O Fortuna

Respect the goddess
Fortuna was the Roman goddess of fortune, “the personification of luck… and came to represent the capriciousness of life” (per Wikipedia). During the Middle Ages the Wheel of Fortune became a common depiction. Medieval representations of Fortune also show her as two-faced and unstable–such as two faces side by side like Janus; one face smiling the other frowning; or half the face white the other black. The notions of reward, of chance, of risk, of mutability and of time are all inherent in Fortuna. We only have to go back to 2008, when the S&P lost about 40% of its value, to contemplate a huge reversal of fortune in a very short time and to remind us that there is always an element of chance in investing and as well as in life. We need more respect for the goddess.

The wheel of Fortune still turns for us as individuals, for companies and for nations. And unless you take charge of your retirement investing she will control your financial fate. Photo of book cover John Bogle on InvestingJohn Bogle is the founder of Vanguard Funds, the pioneer of index funds and the champion of the individual investor. He has written a number of helpful books. One that I have is “John Bogle on Investing”, a collection of keynote addresses and speeches he has given over time. As he puts it: “Once retirement comes, you will depend on your accumulated capital to provide you with monthly income, indeed income that must grow in an amount sufficient to protect you against rising living costs.” (John Bogle The Clash of the Cultures in Investing -p 19) So hopefully, now that retirement has come, you have accumulated sufficient retirement assets to provide you with monthly income.”

John Bogle cites four factors of retirement investing: Reward, Risk, Time and Cost. For Bogle reward is the most important. It is the one factor that you cannot control. Reward is certainly controlled by the goddess Fortuna. You have more control over the other factors of risk, time and cost. It is by controlling these factors that you give yourself the best chance to maintain a secure financial future.

Rewards are simply the gains you make from the money you invest and are usually measured as a percentage change of the value of the whole portfolio or the individual stock, bond or other asset. Unfortunately, these percentage changes are sometimes negative. Not only will you get no gain, but you can lose a portion of the hard-earned savings that you originally invested. I guess that is a negative reward. These gains and losses are what you cannot control.

There are still many people who think this is something they can control, especially in the stock market. When the stock market is going up people think they are doing great and attribute their success to their own brilliance. When the market goes down, it’s not their fault. When I say there are people that think they can control rewards, I mean there are significant numbers of people who invest that think that they can pick winners in the stock market and an even higher number that think that they can select mutual fund managers that can outperform the stock market on their behalf. Robert J Shiller, in his book Irrational Exuberance, reports the results of his 1996 survey of individual investors. He reports that 40% responded that trying to pick individual stocks or trying to predict if and when a particular stock will go up is “A smart thing to try to do, I can reasonably expect to be a success at it.” 50% responded that trying to pick mutual funds and figure out which funds have experts that can pick stocks that will go up is “A smart thing to try to do, I can reasonably expect to be a success at it.” Even with respect to mutual funds, as Shiller puts it, “…there is only modest evidence that one can in fact be a success at picking mutual funds…” (IR p 201) Robert J. Shiller is one of the pioneers in the field of behavioral finance. I highly recommend that you read this book in its entirety.

In his keynote speech Clash of Cultures in Investing in February 1999 John Bogle is less equivocal. He states that: “No matter where we look, the message of history is clear. Selecting funds that will significantly exceed market returns, a search in which hope springs eternal and in which past performance has proven of virtually no predictive value, is a loser’s game.”  (p 19) “…in the past 15 years, for example, only 42 of the 287 funds that succeed in surviving the period—one out of seven—outpaced the all market Wilshire 5000 Equity Index (a much less demanding standard than the Standard & Poor’s 500 Stock Index). Fully 245 funds failed to do so.”

In another address, entitledThe Needle or the Haystack Bogle provides more compelling data. At the time of the speech, November 1999, there were 3500 mutual funds. Going back 30 years to 1969 there were 355 stock funds “in the market haystack”. More than half of the original group of funds, 186 funds, went out of business. (By the way this introduces survivorship bias.) That left 169 remaining funds. For these funds the average fund return was 11.5% per year, 2.5 points behind the total stock market return of 13.6%. “Only nine funds beat the aggregate return on the US stock market by more than 1%. We’ll describe them as the winners. Another 18 beat the market return by less than 1% and 29 fell short by less than 1%, a group of 47 funds that we can describe, more or less, as market matchers. That left 113 funds that fell behind by more than 1% annually. We’ll describe them as the losers.” (The data source was Lipper)

Market performance # of funds
-4% or less 25
-3% 14
-2% 41
-1% 33
0 to -1% 29
0 to 1% 16
1% 3
2% 4
3% 1
4% or more 1

Table: Returns of surviving funds 1970 to 1999

You have to ask yourself if professional fund managers with lots of resources at their disposal cannot beat the market, what makes an individual (you or me) think that he or she can be more successful? And if you are going to pick fund managers, how are you going to find in advance the very few that will beat the market?

I make a big deal out of this because in my relative youth I thought I could beat the market. I thought that indeed I have to make choices when selecting mutual funds for a 401K. So why not pick winners? I would berate myself when I lost money because I made the wrong pick. At times I did not invest out of fear of making the wrong choice. All this was the result of ignorance and I wasted a lot of precious time. However, the belief in stock picking and superior investment performance dies hard.

Academics have studied the broad question of whether investors, amateur or professional, can beat the market. The conclusion reached by the academics is no. And thus the prevailing academic view is that the stock market is a “random walk”. This means that stock market prices cannot be predicted, in the short term at least. The most well-known champion of the random walk is Burton Malkiel, whose book “A Random Walk Down Wall Street”, first published in 1973, has been revised and updated several times since then. I strongly recommend that you read this book if you have not already. Burton Malkiel similarly reports that “The S&P beat approximately two thirds of professionally managed portfolios in the decades of the 1980s and 1990s. Moreover, you can count on the fingers of your hands the number of mutual funds that have beaten any index fund by any significant margin. “(p 360)

So where does this leave us? Are investing rewards completely capricious? Should we just throw darts? What does the research say? It says: Portfolio returns are determined by the asset classes in the portfolio. This I will take up in another article.