If You Want a Great Money Manager, Don't Pay For It!
In this final part of a three part series on rational-sounding investing myths, I'm going to address the need to pay for top money management performance. On Monday, I wrote about why following our instincts can lead to disaster. On Wednesday, I addressed why being proactive with our portfolio leads to a declining portfolio.
Myth #3: If you want a great money manager, you need to pay for it
You get what you pay for is a bias that goes to the bone. The much-made argument is typically something like, "if you needed a heart transplant, you wouldn't go to the cheapest heart surgeon." Much as I'm always on a value quest, that argument has my buy-in 100 percent since my financial plan does not have any provision for taking money with me when I leave this world.
You know what's coming. When it comes to investing, that logic falls apart. In the land of the stock market, the professional is king with more than 90 percent of all assets professionally managed or advised. Instead of giving investors an edge, the reality is that they are paying their professional in the hopes of outsmarting the other professionals. As Vanguard's chief investment officer Gus Sauter once put it to me, my heart surgeon wouldn't need to make someone else sick in order to make me better. However, our money manager has to outperform all the other money managers by enough to cover their fees. The odds of that working in the long term are less than one percent.
This dynamic of paying more and more to money managers to outsmart other money managers, also making more and more, is as rational as the boat design here. You can plunk down the change for Olympic rowers, but all it will do is make the raft spin around faster and faster and still get nowhere. In reality, it was the genius of the professionals that fueled the sub-prime crises, since they were the ones who continued to buy supposedly "risk-free insured" sub-prime mortgage garbage.
My advice:
As a financial planner, I think a good professional can add value when it comes to portfolio design, tax-efficiency, risk management, and estate planning. I just think it's irrational to pay us to try to outsmart other professionals. Keep your portfolio costs dirt low and you will get what you don't pay for, as John Bogle often says. Low cost index funds offer more consistent returns.
When it comes to investing, there are many beliefs we assume to be rational but end up costing us. Just because something feels like it ought to be true, doesn't make it so. Though it feels as if paying top dollar for a proactive money manager should yield some