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January 27, 2017

3 lessons from 2016

Every year the market provides us with some important lessons on prudent investing. Last year gave us three key lessons. You might have heard some of them before, but unfortunately, many investors fail to learn from them.

1. Most flagship funds perform poorly

We pointed this out before: fund size is negatively correlated to net returns and alpha (= excess return relative to a benchmark). 2016 was a case in point. The following table shows the mutual fund heavyweights in Germany (by assets under management). The 2016 performance was mediocre again, ranging from -4.7% to +7.3%. The average return of the ten largest funds was a lackluster +2.9%.

Why is this performance so disappointing? Because a simple 60% / 40% portfolio consisting of a global equity index fund and a global bond index fund would have performed better with a return of 8% in 2016. This is also true on a risk-adjusted basis, because many of the large funds in this table have a higher exposure to equities.


We do not use any of these funds for our clients. One of our main selection criteria is fees and we exclude all funds which have fees in excess of 1.0% p.a. Actually, the fees shown in the table do not include all the costs of the funds (trading, front-end load, etc). All-in costs for many of the retail mutual funds in Germany are actually in the range of 2-4%. The chances of picking a fund with such an abysmal fee structure that can still generate long-term real returns after inflation and taxes is close to zero.

What this means for you: You need to become more independent and assertive when picking actively managed funds. You cannot go by size alone. If you feel uncomfortable picking the right actively managed mutual fund, you are better off investing in a low-cost, broadly diversified index fund (ETF).

2. Most returns come in very short and unpredictable bursts

2016 started off with a nasty surprise. The US stock market had the worst January since 1930. The German DAX equity index lost 8.8% in the first month. It recovered a bit until November when the DAX ended the first eleven months at -1.5%. However, in December, markets rallied strongly and the DAX finished the year up +6.9%. More than 100% of the annual return came in only 1 month!

These types of results are not at all unusual. Actually over the last 100 years, the best month provided an average return of 10%. The remaining 11 months produced virtually no return. If you missed the one top performing month, you are already lagging far behind without a real chance of ever catching-up again.

What this means for you: It’s in the nature of stock markets to go down from time to time. There is no system to avoid bad markets. You can’t do it unless you try to time the market, which is a seriously irresponsible thing to do. Conservative investing with steady savings without expecting miracles is the way to go.

3. Ignore doom-mongers

It is important to remind yourself that many market commentators make money by scaring people out of their investments. They try almost everything – misleading chart overlays, massive compendiums of frightening statistics, hyperbolic commentary, exhortations to pay them subscriptions so you can learn to churn your own account “like a pro”, websites who will print anything to get you to click, and all other manner of nonsense. Professional investors do not have a crystal ball either. Therefore treat all forecasts with a large grain of salt.

Here are some “highlights” from last year:

  • In January 2016, economists at the Royal Bank of Scotland warned that investors faced a „cataclysmic year“ in which stock markets would fall up to 20%. The advice was to „sell everything“
  • In January 2016, billionaire investor George Soros warned of an impending financial market crisis like 2008.
  • In August 2016, UBS warned of an imminent crash in the S&P 500. The bank predicted there would be a major correction within the next 2 months.

What this means for you: Markets will sell off again – we just don’t know when. Crash-gurus are as useful as a broken clock that is right twice a day.


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