Swedroe: Lessons Of 2017, Part 3

January 19, 2018

One Year Of Outperformance
Perhaps even more shocking is that, over this period, the only year the hedge fund index outperformed the S&P 500 was in 2008. Even worse, when compared to a balanced portfolio allocated 60% to the S&P 500 Index and 40% to the Barclays Government/Credit Bond Index, it underperformed every single year.

For the 10-year period, an all-equity portfolio allocated 50% internationally and 50% domestically, equally weighted within those broader categories, would have returned 6.2% per year. A 60% equity/40% bond portfolio, again with the same weighting methodology for the equity allocation, would have returned 4.8% per year using one-year Treasuries, 5.9% per year using five-year Treasuries and 7.6% per year using long-term Treasuries. All three dramatically outperformed the hedge fund index.

Finally, you may recall that a decade ago, in 2007, Warren Buffett bet $1 million that an index fund would outperform a collection of hedge funds over 10 years. He has now won that bet, with the big winner being a charity called Girls Inc. Over the course of the bet, his S&P 500 Index fund returned 7.1% per year versus just 2.2% per year for the basket of hedge funds selected by an asset manager at Protégé Partners.

The bottom line is that the evidence suggests investors are best served to think of hedge funds as compensation schemes, not investment vehicles.

Lesson 9: Don’t let your political views influence your investment decisions.

One of my more important roles as director of research at Buckingham Strategic Wealth and The BAM Alliance involves working to help prevent investors from committing what I refer to as portfolio suicide—panicked selling resulting from fear, whatever the source of that fear may be. The lesson to ignore your political views when making investment decisions is one that rears its head after every presidential election, and this time was no different. It seems to have become much more of an issue in 2017 because of the divisive views held by many about President Trump.

We often make mistakes because we are unaware that our decisions are being influenced by our beliefs and biases. The first step to eliminating, or at least minimizing, such mistakes is to become aware of how our choices are impacted by our views, and how those views can influence outcomes.

The 2012 study “Political Climate, Optimism, and Investment Decisions” showed that people’s optimism toward the financial markets and the economy is dynamically influenced by their political affiliation and the existing political climate. Among the authors’ findings were:

  • Individuals become more optimistic and perceive the markets to be less risky and more undervalued when their preferred party is in power. This leads them to take on more risk, overweighting riskier stocks. They also trade less frequently. That’s a good thing, as the evidence demonstrates that the more individuals trade, the worse they tend to do.
  • When the opposite party is in power, individuals’ perceived uncertainty levels increase and investors exhibit stronger behavioral biases, leading to poor investment decisions.

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