Traditional Investing Is A Sure Loser

The following is an excerpt of a white paper about the secrets that traditional investment shops don't want people to know:

Let’s start by revealing how the traditional approach to investing almost inevitably results in worse outcomes. First, it must be understood that most investment advisors have learned their investment philosophy from the firms by which they are employed. What makes one financial advisor choose Mutual Fund A and another choose Mutual Fund B is largely determined by which of those respective fund companies has cut a better revenue sharing deal with the investment firm. Proof of this is readily available in firm annual reports.

It is a generally accepted business practice that clients will then own what funds or fund families a broker/dealer has the best revenue sharing agreements. This “pay to play” business model is disclosed to clients in the bowels of an annual report and little light is shed on this fine print. Herein lays the first of many identifiable conflicts of interest issues inherent inside the financial services industries.

The traditional investment approach used by most financial advisors is also an ‘active’ approach. In the mutual fund world where most investments are made, this means the industry is trying to own the ‘right’ mutual fund at the ‘right’ time.

Active investing, or picking the ‘best’ securities or funds, is in fact centered around the concept that advisors can beat the market by accurately predicting the future. This traditional approach wants you to ignore the fact that the aggregate market is a zero-sum game – and therefore ignore the mathematical certainty that any one individual’s gains must be matched by equal losses by other players.

This zero-sum game conclusion is even worse than it sounds. Factoring in the marketing, administrative, and other fees charged by most mutual funds (estimated to be more than $100 billion annually for just domestic equity mutual funds) investing actually becomes a negative-sum game. In other words, the very act of buying and selling of securities reduces the size of the pie that is destined to be divided equally among the various players. And the more frequent the buying and selling, the smaller the pie gets.

The traditional investing approach not only wants you to ignore the zero/negative-sum game fact, it also wants you to ignore the overwhelming academic research proving that few fund managers beat their long-term respective benchmarks. Here again, that fact is actually even worse than it sounds; statistically speaking, fewer managers beat their long-term benchmarks than would be expected to simply by chance. (In other words, they aren’t even good coin-flippers!)

So what's the alternative? The answer is an independent and passive investing approach, which is a blog topic for another day.