We’ve all been there. It was a long day at work, meetings ran later than you expected, and you didn’t have time to go food shopping, let alone find a recipe and cook, so you fire up your trusty app, Door Dash, to have dinner delivered to you. Maybe it wasn’t work, but your kid’s practice ran late, you had a flat tire on the way home, or perhaps mom and dad needed help with something at home… the excuses are essentially limitless as to why you needed to go through the drive through at McDonald’s or Chick-fil-A.
Sure, to most of us, fast food tastes great and it saves us time to do things we need to do or would rather be doing other than cooking. At the end of the day, deep down, we know fast food is bad for us.1 You make the tradeoff… convenience for quality. You pay for the convenience and sacrifice your health.2 Heck, you probably don’t even know what goes into your quick meal. You would know every ingredient if you took the time to make the food yourself or cook with a family member or friend; setting yourself on a healthier path going forward.3
It’s crazy to say this, but people treat their investments exactly like they treat their food, and for the most part, even wealth managers do as well. Keep in mind 32% of the United States is clinically obese.4
Index investing has gone from fad investing to a cult-like following. Passively Managed Index funds AUM nearly doubled from 2018-2022, while the AUM of actively managed funds grew 38%.5 Frankly, for those not inclined to do work, or too busy with their day-to-day to worry about their financial future, the sales pitch for indexing is simple and intoxicating (like getting a cheeseburger, chicken nuggets, and Frosty with the click of a button). “Why put in the work to look for investments when you can own a specific sector or the entire market?” Sprinkle in lines like, “It’s impossible to beat the market,” and, “Everyone else is doing it,” and it is easy to see why the novice, uneducated, and often lazy investor is persuaded to invest their hard-earned dollars into indexes. It’s easy and it’s done as quickly as microwaving a cup of ramen noodles (just ignore all the sodium).
Let’s examine some cold hard facts. Indexing doesn’t just make beating the market impossible, purchasing an index fund GUARANTEES you will underperform the market. For the uneducated, an S&P index will typically invest an amount in each company in the S&P in direct proportion to the size of that company in relation to the total size of all companies in the S&P 500 – for a small fee, on average .06% – 0.16%.7 If a particular index increases 10% in a given year, deduct your annual expense of .06%, and your return was 9.94% for the year. See what happened there? You just underperformed the market. Try it again, the math works every time. No matter how much the index rises or declines you will underperform it, every time. Additionally, if you are one of the unfortunate investors using a traditional wealth manager that just indexes, you could be paying an additional 1-1.5% for the privilege of underperforming the market. That 10% market return now is only 8.94% or less. Talk about empty calories.
Further, indexing may also guarantee that an investor will overpay for high P/E stocks. Currently, “SPY” has nearly 4% of its total holdings in Tesla and NVIDIA, which are respectively trading around 51X and 153X P/E. Without questioning the value of the investment, many investors will keep adding to these high P/E companies. Through 401Ks, many investors add to these indexes bi-weekly, regardless of whether the index or the value of the underlying companies goes up or down. This all but ensures that even if the price of the index goes up every week, investors will keep purchasing it, locking in higher and higher purchase prices without even pausing to think if it is in their best interest. Talk about potentially adding excess bulk!
Maybe you like paying for convenience. Maybe you’re ok with paying more to get less. Perhaps you don’t like taking time to do research or find a firm or fund that does the work for you. There is nothing wrong with that. However, if you are interested in taking a little bit of control back in your quest for financial health and freedom, and not being at the whims of simple market movements, maybe you should look for active investment management.
To be fair, since I compared indexing to fast food, I should point out that I am not simply saying all active management is better. Some active management can be downright dreadful, akin to eating a slab of bacon every morning for breakfast, a cheeseburger every day for
lunch, and steak and potatoes every night for dinner. It doesn’t take a Ph.D. in food science to realize that eating nothing but red meat every day will lead to serious issues down the road, and it’s the same with active managers. As an investor, you need to evaluate their process and philosophy to see if their strategy is right for you. There are quality active managers all around, you just need to look around and ask. A 2017 University of Virginia study showed that 20% of Active Managers were nothing more than “Closet Indexers.”6 Don’t worry meat and potato lovers, active management doesn’t taste as bad as kale. The pricing is reasonable when you consider their potential market-beating returns or risk-adjusted returns.
When it comes to active management, I suggest finding a manager that has an investment process that feels like a well-balanced diet. Ideally, seek out an investment manager that spreads their investments across the 11 major industries and favors allocating evenly among companies rather than over-allocating or “filling up” on one position to the detriment of another. Also, watch out for active management funds that have more than 40% of their investments in just three companies. Don’t be swayed by single sector funds. While there is something to be said for expertise, not every year is a great year to invest in tech, although nearly every tech fund manager will tell you otherwise. Further, try to find a manager that attempts to deliver what their strategy implies. If you need dividend income, do not get fooled by a dividend strategy that only provides a 1% dividend and focuses on growth because it won’t provide the income you need.
To be clear, I don’t want you to be fooled by the potential harm indexing is doing your portfolio or be tricked into thinking you are selecting active management by funds that are essentially indexing. Whether you are health conscious or not, take an interest in your financial health, explore if true active management is right for your entire portfolio or just a portion. See if the extra time you invest upfront can be as beneficial for your financial health as a well-balanced diet and well-planned home cooked meal can be for your physical health.
If you have any questions about Altrius Capital or Altrius Funds you can contact us at 201.399.0580.
Disclosures: The information provided in this material should not be considered a recommendation to buy, sell or hold any particular security. Investments made with Altrius Capital Management, Inc. or Altrius Funds are not deposits or obligations of any bank, are not guaranteed by any bank, are not insured by the FDIC or any other agency, and involve investment risks, including possible loss of the principal amount invested. Past performance is not a guarantee of future returns.
Sources:
1. Medical News Today: “Is fast food bad for you? All you need to know about its nutrition and impacts” https://www.medicalnewstoday.com/articles/324847
2. A Colby Community Website for ST297, Fall 2018. “America’s Fast Food Obsession” https://web.colby.edu/st297-global18/2018/10/29/americas-fast-food-obsession/
3. Harvard Health Publishing, Harvard Medical School. “Home cooking: Good for your health” https://www.health.harvard.edu/blog/home-cooking-good-for-your-health-2018081514449
4. USA FACTS. “Percent of Adults with Obesity” https://usafacts.org/data/topics/people-society/health/health-risk-factors/obesity/
5. Yahoo Finance. The democratization of investing: Index funds officially overtake active managers” Yahoo News: ‘The democratization of investing’: Index funds officially overtake active managers
6. Mayo Center Insights; November 2017. University of Virginia, The Growth of Passive Investing Worldwide.
7. Bankrate: “What is an index fund and how do they work?” https://www.bankrate.com/investing/what-is-an-index-fund