Growing and Protecting Your Money (Part 3)

Speculating v Investing

Capitalism produces returns for investors; it’s what it does. These returns, on average and over time, are predictable and there to be had for investors who stay disciplined and invest long term.  What we absolutely can’t do is predict short term movements; no one (whatever they might say) has a crystal ball and can forecast short term winners and losers with any degree of accuracy.  As the investment legend Warren Buffet says, ‘forecasts may tell you a great deal about the forecaster, they tell you nothing about the future’.

There are (broadly speaking) two schools of thought as to how investors can capture the returns that capital markets offer. These ‘schools’ are broadly polarised into the ‘Active’ sector, made up of stockbrokers and fund managers, and the ‘Passive’ community. The former attempts to gain an ‘edge’ by trading and exploiting ‘mispricing’ in markets in an effort to ‘outperform’ the market; the latter accepts that overall, markets are efficient i.e. that prices fully reflect all the available information and that buying the whole market via index funds will produce the returns investors require.

Let’s assume that over a period, ‘the market’ produces an annualised return of 5%. The active investor would aim to generate a greater return than 5%. The passive investor would accept that 5% is the return you get for doing nothing, other than remaining disciplined and staying the course (not getting greedy in the good times and not getting scared in the bad times).

To achieve greater returns than the market, the active investor must speculate on the future success or failure of securities (stocks and bonds) and identify the winners and losers, at the right time and consistently get these calls right. They must second guess or speculate on price movements in order to ‘win’.

The success or otherwise of stock selection and market timing is further complicated when the cost of active investing is thrown into the mix. In other words, a portfolio with trading costs of 2% per annum (not unusual) would need to produce 7% per annum to generate ‘the market return’.

In short, there is more trading conducted so costs will increase. Equally, there is less diversification as the aim is to ‘lose the losers’ from the portfolio, which in turn may well eliminate the winners. 

A final word for now on active management; you are probably reading this (and well done if you managed to get this far) on some kind of device linked to the internet. I accept it may not be high on most of the world’s reading priorities, but the fact is that in 2018, this article can be read by pretty much anyone, anywhere in the world at any time. As can all company information, news, warnings, notes, accounts etc etc. If there were previously pricing advantages out there, identifying them in the digital age has made this incredibly difficult, if not impossible.

The other side of the investing coin is ‘Passive’ investing, whereby an investor can obtain market returns at minimal cost, simply by buying the indices that make up the ‘markets’. As there is little or no trading, the costs associated are significantly lower and by buying the market, diversification is greater. In other words, low cost access to the returns that capitalism produces and an expected return that can be relied on, provided you have time and provided you stay disciplined.

Passive, as a word, suggests ‘doing nothing’ which is not something that generally produces positive results; except in the world of investing, where it can and usually does, precisely that. 

You are probably getting the impression now that Manse Capital espouses this ‘Passive’ approach and broadly, yes we do, but with a twist. We prefer to regard our approach as ‘Evidence Based’ in that we take the low cost, diversified, asset mixes of ‘Passive’ and apply additional factors to our model portfolios. These factors are not based on our pretence that we can forecast the future or that we know better than the market, but based on decades of evidence which identify dimensions of returns that provide returns greater than the market. This evidence is not propaganda put out by the giants of the global financial system, but the combined efforts of the academic community attempting to answer, ‘where do returns come from?’

In summary, keep your costs low and your diversification high. Buy thousands of assets not handfuls. Stay calm no matter what you hear or see in the media, the pub or your neighbours lounge. Trust capital markets to produce over the long term. Rely on evidence of how markets work, not on speculative predictions. Believe the academics not the investment industry, and you will win. Yes, there will be some bumpy times, but ride the waves and stay disciplined and you will reach your goals and be able to live life; which after all, is what it’s all about.

Jon Slater