Would You Fire ‘God’? On Fund Switching & Volatility

Written by Tom Stanley, Investment Adviser, 29 May 2022

Would You Fire ‘God’? On Fund Switching & Volatility

Not to worry, my note this month is not a religious sermon, or any form of preaching… The title of this month’s note relates to a study from Alpha Architect that offers useful context given the recent market volatility.

Before you read on, I want to plant two seeds to consider:

1. Based on historical cycles, assuming a 50-year investment horizon, you can expect to be invested through approximately 14 bear markets (a bear market is when the overall stock market drops in value by 20% or more from its recent highs).

2. ‘Switching’ or making a strategic change to your investment plan during a ‘bear market’ or period of volatility is the equivalent of you ‘firing’ your fund manager.

With the above in mind, I want to draw your attention to the question posed by the team at Alpha Architect:
‘If God is omnipotent, could he create a long-term active investment strategy fund that was so good that he could never get fired?’
Side note: What is an ‘active’ investment strategy? Active investment is the idea of picking individual investments (e.g. shares in Apple or shares in Fletcher Building) based on their merits. The goal of an active manager is to achieve better returns than the market net of fees – and example of an active manager in New Zealand is Milford. The opposite of an active investment strategy is a ‘passive’ investment strategy. Passive investment is the idea of getting exposure to broader markets, buying all of the companies in a market, rather than trying to ‘pick the winners’. The goal of a passive manager is to track a broad market benchmark as closely as possible, at the lowest cost possible – an example of a passive manager in New Zealand is AMP or Simplicity – reach out if you want to discuss this further.
So how did the team at Alpha Architect check god’s homework? For the detailed answer check out their 2017 white paper here, in summary:

– They took 90-years of S&P500 Index returns (the US stock market).
– Then created ‘God’s Portfolio’ holding only the best 50 performing shares on a rolling 5 year period.

The outcome… Holding equities for 90-years creates wealth, material wealth!

– The S&P500 Index return compounds $1 into $50,000 – a 10% return per year, nothing to laugh at.

How did God do?

– ‘God’s Portfolio’ turned $1 into $12 billion! – That’s a 29% return per year for 90 years.

Now, wouldn’t it be great to hold god’s portfolio (unfortunately it is not possible for many reasons), but what if you could? Would it be a breeze knowing that if you ‘stuck with him’ God would return you on average 29% per year? The answer is striking, even God  experienced tough times and would get fired… many times over – Let’s unpack that.
The below chart shows that even god takes a hit during bear markets, losing more than -20% at least 10 times over the 90 year history of the study, with the worst loss God suffered was a staggering -75.94%!
Source: Alpha Architect, 2017

Now you might glance at the above chart and note that God did better than the S&P500 Index most of the time, but if we look at relative performance over time (comparing God’s annual returns vs the S&P500 Index returns), God materially underperformed at a number of times also!

Source: Alpha Architect, 2017

In summary, during volatile times in markets, there isn’t anywhere to hide – even God takes a hit. So instead of focusing on your 3 month, 6 month or 1 year returns, our job is to focus on what we can control, whether we choose to ‘switch’ funds to numb the pain is one of the things we can control.

For some insight on ‘switching’ or changing investment strategy, I want to point to another study that is more recent, and closer to home.

Financial anxiety and media coverage of COVID’s impact on financial markets through March/April 2020 caused a lot of people to switch their KiwiSaver funds. The Financial Market Authority (FMA) did some research into why people were switching at one of the worst possible times. What did they find?

  • In March 2020, there were seven times more KiwiSaver account switches than the monthly average for the previous year.
  • Over 70% of switches were to lower-risk funds.
  • The 26 to 35 age bracket made up 30 per cent of those switches.
  • Millennials made 21 times more switches to lower risk funds than in the same period of the previous year.

So a lot of people – in particular, younger people – switched their KiwiSaver fund in March 2020. Why is this a big deal?

Because it meant a lot of people lost money. And many of them could still be holding back their retirement plans. The report identified that by August 2020, only 9% of those who left growth funds to go more conservative had switched back – meaning 90% of people who ‘switched to numb the pain’ locked in their losses and were still sitting in a lower risk fund when global markets had fully bounced back!

Seeing your balance drop is scary and markets can be volatile – Having a clear plan and maintaining our discipline through bear markets will pay off in the long term.

We are here to help, and appreciate everyone’s financial situation is different, as well as their risk tolerance, ethics and goals.

If you are concerned about your investment strategy, book a time for a call with one of our investment advisers by clicking on links below. If you’re concerned about your KiwiSaver, take our KiwiSaver Quiz and we can help you make sure you’re in the right spot.

In summary, what can we take from Alpha Architect’s study and the above KiwiSaver ‘switching’ data from the COVID-19 market sell off?

  1. Don’t switch KiwiSaver funds or your investment strategy just because the market drops – As investors, timing the market is futile – Investing does involve skill, but buying bottoms and selling tops is a game played by fools and won by liars.
  1. If you feel compelled to take action or ‘switch’ now? Hold that thought – book a meeting with us and lets discuss your goals and how your investment strategy fits.

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