I got a phone call from a finance advisor the other day (yes, during the second week of the worldwide quarantine).
After his introductory spiel on how he can help me reach my financial goals and all that jazz, our conversations was in the lines of the below dialogue:
- Me: How much do you charge?
- Advisor: X%
- Me: That's 20-30 times the fees I would be charged for an index fund.
- Advisor: Yes, but an index fund will only give you average performances, whereas our advice will help you beat the market.
- Me: Do you guarantee that?
- Advisor: Ehm, we can't really guarantee any returns.
Now, his main argument was that index funds only give you average returns. What he forgot to mention that the average return of an index fund such as one for the S&P 500 is greater than the average return of managed funds.
The book “A Random Walk Down Wall Street” popularized the random walk hypothesis which essentially says that stock price changes are essentially random – at least in the short term – and cannot be predicted.
Thus, paying someone to do the job of an oracle is just a waste of money. In fact, employing a monkey to do this job would be far more efficient and less costly – considering that a few bananas are much cheaper than a finance advisor’s bonus.
Research has shown that a random collection of stocks (one that would be picked by a monkey) beats a hedge fund with large fees and impressive financial jargon.
This is a strategy that Warren Buffet has recommended to most people who want to invest and he had stood by this principle by betting a million dollars on an index fund against the performance of actively managed hedge funds.
As you can see in the chart above the index fund has much better returns over the course of 9 years than any of the hedge funds.
On top of that, you should add the fact that a hedge fund will cost a lot more in fees than a simple index fund. In many cases, the fees might even wipe out the returns you had from the finance advisor’s fund.
Before someone tries to sell you financial crystal ball services, I recommend you read “Where Are the Customers’ Yachts?” by Fred Schwed, written 80 years ago.
The title of the book refers to a story about someone visiting New York and noticing all the brokers’ yachts. Naturally, he wondered where the customers’ yachts were.
I’ll let you answer that for yourself.