Today I reached page 51 in the highly regarded personal finance book The Wealthy Barber, abruptly closed the book, and hung my head in sadness. Until this point I really liked the writer’s style and it seemed to be an interesting take on explaining investing to beginners. All was well until this passage on picking mutual funds:
“Make sure that if a fund has solid rates of return, the manager who created them is still there. You’re not buying past performance numbers; you’re buying a manager’s expertise. If fund ABC averaged fifteen percent a year under the guidance of Jack Smith, but Jack Smith left, stay away from ABC. You can’t be sure what you’re getting.”
First, picking actively managed funds is a highly frowned upon activity in these parts. We know they consistently underperform cheaper index funds.
Second, if fund ABC averaged fifteen percent per year and Jack Smith left, how can we be certain he wasn’t a DRAG on returns during his tenure, where theoretically a passive index fund could have returned something like twenty percent per year? In this case we’d have been buyers of Jack Smith’s LACK of expertise!
Third, we know what we’re getting in receiving Jack Smith’s replacement. We get the same exact risk we had when Jack was at the controls: the elevated probability our manager screws something up because he/she is an emotional, over-reactive human being capable of letting behavioral biases affect returns. It’s nothing personal: we’re all this way, and it’s always best to remove the chance of doing some stupid human thing to our portfolios. Don’t believe me? A Fidelity study showed the best performing portfolios are those whose owners forget they even had the accounts!
There are genuinely good managers out there, but finding and retaining them is a futile effort chock full of pitfalls and disappointment. It would be a huge boost to investors across the world if we could abolish this notion that superior returns can be had by simply picking the “hottest” fund managers. Investors see past returns as a Oujia board for manager selection when, instead, the reality is they’re utilizing nothing but a dartboard where only a bullseye will bring acceptable results.