Stock Pros Are Losing

Daniel Drew,  11/30/2014


The stock market is one of those interesting arenas where the average player is a loser.

In sports, there is a winner for every loser at the end of every game. Your team is either over or under 50%. But in the stock market, you need to be over 85% just to be a winner.

As of November 25th, 85% of active large cap stock fund managers have underperformed their benchmark index. Of course, there is always an excuse. Jason Subotky, the manager of the $14.2 billion Yacktman Fund, said he was skeptical of high stock prices so he held 17% of the fund's assets in cash. That's right. You are paying him 0.74% of your assets so he can sit on them. Great deal for Subotky and his staff.

The interesting part about this situation is you can keep your money and be skeptical of the stock market on your own - without paying Subotky a dime. Or you can join the index fund religion, bow down at the altar of Jack Bogle, and buy an S&P; 500 index fund. This is a better option than the active manager route, but only in the sense that traveling across the Atlantic Ocean in a 25 foot boat is better than traveling across it in a lifeboat.

If you bought the S&P; 500 20 years ago, you would be up 356% right now. However, you would have lost 50% of your assets two times during that period. The first time was the dot com crash in 2000 - 2002. The second time was the 2008 financial crash. Losing half my money two times and then recovering does not sound like wise investing. It resembles the progression of my chip stack at last night's poker game.

But as long as it eventually recovers, what's a little drawdown among friends? So you don't care if you lose half your money, as long as it comes back a few years later. Even if you have this strange sentiment, it still does not give you the big picture of what can actually happen to you in the stock market.

Index investing was not started until December 31, 1975, when Jack Bogle launched the Vanguard Index Trust. However, if index investing had been around in 1929, I wonder if the concept would have survived. In 1929, the Dow Jones Industrial Average hit 381. Over the next 3 years, it declined in a violent series of crashes and rallies. It eventually reached 41. That was a decline of 89%. It did not recover to 381 until 1954.

If you had been an index investor in 1929 and stayed the course, you would not have come back to breakeven for 25 years. All the stock investors who stick to their guns during market crashes are assuming they will recover within a few years because that is what has happened in recent memory. They assume this pattern will continue in the future. Stock investors from 1929 see things differently.

The reality of the situation is when you buy an index fund, you are risking all of your money. You are investing in companies that you know nothing about, with employees you have never met, with managers who are only interested in boosting the stock price until their stock options can be exercised, and with CEOs who get golden parachutes. You also agree to sacrifice your claim on assets to bondholders in the case of a bankruptcy situation. You sign up to be the captain who goes down with the ship that was never his to begin with.

Does this mean you should never invest in anything ever again? Of course not. However, "be careful" doesn't even come close to being a sufficient warning. There is a saying that many associate with Ronald Reagan: Trust but verify. It is actually a Russian proverb: doveryai, no proveryai. In investing, even the Russian wisdom is not good enough.

When you put your money somewhere, Never Trust, Always Verify.