5, or 5-0.

  17. @Michael. There are too many hockey games in a season – try football instead, which only has 16 games a season. The teams that go 5-0 at the start of the season will make it to the post-season more often than the one that goes 0-5. As for winning the Superbowl, it’s still not a good measure because I think last season there were about 6 teams that had a 5-0 start to the season! 6 teams can’t all win the Superbowl, but it would still be sweet to be a fan of one of those teams.

    And by the way, I lived in Toronto for about 15 yrs of my life so I feel that I’m qualified to say “Leafs Suck”. I wish that Balsillie was successful at bringing a 2nd team to the GTA, but I agree that he could have at least tried to be diplomatic about his approach.

  18. This is sage advice from CC. Thanks for this post!

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  20. I admire the patience you have here. You’ve probably talked about this already but as an active investor and finding it difficult to make money in a volatile market, how much is my active investing worth? 5% returns? 10% returns? 3% returns? I would have to say that maybe it’s worth 5% above passive returns. I have a financial advisor that passively manages my money and my goal is to beat the returns that he gets with my money. If I can’t beat him by 5% then should I just give up?

  21. If your goal is to try to pick the best investing strategy every year, or even over three-year periods, don’t even think about indexing. A broad-based index fund will never be in the top 10 in any year, guaranteed. A diversified portfolio will always lag the asset class du jour, guaranteed. If this bothers you, turn the other way and run because indexing is the wrong strategy for you.

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