Blog post #476
While many of you have been clients for well over a decade, some of you are newer to WWM and our investment philosophy. We want to help you to have the best chance to reach your financial goals. We hope this post provides you with a summary of why we adhere to certain philosophies and practices.
Why do we use mutual funds and ETFs, rather than individual stocks?
To provide you with the best chance for financial success, we believe it is better to own diversified mutual funds (or ETFs, exchange traded funds, which are used interchangeably in this post), and not a portfolio of individual stocks. Investing in only a few companies is much riskier, in general, than investing in the markets as a whole. It is also difficult to pick which stocks will outperform the market over the long-term. We believe that it is very difficult to identify successfully, in advance and consistently over a long period of time, which individual stocks will outperform the markets.
We strongly believe that investors should be well diversified in many respects (by size of companies, by industry sector and geographically), which mutual funds and ETFs can provide. For most of our clients the core of your portfolio should be in mutual funds or ETFs, even if you want to invest in a handful of individual stocks as well.
Why do we use “passive” stock strategies and not “active” managers? And what about index funds?
There are huge amounts of academic and financial data that show money managers who “actively” try to pick and choose stocks to buy and sell generally underperform their asset class peers over short- and long-term periods of time. These “active” funds tend to be much more expensive, which is a hard hurdle to overcome. They trade more, which adds to expenses and causes more taxes, compared to a buy and hold approach. See these past blog posts, 10 Things You Should Know and 10 (or more) Things You Should Know, where we provide more details on how few active managers have been able to outperform their respective benchmarks.
Thus, when developing a strategy to strive for long-term financial success, we follow the data that “passive” money managers generally outperform “active” managers. It is very difficult to identify successfully, in advance and consistently over a long period of time, which money managers and mutual funds will outperform. Active managers may have some hot years of outperformance, but very few consistently outperform their peers or benchmarks over long time periods, such as 5 or 10 years or more.
The funds we utilize are similar to index funds but different. Index funds must track a specific index and they have little flexibility. A passive approach allows for the diversification and buy and hold benefits of indexing, with additional flexibility, such as not being strictly tied to an index. For example, if an index fund had owned Gamestop in the past few weeks, the index fund would not have been able to sell, as they need to hold the stocks in the index they track. A passive fund would have the flexibility to sell Gamestop, as they don’t have to strictly adhere to a specific index.
Why do we believe in utilizing so many different asset classes?
We make many of our investment decisions based on historical academic data and investment research, along with our own investment experience. We recognize that no one can accurately predict which type of stocks (asset classes) will outperform another asset class over the long-term.
To structure a portfolio to reach your goals, whether your goal is to grow your portfolio or to be able to feel secure and maintain your lifestyle, we apply these concepts. We want your portfolio to be very diversified, as that reduces individual stock risk. Being diversified does not eliminate the risk of investing in stocks, but it reduces the likelihood of incurring huge mistakes that are hard to overcome.
Financial research shows that the following applies, over varying long-term time periods, some back to 1926:**
- Small stocks outperform large company stocks, both in the US and Internationally
- Value stocks outperform growth stocks, both in the US and Internationally
- International stocks and Emerging markets stocks (of undeveloped countries) have outperformed US Large Caps during many time periods.
We tilt most portfolios toward these factors, while remaining broadly diversified. While this data may be true over long-term periods, say over 10 years or more, it does not mean these trends (“factors”) will apply all the time or every year.
What this means to you is that we do not invest in only the S&P 500, as other asset classes have outperformed the S&P 500 over long periods of time. Financial research shows that a broadly diversified portfolio should do better over the long-term than owning just the S&P 500, so we do that.
Why do we believe in global diversification?
We recommend investing globally for the same reasons. Financial research shows that over the long-term, a broadly diversified portfolio, which includes US and International stocks, as well as large and small company stocks, with both value and growth, has outperformed owning just the S&P 500.
For example, from the period 2000 – 2010, a globally diversified portfolio would have far outperformed the S&P 500, as that index did poorly for those 10 years, while many other asset classes did quite well. In recent years, the opposite has been true, as the S&P 500 has outperformed International stocks. But as the world is constantly changing, no one can know what sectors or regions will do best over the next 5-10+ years.
Thus, we recommend some International exposure for most clients.
Talk to us. We want to listen. We want to assist you, your family members and friends.