Today, I heard a story that’s repeated regularly: very few professional money managers outperform their benchmark index. The study was conducted by Morningstar, and it reported that 47% of active managers outperformed their passive counterparts over the 12-month period ending on June 30, 2021. This is bad because people are actuallypaying these guys to underperform. One could argue that over only a year things can fluctuate. But when the study looked at the managers’ performance over a very long period of ten years, the results were even worse: only 25% of money managers outperformed their passive benchmarks. And even worse, only 11% of large cap money managers outperformed over that 10-year period. I have friends (and people who follow what I write) who are money managers, and I realize that some of them may be reading this. Yes, I have opinions about the money management business, and I realize that there are excellent money managers out there. But they are far and few between. So while I mean no disrespect to all the good money managers out there, I will share (below) something that I wrote and posted on Saul’s board on March 31, 2018. Here is that post (posted as GauchoChris):
The money management business is a great business. People are making millions of dollars. How do they do it? It is based on the principle that a money manager takes control of someone else’s assets and invests it for them. It is really a simple concept. Accumulate enough assets from other people and invest it for them. In return, the money manager almost always takes a percentage of the managed assets regardless of how much the manager returns on the assets. The cut is taken even if the money manager loses money for his clients. The cut can range in amount. I think that 1% of the assets as a fee is common. Sometimes clients find someone who will manage their money for as low as 0.25%. Other times so called famous hedge fund investors take 2% of assets plus 20% of the profits; this is the common fee structure that venture capitalists use. There are some money managers that offer other financial services such as estate planning so there can be some benefits to hiring a financial advisor.
So how can money managers get rich?
1) They try to accumulate as much money to manager as possible. If someone is taking a 1% annual fee then they will try to get as much AUM (assets under management) as possible. If someone can manage $100M then they will generate $1M per year in fees.
2) They need to sound like they know what they are doing. Being a smooth talker certainly helps because, after all, they must convince someone to hand over their hard earned money. The key is to convince someone of 2 things: First, they must appear to be completely honest and trustworthy. No one wants to end up in a Bernie Madoff like situation where they get scammed out of their assets. If someone is part of a large firm like Morgan Stanley, Wells Fargo, Fidelity, or Blackrock then people will tend to feel comfort and safety. Another way to convey trust is word of mouth; if a person’s friend recommends a certain money manager then they will be more likely to trust that person. The second thing they need to do is to convince clients that they know what they are doing and that they can get good returns.
There are reasons why this money management industry is so large. As a country, the United States is quite financially illiterate. I read somewhere that 75% of Americans don’t know what a trillion is. Sure, most people don’t ever use a number this large in their every day lives, but the national debt is approaching $20T. People should know what a trillion is. I bet a lot of people don’t know what a billion is either. Our education system does not provide people a way to become financially literate in a way that effectively teaches them how to manage their finances. I hardly learned anything about personal finance in school, college, or even during my MBA program! I learned about personal finances on my own and maybe a little from my family. Mostly I took a personal interest and used what I thought to be common sense:
Personal finance is one thing but investing is a whole other level that takes much longer to learn. Most people have no idea what a good investment is. So we really have a society where most people are not great at managing their own personal finances and have no idea how to find good investments or distinguish good investments from bad or mediocre investments. What a great situation for the money management industry: there’s a whole society that is clueless about investing. So what ends up happening is that people, who establish a brand of trust and are able to convey a level of competence and skill, take control large sums of assets so that they can take a cut. The most sad thing about this situation is that most people do not have the skill to distinguish between the huge majority of money managers who can’t consistently beat the market and those are exceptional asset allocators. I think that a huge number of money managers rely on others to do their research and they just allocate into someone else’s recommendation. Or worse the money manager will just buy some mutual funds for their clients to “diversify” them. So the client pays the money manager a fee, and they also pay a fee to the manager of the mutual fund. Fees on top of fees. The clients could just look up the mutual’s holding and allocate themselves. Or they could just buy the market and do better that putting the assets with a money manager.
Why don’t more people learn about personal finance and take control of their own destiny by learning to invest. You don’t have to be as good as Saul to outperform almost any money manager? People have their lives. They are busy and focused on other things. Many people don’t know what they don’t know and assume that managing their own money could never be in their wheelhouse. I meet a lot of people who in causal conversation learn that I manage my own money. I even have close friends who I have known for many years who know that I manage my own assets. Only a small fraction of them are curious enough to ask me anything in depth. Many will ask questions like “What do you think about Bitcoin or cryptocurrency”. I tell them about Saul’s board and how they could learn how to invest so they won’t need to work as many years. I would say that less than 3% end up going to Saul’s board, reading the Knowledge Base, and begin to learn. I am really baffled by this. I suppose they continue to believe that investing is an almost magical skill that they could never attain. They continue to believe that just because someone is associated with Goldman Sachs or is a professional stock analyst that the “professionals” will always be better at choosing investments. Most think that an ordinary person cannot possibly acquire the needed skill to pick better investments.
Many people on Saul’s board have learned that there are a lot of myths imbedded in the ideas above. Many people have witnessed Saul crush the professionals. Many people have seen that people who the public views as a more knowing professional, can be an idiot who draws obviously incorrect conclusions. Andrew Left anybody [I’m referring to when he shorted Shopify at around $130/share]? And some people here are laughing all the way to the bank because they know they can be better than the “professionals”.
The opinions, thoughts, analyses, stock selections, portfolio allocations, and other content is freely shared by GauchoRico. This information should not be taken as recommendations or advice. GauchoRico does not make recommendations and does not offer financial advice. Each person/investor is responsible for making and owning their own decisions, financial and otherwise.