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In this short series (see the Introduction), I lay out the four key categories of work that we do on behalf of our investment management clients — four kinds of activities that are difficult for folks without our training and experience to do for themselves. I hope that this series will help explain what we do for our clients, why we do those things, and how we think that these things help explain the fees we charge. As always, if you have questions about these posts, let us know!   DISCIPLINE When the markets do something odd, even unprecedented — say, trip the automatic “limit down” trading beakers twice in one week (Monday and Thursday, March 9 and 12) after not tripping them for the decade since they were installed, only to trip the automatic “limit up” trading breaker to end the week (on Friday, March 13) — clients call, asking what we’re planning to do. Aren’t we going to sell all their stocks? Shouldn’t we sell everything, and wait for something to change, so that we all know it’s safe to get back in? Those who haven’t been with us all that long are surprised to hear us say that we want to have a conversation about their goals first, and need to think carefully before we consider doing anything; and even then, we should probably do nothing. To review for a moment: As part of our ongoing research and management processes, we perform extensive due diligence on various investment opportunities in which we could invest our clients’ assets, and we create asset allocation models from those with broad diversification as one of the key deciding factors. With each new prospective client, we engage in a substantial discovery process, to learn who they are and how much risk they can (sometimes must, like it or not) accept, in order to have a good chance of meeting their long-term financial goals. We create an Investment Policy Statement for each of our investment management clients, on the basis of all that research, analysis, and information — a long-term plan that we can all agree on. We want to be able to look back at the IPS in moments when the market worries us, so that we can stick to that plan, because we believe that’s most likely to give us the best long-term results. This paragraph is printed at the very beginning of every IPS:
History teaches that both investment managers and clients need help if they are to hold successfully to the discipline of long-term commitments. This means restraining yourself from reacting inappropriately to disconcerting short-term data and keeping yourself from taking those unwise actions which seem so “obvious” and urgent to optimists at market highs and to pessimists at market lows. In short, policy is the most powerful antidote to panic. The best shield for long-term policies against the outrageous attacks of acute short-term data and distress are knowledge and understanding – committed to writing.

— Charles Ellis, Winning the Loser’s Game

Why do we think that Ellis is right? Well, from a “common sense” standpoint, we believe that making a simple plan and sticking to it seems to produce good results in other areas, like weight loss, and might by analogy work in the investment world as well. But we also have specific research:
  • Research firm DALBAR produces an annual study comparing investment performance of the “average mutual fund investor” with a relevant index. We haven’t seen the latest study yet, but last year’s study showed that for 2018, stock fund investors lost about 5% more than the index; and over the 20 years from 1999-2018 gained 1.74% less than the index (on average, per year).
  • Morningstar, similarly, does an annual study of the difference between the performance of the funds in their database and the investors who own the shares of those funds. They show that stock fund investors gained an average of 1.6% less than the funds in which they were invested for the 10 prior years (on average, per year).
  • BTN Research has found that trying to find the perfect time to get into and out of the market is a fool’s game: While the average annual total return of the S&P 500 index during the recently-ended eleven-year bull market was 16.8% per year, missing just the 20 best days during that time would reduce that return to 8.5% per year on average.
These studies have different time periods, and different methods, but strikingly similar results: When markets give just under 6%, investors earn just over 4%. The simple reason is, according to the DALBAR analysis, that “the general temptation for investors to try and time the stock market often results in the investor diving into the market at the top and fleeing at the bottom”. One of the most dramatic examples of this is the height of the dot-com boom: in March of 2000, approximately 80% of all new money coming into mutual funds was purchasing tech funds — which turned around and lost 50-67% of their value, sometimes more, in the ensuing crash. The strategy that we prefer is sometimes called “strategic asset allocation”: find a specific asset allocation target for your portfolio, and rebalance when markets push the allocations out of your tolerance levels. Other advisors prefer a more “tactical asset allocation” approach, actively adjusting the allocation on the basis of some specific market dynamics. While we still believe that the strategic approach is superior, with the help of some emerging partners, we are exploring tactical options and opportunities. In part because the broader research seems to be agnostic: it may not matter what sort of plan you use, as long as it’s simple enough, and persuasive enough, that you’ll continue to stick with it in even the worst times. Periodically, I run across articles and books (I won’t cite them here) that argue that nobody needs an advisor, really: one “total stock market” index fund, and one “total bond market” index fund, allocated according to some particular formula based on your age, is enough. “Buy those two funds, and rebalance them as needed, and you’ll be fine!” — Well, maybe. But maintaining discipline in the face of extraordinary volatility, such as we’ve seen in the last few weeks, is extremely difficult. Saying “don’t panic” to someone who is already, let’s say, quite concerned, has about the same success rate as telling someone “calm down!” — awfully close to zero. So let’s not say that. But let’s not make changes to your portfolio, unless something vital has changed in your financial situation. Our best tools so far have been diversification and calm discipline; let’s not give those up quite yet. But If you have questions about any of this, want to review your portfolio and Investment Policy Statement, or are interested in discussing a brand-new relationship with Horizons, please let us know. We’re happy to help!