Originally Posted by
DAL 88 Driver
Here's an old article from Kim Snider's blog that does a good job of illustrating the difference consistency of return can make to a portfolio over time:
The Fred Fiasco
Also, here's an article (also from Kim's blog) about "risk adjusted return" that makes some interesting points along the lines of what you are saying:
Risk Adjusted Return
DAL88-
Just for a point of discussion (not picking on you or Kim), but I think Kim contradicts herself in those two articles. In one article she talks about risk adjusted return and the Sharpe Ratio and makes a valid point. But I feel she makes a mistake talking about Fred's portfolio and makes an excellent case for index investing.
First of all, she talks about Fred's return vs. the S&P 500 and laments over his underperformance. First of all, how can she say Fred's performance was worse than the S&P's performance without adjusting each portfolio for risk?? Where is that all important Sharpe Ratio for the two portfolios she is comparing? Further, is the S&P 500 the appropriate benchmark comparison? What if Fred's portfolio was 50% bonds? Then the S&P 500 would not be the appropriate benchmark to compare Fred's performance to by itself. Of course a portfolio consisting of bonds and S&P 500 stock will underperform (over a long period of time) the S&P 500 alone, assuming historical returns for both asset classes.
Further, had Fred simply purchased a S&P 500 index fund over the same period, it appears he would have beaten both the Merill Lynch guy and her method.
Her point about brokerages like Merill Lynch and their "financial advisors" is well taken. They often charge large fees and use loaded mutual funds to enhance their pay check, which means less return for you. Her point about "superstar advisors" is also taken. Only a small percentage of money managers will beat their benchmarks over long periods of time, whether through luck or skill. As investors, of course, we want to pick the skillful ones. Unfortunately, there is no way for us to know who those skillful ones will be except in hindsight. I saw an interesting presentation by Rick Ferri that illustrated the point. Even if you pick the best money management performers of the past 10 years, only a small percentage of those performers will go on to beat their benchmarks the following 10 years, leaving us in the "choosing predicament" described above.