Passive indexing has long been popular among the smaller investors. But wealthy investors often pursue more active strategies, either with active managers or on their own. After all, they didn’t accumulate their wealth by sitting back and doing what everyone else does, right?
But the evidence against active management is strong, with the most managers failing to beat the index over time. So why do wealthy investors tend to shun a passive approach to managing their money?
Compare your finances to standards of excellence and use them to make enhancements
When people with wealth describe to me how they view their current position, they use a wide variety of yardsticks to measure themselves. Some are troubled because they are comparing their finances to friends, family, or associates who appear to be much better off. Others are troubled because they have lost a large portion of their net worth through market declines, bad investments, or business setbacks.
It is more common, though, to meet people who feel quite confident and secure because they’re doing much better than they imagined they would when they were younger. Their confidence may be fueled by the good opinion of others around them, since wealthy, successful people are often accorded tremendous respect and kid-glove treatment.
There is nothing wrong with these benefits of success, but you can’t allow them to lull you into false assumptions about your financial position. If you want to know where you really stand in terms of financial strength, you need to employ objective standards of excellence.
An Ill-Advised Investment
In 1929 Winston Churchill, the future British Prime Minister, was touring the United States and Canada. Churchill had just stepped down as Chancellor of the Exchequer, a high government post equivalent to the Treasury Secretary in the U.S. Freed from his duty of overseeing financial policy for the British Empire, Churchill had time to focus on his personal wealth management and investments. In a letter to his wife, Clementine, dated September 19, he boasted of his success in this new pursuit:
Oil crisis in Russia. Bad debts in China. Impeachment proceedings in Brazil. Emerging markets have plenty of issues to navigate, but a closer look shows that much of these concerns are already baked into the stock prices, perhaps overly so.
Emerging markets present attractive long-term growth opportunities generally not seen in developed markets: Younger demographics, a growing consumer base with rising wages and debt-free balance sheets, and government policies that are opening up countries to outside investors.
But emerging market stocks have lagged their developed market counterparts badly in recent years. Since October 2010, emerging markets have declined 6.0% annually while U.S. large cap stocks (as measured by the S&P 500 Index) have gained 10.0% per year. The last time emerging markets lagged this much was when the U.S. went through the 1990s tech boom:
“People only see what they are prepared to see.”
-Ralph Waldo Emerson
On Thursday, investors will get a first look at Q1 GDP that is unlikely to impress. According to Bloomberg, economists expect Q1 economic growth of just 0.6%, and it’s possible we could even see a negative number. However, the intelligent investor won’t overreact, especially given the recent issues in reporting Q1 GDP data.
We first wrote about the anomaly in Q1 GDP data back in July 2015. Simply put, research from the Federal Reserve seems to indicate persistent errors in first quarter GDP reporting. According to a study by CNBC that looked back to 1990, these errors average out to GDP revisions as large as 1.3%. In other words, a 2.0% GDP figure could ultimately be revised to anywhere from 0.7% to 3.3%. Even the Bureau of Economic Analysis, the government body in charge of GDP data, acknowledges issues.
Investors have surely noticed the recent volatility in the global market place. In the first few weeks of 2016, we have experienced very volatile markets both domestically and internationally. The catalysts of the global sell off have been the volatility experienced in the Chinese markets and the plunging price of oil.
On top of the China’s current economic issues, devaluation of the yuan has added angst around the globe. Although China’s economy is the second largest in the world, its stock market represents a fraction of the global equities market. Investors need to remember that China equity falls are more correlated with short-term psychological factors rather than the underlying China economic conditions.