RETIREMENT: Don’t be led astray by market ‘experts’
BY DARREN VILARDO / CONTRIBUTING COLUMNIST
“There is no significant evidence of superior stock-picking ability for the market experts.”
So says Stefaan Pauwels, a researcher at Belgium’s Ghent University, in a recently published academic study. The study judged active portfolio managers’ level of skill by comparing returns on the Morningstar Stock-Pickers Index with average returns on groups of stocks generated randomly on a quarterly basis. The experts, portfolio managers whose job it is to pick stocks they think will outperform, produced a return that was approximately 3.9 percentage points lower than the S&P 500.
So are you too concerned with beating the market? Are you buying into the mythology that there are some elite few with the knowledge, wisdom and experience to beat the market? Does your money manager or financial adviser talk about the quality of the firms that are actually managing your portfolio? Is he boasting about his ability to discover the best asset managers? Does he boast that only his firm has access to these “experts”?
It’s a myth, a fallacy, a fugazzi. It’s created and passed on in order to have you believe you are better off paying “experts” a fee for their “stock-picking expertise.”
Nobel Prize-winning economist Daniel Kahneman, now a professor emeritus at Princeton University, says, “There are domains in which expertise is not possible. Stock picking is a good example. It’s been shown that experts are just not better than a dice-throwing monkey.”
Indeed, the Pauwels stock-picking study suggested that any superior performance of the expert fund managers was “based on luck.”
Yet investors continue to look for the holy grail of money managers who can beat the market. Those who recognize outperformance may not be possible ride the ups and downs of market volatility using an index fund to lower investment costs. It’s the myth of outperformance and some measure of protection in a down market or the emotional roller coaster of pure index performance, albeit at a lower cost.
Both methods truly focus on the wrong side of the plan. Too much emphasis is being placed on asset values, returns and volatility, instead of focusing on a portfolio’s ability to produce a given income, specifically in retirement.
In basic terms, the question we need to ask is not whether we can beat the index, but rather what is the minimum amount of return we must achieve in order to maintain our lifestyle in retirement. If you can live the life you have envisioned, your perfect retirement, with a 3 percent return, then why are you chasing more? To state it another way, why are you taking so much unnecessary risk with your investments, when you don’t need the extra money to live your life?
Most of us would say that someone who had a million dollars would be classified as rich. Virtually none of us would say that someone with a pre-tax income of $40,000 is rich. Yet it is the $40,000 of income that the million-dollar portfolio can likely generate in retirement. The millionaire becomes scarcely middle class.
Placing the focus on the income side of the equation, rather than on the quest for maximum returns, is likely to result in better outcomes. Specifically, avoiding the quest for a mutual fund or money manager that claims to perpetually beat the market.
When transitioning a pool of assets form the growth and accumulation phase into the preservation and distribution phase, it is critical we focus more on the income that can be generated. Specifically income that will keep up with the pace of inflation, and that is guaranteed for life to protect against longevity risk.