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Posted by on May 23, 2014 in ETF Strategist

You Are Wasting Your Time Trying to Keep Up with the Joneses

You Are Wasting Your Time Trying to Keep Up with the Joneses

By Roger Nusbaum AdvisorShares ETF Strategist

Barry Ritholtz posted a link to an article by Lance Roberts from STA Wealth Management that covered a lot of ground. It started talking about a flawed argument in the active versus passive debate. He noted the tendency for more active managers to lag during periods like the last few years when the market has gone essentially straight up and by a huge amount has it gone up. Active management tends to look better during bear markets and he cites some stats from SPIVA to support his argument.

He then transitions into a discussion about the pitfalls of comparisons. He gives the example that people would generally be thrilled to get a new Mercedes as a bonus at work but then would immediately be disappointed to hear that everyone else got two cars. Likewise an investor might be happy to see a 12% return in a given year but then be disappointed to then hear that everyone else got 14%.

Roberts showed the results of applying a strategy akin to the 75/50 portfolio (although his model was different) in isolating how crucial it is to avoid large declines or the full brunt of large declines anyway. As a reminder the 75/50 seeks to capture 75% of the upside with just 50% of the downside. There will be years of “underperformance” only tracking 75% of the bull market but the way the math has historically worked out it is more than made up for during the bear phase.

This is all ground we have covered before on Random Roger and these are all concepts I believe in and to the extent these idea resonate with you then reading them from someone else can be constructive.

The idea of active versus passive has a lot of moving parts. Arguably anything other than 100% in Vanguard Total World Stock Index Fund (NYSEARCA: VT) is active management. VT allocates 7% to emerging markets with the rest in developed markets. The small cap weighting is 4.7% and 49% of the fund is invested in US stocks.

Some would say that a portfolio that weights 60% to US, 15% to small cap and 10% to emerging even through index funds is a form of active management.

Another part of the equation could be mandates from the client (even if you are your own client). Some clients want their portfolio to tilt to yield. It would not be insanely difficult to construct an equity portfolio that yielded 3% but some sort of yield targeted portfolio will not always keep up with the S&P 500 or some other benchmark index and in this example it probably isn’t the client’s top priority. Clearly a client whose top priority is managing volatility will be less worried about beating the market

This connects to Roberts’ comment on comparisons. A fund or portfolio manager is probably going to need to be measured in some context against a benchmark; if a manager says they are trying to beat the market on a quarter by quarter basis then the client needs to be on board with that and judge them accordingly. If some talks about many years at a time then again the client needs to be on board and judge them accordingly but in terms of long run importance for the client I would make the point I have made many times before. Without looking, how did the market do in the second quarter of 2011 and how did you do in the second quarter 2011? You don’t remember because it doesn’t matter. You are either on track or you are not. If not, the prudent answer won’t be “I’ve got to get higher returns” the prudent answer will be I need to save more.

Any given client may make a priority out of tracking the market very closely but ultimately what matters is whether or not the client has enough money when they need it and a big part of that, bigger than performance, will be savings rate. Someone with a great long term record of beating the market but who does not save enough still faces running out of money.

Regardless of how it happens, being 85, healthy and out of money is not a great situation to be in. The real role of an advisor is to give their client a decent chance of having enough when they need it and preventing them from doing financially self-destructive things during emotional times.