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Monday, March 21, 2016

How Active Managers Sucker Naive Investors In

Here is another article at MarketWatch that naive investors should throw in the trash:

 Why buy-and-hold is a bad idea for retirees by Ken Moraif.

Two points first:  MarketWatch is one of my favorite sites because most articles are informative, timely, and well-written.  Secondly, this straw-man type of bashing of "buy and hold" is quite popular and used to charge egregious fees in my opinion.

Why should the article be trashed?  I suggest you read the article first and see if you can figure it out.  If you can't, then you need help in the investment world because you are set up for the manager who wants 1% to 2% of your assets annually and is likely to underperform.  You need to do some research or get some guidance on the hit your nest egg takes over a longer period of time as you contribute to the average underperforming active manager's coffers (see:  article on recent SPIVA scorecard.)

Now to the article.  The author presents an example which shows the retiree who put all of his or her money in stocks in 2000:

So in 2000, your first year of retirement, you took out $40,000, but, oops, the market went down 10%, and you lost $100,000. You were left with $860,000. Then the market dropped 13% in 2001, gobbling almost $112,000 of your investments, plus you took out $41,200* to live on. Your investments fell to $700,000.

After 3 years he claims:

You lost half your nest egg in three years.

Now let's take a deep breath and step back a minute and ask the very basic question of who would put their nest egg 100% in stocks.  Maybe the author's firm recommends retirees put 100% in stocks, but I know of no others that do.

To be clear on the difference, let's take a look at his returns versus more reasonable numbers.  He says the market was down -10%, -13% and -23% in 2000, 2001, and 2002.  What was the performance of a buy-and-hold investor for these years using a 65% stocks/35% bonds basic, reasonable buy-and-hold allocation? Using the BlackRock Asset Class Returns chart, you can see they were -1.1%, -4.8%, and -9.8% for 2000, 2001, and 2002 respectively.  A huge difference!

The discerning reader may have also noticed that the author assumes 3% inflation for the withdrawal schedule.  He could have an interesting conversation with Fed Chairperson Janet Yellen who has been trying to reach the Fed's goal of 2%.

The bottom line is that the author has used wholly unrealistic assumptions to reach his conclusions--which could negatively impact the undiscerning reader. 

What if I was to flip this around and seek to create a straw-man type of argument in the other direction and ask how active investors fared who put their entire nest egg in Pershing Square (the firm managed by former active hedge fund manager Bill Ackman).  That story by Brett Arends is here:  Bill Ackman's stock drops.