Every year, the markets provide us with lessons on the prudent investment strategy. Many times, markets offer investors remedial courses, covering lessons it taught in previous years. That’s why one of my favorite sayings is that there’s nothing new in investing—only investment history you don’t yet know.
Last year supplied 10 important lessons. As you may note, many of them are repeats. Unfortunately, too many investors fail to learn them—they keep making the same errors again and again. We’ll begin with my personal favorite, one that the market, if measured properly, teaches each and every year.
Lesson 1: Active management is a loser’s game.
Despite an overwhelming amount of academic research demonstrating that passive investing is far more likely to allow you to achieve your most important financial goals, the vast majority of individual investor assets are still held in active funds. Unfortunately, investors in active funds continue to pay for the triumph of hope over wisdom and experience.
Last year was another in which the large majority of active funds underperformed, despite the great opportunity active managers had to generate alpha through the large dispersion in returns between 2017’s best-performing and worst-performing stocks. For example, while the S&P 500 returned 21.8% for the year, including dividends, in terms of price-only returns, 182 of the companies in the index were up more than 25%, 49 were up at least 50%, 10 were up at least 80.9%, and three more than doubled in value. The following table shows the 10 best returners:
To outperform, all an active manager had to do was to overweight those big winners. On the other hand, there were 125 stocks within the index that, on a price-only basis, were down for the year. Fifty-nine stocks lost at least 10%, 20 were down at least 25%, and the 10 largest losers (see the following table) lost at least 44.2%.
To outperform, all an active manager had to do was to underweight these dogs.
It’s important to note that this wide dispersion of returns is not at all unusual. Yet despite the opportunity, year after year, in aggregate, active managers persistently fail to outperform.