The Simplicity Manifesto

We live in a time of broad assertions. Here is mine. I call it the Simplicity Manifesto. It’s based on a fundamental idea. If someone wants to manage your money, they should first prove, beyond doubt, that their method works.

Otherwise, what’s the point?

Seriously, why should you give a guaranteed portion of your savings, year after year, to someone who can’t guarantee a return greater than a dirt-cheap broad index fund? It’s a simple question. Why does the investment industry continue to market expensive investment products that fail this test?

The answer is equally simple: It’s how they make their living.

It’s not about your performance. It’s about their  income. As long as you believe their blarney, your money will continue to contribute to their Mercedes payment.

A simple premise

The premise of the Simplicity Manifesto is this: Easy plus Cheap equals Superior. Corollary: Easier and Cheaper leads to Better.

That’s it.  The idea is supported by decades of data.

In practice, this means that a basic Couch Potato portfolio (one-half U.S. stock market, one-half U.S. fixed income) is likely to produce better results than you can get from anyone. Yes, anyone — your golf buddy stock broker, your tables and charts investment adviser, or the distant pension managers who steer billions of dollars.

 Three examples

— The managers of your pension fund (if you are lucky enough to be in a pension plan) routinely fail to beat a simple index fund. This is in spite of underperforming the classic Vanguard Balanced Index fund for a decade, as I have shown here, here, and here for Texas pension funds. They’re still fans of alternative investments, hedge funds and other costly ways to invest.

— Your 401(k) plan (if you work for a company that has one) has devoted much effort to herding participants into diversified target-date mutual funds. These funds change asset allocation from youth to retirement and now dominate the money going into 401(k) plans.

But these funds are more expensive than basic index funds. Researcher Rob Arnott demonstrated seven years ago that a simple 50/50 index fund portfolio produced superior results.

— Endowment fund managers – the folks who manage money donated to nonprofit universities, hospitals, museums and churches — suffer the same problem. A recent (December 2018) study found that endowment managers produced median returns well below a 60/40 mix of domestic stocks and bonds. This happens in spite of the size and sophistication of some endowments. Indeed, Harvard has been described as a “$37 billion hedge fund with a university attached.”

I have to admit that I drank from the doctrine of broad diversification. The idea of investing outside our country in both developed and emerging economies seemed entirely reasonable. I also believed that proven “factors,” such as investing in small-cap stocks or value stocks, was a path to higher returns.

The Kool-Aid of complexity

This kind of thing is the Kool-Aid that lets so many investment professionals drink Dom Perignon. Like the belief that individuals and institutions can beat the market with adroit stock picking, having experts select a complicated asset allocation is just another exercise to sell hope and gather fees.

I wouldn’t say this if the facts didn’t speak. But they do. Year after year. Decade after decade.  The facts speak in every venue of money management.

Those facts say one thing: “Easy plus Cheap equals Superior.”

Why simplicity works

Here are the three most powerful reasons for utter simplicity in investing.

—If you buy the U.S. stock market, you’re already globally diversified. According to an analysis done regularly by S&P Global, 43.6 percent of sales by the S&P 500 companies were in foreign countries. Coca Cola, a canonical American company, has 58.4 percent of its sales outside of the U.S. The comparable figure for Wal-Mart is 24.1 percent, 40.1 percent for Ford and 58.1 percent for Procter & Gamble.

This works the other way, too. The United States is a major source of revenue for Honda and Toyota, quintessential Japanese companies. At the far extreme, only 3 percent of Nestlé’s revenue comes from its home country, Switzerland. You can’t identify the revenue sources of a company by its home address.

This isn’t just for the big companies. Recently, I met a friend who is a small- technology business owner in Dripping Springs at Mazama, the local coffee shop. I asked how things were going. He said fine, but he was surprised at how difficult it was to do business in Romania. It was more complicated than France, which was easy, or China, he said.

—Diversification is not a free lunch. Similarly, the grass may seem greener in “factor investing.” That’s when you select a subgroup such as U.S. small-cap stocks or U.S. “value” stocks that sell at relatively low prices. But Gene Fama, the Nobel laureate who identified the higher returns associated with these factors, is quick to point out that the higher returns from those factors also come with higher risk. If you adjust for risk, your return may be lower, not higher.

—Some asset classes and asset factors may have higher returns much of the time, but you don’t know which time. You may miss the window. Think of it as “factor capture risk.” If you have been a “value” investor over the last 10 years, for instance, you’re still waiting for the superior performance of value stocks while having endured higher risk.

This doesn’t happen often — only 14 percent of all 10-year time periods, according to investment strategist Larry Swedroe. But 10 years is a long time for normal humans. Given the uncertainty, it’s good to remember a wise observation: “The market can remain irrational longer than you can remain solvent.”

What broad asset allocation may do (operative word “may”) is increase the long-term survival odds for your money. But if you pay too much for the allocation, you’ll lose the odds improvement. See “Should A Cat Be Your Investment Advisor?”)

More reasons to choose simplicity

There are other reasons to choose utter simplicity over complexity. They all involve higher expenses for you and me as investors.

Think about these:

— Funds with any specialization have higher annual fund expense ratios.

— Funds with any specialization also have higher trading costs and are likely to create more taxable distributions.

— Funds with any specialization also bring higher commission costs for portfolios simply because they contain more asset classes.

The reality of higher expenses is good for Wall Street and all those who make their living from our savings. It’s never good for us.

Related columns:

Scott Burns, “Should A Cat Be Your Investment Adviser?,” 3/15/2019

https://scottburns.com/should-a-cat-be-your-investment-adviser/

Scott Burns, “Local Pension Fund Performance: All the Wrong Monkeys, 11/26/2018 https://scottburns.com/local-pension-fund-performance-all-the-wrong-monkeys/

Scott Burns, “Couch Potato Investing versus Texas State Pension Funds, 10/6/2018 https://scottburns.com/couch-potato-investing-versus-texas-state-pension-funds/

Scott Burns, “Can Couch Potato Investing Do Better than the Teachers Retirement System of Texas?”, 9/16/2018 https://scottburns.com/couch-potato-investing-versus-texas-state-pension-funds/

Scott Burns, “Index Investing – It’s way more than a gentleman’s “C”, 9/28/2018 https://scottburns.com/index-investing-its-way-more-than-a-gentlemans-c/

Sources and References:

Rob Arnott, “The Glidepath Illusion, 9/2012  https://www.researchaffiliates.com/en_us/publications/articles/f_2012_sep_the_glidepath_illusion.html

Howard Silverblatt, “S&P 500 2017: Global Sales, https://us.spindices.com/documents/research/research-sp-500-2017-global-sales.pdf

Sandeep Dahiya and David Yermack, “Investment Returns and Distribution Policies of Non-Profit Endowment Funds,” 12/27/2018 https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3291117

The Pew Charitable Trusts, “State Public Pension Funds’ Investment Practices and Performance: 2016 Data Update,” 9/2018  https://www.pewtrusts.org/-/media/assets/2018/09/statepublicpensionfundsinvestmentpracticesandperformance-2016dataupdate_chartbook.pdf

Standard & Poors, SPIVA Reports: https://us.spindices.com/spiva/#/reports

Larry Swedroe, “Value Premium Lives!,” 5/16/2018 https://www.etf.com/sections/index-investor-corner/swedroe-value-premium-lives?nopaging=1

This information is distributed for education purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, product, or service.

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(c) Scott Burns, 2019