How to Fail as an Investor In Three Simple Steps, or Why Institutional Investors Can’t Do Third-Grade Math

It’s one thing for your average Joe or Jane out there to be a poor investor. They likely don’t know much about investing, and they’re so busy with jobs and family that they don’t have a lot of time (or desire) to learn about the subject.

But sophisticated institutional investors would know how to be successful investors, right?

Wrong. And I don’t mean kind of wrong, I mean off the charts, hilariously and frighteningly wrong.

A recent survey of institutional investors (people in charge of hiring manager for pension, insurance, sovereign wealth and endowment funds) from around the world showed the exact steps needed to fail as an investor.

Step 1:   Set Unrealistic Expectations

On average, institutional investors expect their portfolios to earn 10.9% a year for the next five years. As I’ll show in a bit, that’s ridiculous. However, it gets better when you look at the expected annual returns from the assets in their portfolios:

  • Stocks:                 10.0%
  • Bonds:                    5.5%
  • Real Estate:        10.9%
  • Commodities:      8.1%

Do you notice something a tad askew?

Three of the four assets are expected to earn LESS than the overall expected return of the portfolio, and only one – Real Estate – is expected to earn the SAME as the portfolio. So how exactly is the portfolio supposed to earn 10.9% a year if the underlying assets earn the same or significantly less? I mean, diversification does add a little to returns but not that much.

Also, given that 10-Year U.S. Treasury bonds are paying around 1.5% a year interest, how is the fund going to get 5.5% a year from its bonds? Even dangerous junk bonds aren’t paying that much in interest at the moment, so where’s that extra four percentage points going to come from?

What about stocks? Most estimates for the large American stocks (the kind of stocks that dominate institutional funds) is around 6% a year for the next 10 years. Where are the other four percentage points a year going to come from?

Everything about these expectations is insane.

Step 2: Don’t Honestly Track Your Performance

Investors – like gamblers – are notorious for remembering their wins and forgetting their losses. Looks like institutional investors aren’t much different. When asked if their expectations were being met, nearly 75% of them said yes.

Really, because the data shows that institutional funds have averaged between 6.0% and 7.0% a year for the past decade depending on the size of the fund. After employing IBM’s Big Blue to run a deep math analysis, I have determined that 6.0% and 7.0% are less than 10.9%. Hmm.

Step 3: Demand Unrealistic Time Frames

I’ve always said that the central reason that investors do so poorly is that for human beings, three years is a very long time and five years is an eternity, but when it comes to investing five years tells you nothing about a strategy. Basically, investing demands a level of patience that’s literally inhuman.

Every proven, successful investing strategy goes through periods of under performance that lasts well over ten years. Heck, stocks under performed bonds for a 40-year period. Forty years! Puts three years into perspective, doesn’t it.

Now, you’d assume that sophisticated institutional investors would understand this, right? You guessed it. They didn’t; indeed, they are some of the most impatient investors on the planet.

Regardless of the strategy employed by their managers, not one institutional investor was willing to wait more than three years before firing a manager. Unbelievably, 80% of institutional investors whose managers used a “Smart Beta” strategy (my strategy, by the way) would fire their manager if he or she under performed for one year. (Makes me realize yet again that I am blessed to have my clients.)

That’s truly the craziest thing that I’ve ever heard. A well-diversified portfolio – while a proven winner over history – is guaranteed to under perform any benchmark a good portion of years and has under performed for more than ten years several times in the past. (Yes, ten years. Investing is a game won through patience, which is why almost no one succeeds.) These time frames show that institutional investors have absolutely no understanding of the strategies of their managers, nor are they willing to show the patience needed to outperform.

So there it is: How to fail as an investor in three easy steps. Of course, if you want to be a successful investor, you could simply do the reverse. But who wants that? It’s more fun to jump from manager to manager every time your portfolio hits a rough period. Sure, you end up making a lot less money, but you had the satisfaction of feeling like you were “doing something.”

About Mark Helm, CFP, EA

Mark Helm is a Certified Financial Planner and Enrolled Agent. He is the founder of Helm Financial Advisors, LLC, a fee-only financial planning firm dedicated to helping people reach their life goals.
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