28 Mar 2014 Persistence

Persistence, defined as “continuing without change in function or structure,” can be a remarkably good force in our lives or a devastatingly bad one; depending upon our track. What we persist in, we generally accomplish; good or bad.

Persistence has a number of applications in the realm of investing. For instance, there’s the persistence of rising stock prices. Stocks rise, on average, four out of every five years. Underlying this trend is the powerful persistence of companies to grow their profits. The ones that do, attract more investors who bid up their prices. As long as they persistently grow their profits, they will lead their market index.

One of the most powerful phenomenons I’ve observed in my long career is the persistence of indexes. As companies are generally profitable most of the time, stock indexes generally move more consistently forward than the individual companies that comprise them. Leadership within the index is not persistent, today’s leaders are often next month’s laggards.

Picking today’s leaders is easy. Turn on CNBC or check out a financial website. However, selling leaders before they become laggards and buying tomorrow’s leaders before everyone else knows about them a rare talent. There are professional investors, persistent in their discipline and devotion who posses such uncanny abilities, but they are few and are mostly unavailable to the public.

Now we come to the crux of the question; which track is right for you – indexer or leader-picker? And to make answering the question all the more difficult, there lies within us perhaps the most powerful form of investment persistence.

It is that persistent idea that we can be that investor, or that we can find that star professional investor. If you find yourself in the grip of that kind of thinking, it may be time to consider changing tracks. In fact, staying on the wrong track, statistically speaking will have a measurably negative impact on your lifestyle.

A study done by Rick Ferri and Alex Benke, published in the peer-reviewed Journal of Indexes in January 2014 demonstrated that index investing outperformed active (stock-picking) investing 83% of the time, over a 15-year period. The extra 17% is not much different than random noise or pure chance. What’s does being wrong 83% of the time cost you on average? The study found that the median annual shortfall of the losing active portfolios was -1.25%.

A 1.25% reduction in the investment returns of a 40 year-old couple who invests $90,000 annually for the next 15 years in an 80% stock portfolio has the impact of reducing their retirement spending from $100,000 to $60,000 for the rest of their lives, if confidence in meeting all other goals is held constant. In retirement, spending is persistent and inflation is persistent.

Every 1.25% we can find in the accumulation phase for savers or in the distribution phase for retirees is important to ensure confidence of meeting or exceeding every important goal our clients value. It is why we continually write about the controllable aspects of the investment process. If you can confidently capture an extra 1.25% by indexing, unless you are Warren Buffett, doesn’t that suggest a better track on which to be persistent than the other 83% of tracks?

Have a nice weekend.