Given our careers in financial markets, we are often asked some very fundamental questions by people who want to know what they should do with their savings. These basic questions are in fact the most important ones and, to some extent, the most difficult.  

On the topic of investing, there are over 50,000 titles currently available on Amazon.com. Investing is endlessly studied and debated. Everyone from your brother-in-law to the cab driver has an opinion. Like any major decision in life, there is no one right answer.

Even if we rely on the advice of others, it is up to each of us to figure out whom we listen to and when. We are each ultimately responsible for charting our own path forward. And just like choosing a spouse, or a career, or where to live, how we choose to approach investing can be extremely consequential.  

It is difficult to do these important topics justice in a few pages. Nonetheless, we attempt here to distill what we believe are the 5 key messages we would impart to any individual seeking to establish a successful investment program:

(1) One way or another, you ought to be invested in stocks

(2) Be an investor, not a speculator

(3) Always balance risk and reward

(4) Don’t get played

(5) Know thyself

Thank you for taking the time to consider our thoughts on what it takes to succeed as an independent investor.  If you find value in this discussion, please check out our website 76research.com to learn more about subscribing to our biweekly newsletter, the 76report, or one of our Model Portfolio packages, which we explain in more depth at the end of this report.  -Trish & Rob

(1) One way or another, you ought to be invested in stocks

We frankly find it remarkable when we encounter individuals with significant personal assets who have essentially zero exposure to the stock market. A successful lawyer, for example, who never invested a dollar in equities, not even in retirement accounts, because he feels more comfortable knowing his money is “in the bank.” Or even a high-earning fixed income professional, who just buys bonds, because that is what she “gets” (despite lower returns and often worst-case-scenario tax treatment).

We understand the stock market can be confusing and intimidating. We understand volatility can be unnerving. We understand the fear of losing as much as 100% of your investment in a single stock or, in times of crisis, the pain of watching the value of even diversified portfolios decline by 30% or 40%.  

We also understand the reasons people provide for not being invested in stocks right now. We are in a bubble. The [fill in the blank] party is leading our country to collapse. I’m waiting for a correction. It’s only getting worse [if it’s a bear market].

To be fair, sometimes this caution is warranted, at least in the short run. But history shows that sitting on the sidelines of the stock market is generally a big long-term mistake, even if there is immediate downside on the horizon.

We analyzed quarterly returns of the S&P 500 Index over the 30-year period ending in December 2022. We chose this time frame because it represents: (1) a span of time over which a reader might have had significant cash available to invest, and (2) it concludes with a relatively bad year (the S&P 500 returned -18% in 2022).

We observed the following results:

• The compound average annualized return over this period was 9.6%.

• An investment of $10,000 at this rate of return would have grown to over $158,000 over the 30-year time frame.

• The average one-year return on an investment made at the beginning of any quarter was 11.4%.

• The probability of earning a positive return within one year on an investment made at the start of any quarter was 82%.

_{(Source: FactSet)}

There are of course no guarantees that history will repeat itself. We are in fact living through a moment right now in which a 40-year trend of declining inflation has abruptly broken.

If we are entering a new era of structurally higher inflation in the United States, as many believe, this is all the more reason for individuals to be invested in equities. Stocks are ultimately ownership stakes in businesses that in most cases have the ability to raise prices and grow their cash flows along with the nominal growth of the economy. In a fiat money world, business ownership is among the best ways to keep pace with the continuous erosion of purchasing power.  

Political risks to price stability

Consider, for example, recent discussions of “Modern Monetary Theory,” or MMT. The Australian economist Bill Mitchell is credited with coining the phrase in 2008, as the global financial crisis sparked an unprecedented wave of monetary expansion via quantitative easing.

At the risk of oversimplification, the central premise of MMT is that sovereign countries that operate with their own fiat currencies can directly fund government expenditures by printing the necessary funds. (Fiat currencies, such as the U.S. dollar or the Euro, are linked neither to commodities like gold nor other currencies.) Taxation can then be used, so the theory goes, as a tool to control inflation in the event such unrestricted money printing becomes a problem.

Under an MMT regime, the government does not have to bargain with taxpayers through the democratic political process to fund its operations but rather can just tell the central bank to cover its costs directly. Unsurprisingly, American politicians who favor a substantial expansion of the federal government have warmed up to this novel framework. Congresswoman Alexandria Ocasio-Cortez has stated that MMT should become “a larger part of our conversation.”

I think the first thing that we need to do is kind of break the mistaken idea that taxes pay for a hundred percent of government expenditure. - AOC

With politicians around the world promoting the idea that trillions of dollars of investments are necessary to address the “existential” risk of climate change, there is a natural interest in restructuring government financing in a way that bypasses taxation as the primary funding mechanism.

It may seem far-fetched at this moment, but how many ideas that we dismissed as fringe or radical ten or fifteen years ago are now mainstream (or even required beliefs under the standards of political correctness)?

During the pandemic, our federal government enacted unprecedented policies that resulted in cumulative inflation of nearly 18% over the three-year period beginning in January 2021 and ending in December 2023. The prior three-year period produced cumulative inflation of less than 6%.

_{(Source: Bureau of Labor Statistics)}

As we move into an era of digital currencies and potentially shifting Federal Reserve mandates, inflation risk ought to remain top of mind. Consider the Federal Reserve Racial and Economic Equity Act, proposed legislation that was reintroduced in August 2023 by Sen. Elizabeth Warren and Rep. Maxine Waters with ten co-sponsors in the Senate.

The Fed can and should take deliberate actions to help reverse the serious racial gap in our economy. - Senator Elizabeth Warren

“Equity” in a political context is an amorphous concept that can be weaponized to justify any number of government interventions. Legislative efforts in the name of equity to modify the Federal Reserve’s current dual mandate of subduing inflation while maximizing employment could seriously dilute the Fed’s commitment to keeping inflation down. Climate change, for example, is often framed as an equity issue because of alleged disparate impacts.

While the impacts of climate change will be felt by all Americans, they will be deeper and longer lasting among the poor, people of color and other vulnerable populations. - Dr. Rachel Levine, Assistant Secretary for Health

Our politicians and their donors, of course, are overwhelmingly owners of stocks and real estate, another inflation sensitive asset class. Many, like Rep. Nancy Pelosi, have been famously active (and successful) stock traders. (Pelosi appears to have enjoyed another fantastic year in 2023, with her portfolio returning 65.5% versus 26.3% for the S&P 500.) They are the policymakers here, not the working-class individual with minimal financial assets who has been getting squeezed by rising food, energy and other prices.

As we all contemplate how we ought to be positioned for the financial future, it is worth keeping in mind who it is that makes the rules and where their interests lie.

Investors who share our concerns around long-term inflation risk may wish to learn more about the 76research Inflation Protection Model Portfolio, which focuses on businesses that we expect would perform relatively well in elevated inflation scenarios. We discuss how investors can use our Model Portfolios at the end of this report.

(2) Be an investor, not a speculator

Notwithstanding the constant attention the media pours on the question of whether or not the stock market is about to head up or down, one of the more well-established truths of investing in the stock market is the futility of market timing. In a 1938 memo, the economist John Maynard Keynes reflected on his work managing the endowment funds of London’s King’s College.

We have indeed done well by purchasing particular shares at times when their prices were greatly depressed; but we have not proved able to take much advantage of a general systematic movement out of and into ordinary shares as a whole at different phases of the trade cycle…. As the result of these experiences I am clear that the idea of wholesale shifts is for various reasons impracticable and indeed undesirable. Most of those who attempt it sell too late and buy too late, and do both too often, incurring heavy expenses and developing too unsettled and speculative a state of mind, which, if it is widespread, has besides the grave social disadvantage of aggravating the scale of the fluctuations. - John Maynard Keynes

The main problem with market timing strategies is that they require an ability to predict how a nearly infinite number of variables (many of which are quite random) will interact. This requires a degree of foresight that likely exceeds human and perhaps even artificial intelligence.

The late David Swensen, the storied manager of the Yale University endowment, emphasizes this point in Pioneering Portfolio Management, which is in our view one of the most important investment books of all time, especially with regard to asset allocation.

Market timing… requires being right in the short run about factors that are impossible to predict in the short run. - David Swensen

No doubt many readers have seen statistical analyses showing the impact that being uninvested for a relatively small number of days can have on long-term compounded returns. We concur with these analyses and would note that many of those critical days of strongly positive returns occurred in bear markets, when many investors are tempted to withdraw their capital in an ultimately self-defeating effort to “play it safe.” There is nothing safe, however, when you permanently miss out on key moments of market upside.

As Keynes noted, one’s attention as an investor is more productively spent on identifying entry points into “particular shares” when they are available at attractive prices, rather than trying to figure out the market as a whole.

Our investment approach at 76research is primarily focused on identifying these opportunities with respect to “particular” securities. We look for moments when an investor can establish a low cost basis in a high quality stock, which will then provide the benefit of long-term compounding in a tax-efficient manner.

There are occasions, however, when it may make sense to take advantage of a potential mispricing in a security that could lead to shorter term trading profits. While the vast majority of one’s investment capital should be tied to investments that will generate returns over a long time horizon, we believe there is no reason an investor should not be willing to allocate some capital when a well-founded insight into a situation points to a high probability of short-term upside.

Such trades should be the exception, not the norm, however. An attitude of reluctance when it comes to short-term trading translates into a higher bar for taking such risks and keeps investors out of the habit of merely guessing and gambling.

(3) Always balance risk and reward

Investing is a constant balancing act between avoiding loss and generating upside. An individual investor’s psychological disposition can have a major impact on how he or she implements a personal investment program.

A risk-averse personality is likely to concentrate on loss avoidance, while a risk-seeking personality dreams of big gains. The key is to stay rational and understand that loss and gain are, in a mathematical sense, generally the same thing over the long run. Not making $1,000 due to a failure to take a risk is mathematically equivalent to losing $1,000 due to a risk that was taken.

A major asterisk to the above relates to what many investors describe as the permanent impairment of capital. While modern portfolio theory characterizes risk as volatility (the degree to which security prices tend to bounce up or down over time), risk can also be seen through the more practical lens of simply losing your money. From the standpoint of a long-term investment program, losing all or substantially all of your money can be catastrophic.  

An investment portfolio cannot recover from a total elimination of the capital base. In this regard, downside risk is in fact asymmetric with upside potential. If you only have $1,000, losing $1,000 is not the same as making $1,000. In that scenario, losing $1,000 is game over.

The logic of diversification

Diversification and other capital protection strategies are therefore necessary to prevent permanent impairment of an investor’s capital base.

Diversification has some critics. The more diversified a portfolio is, the less opportunity you have to perform extremely well (relative to, say, the broader stock market). But the flip side is of course that diversification means you have less opportunity to perform extremely poorly.

The Nobel Prize winning economist Harry Markowitz (who sadly passed away in June of 2023) was one of the most important contributors to modern portfolio theory. He described diversification as “the only free lunch” in investing.

This comment is based on a very straightforward statistical idea. Assume you have many equally attractive investment opportunities, each of which could be expected on average to deliver the same return. By spreading your money across many of them instead of just a few, you can dramatically reduce the probability of a severely negative outcome without sacrificing your average expected return. In other words, while maintaining the same average expected outcome, you bear less risk of a catastrophic loss.

If our careers in the investment world have taught us one thing, it is humility. Never be overconfident when it comes to your ability to peer into the future. Even if your thought process is solid, there are events totally out of your control that can destroy what otherwise may have been a sensible investment.  

Take, for example, commercial office landlord stocks (office REITs).

Who could have reasonably foreseen in February 2020 that a deadly virus would leak out of a laboratory in Wuhan, China which would then, in turn,  (1) cause authorities to demand white collar workers stay home for an extended period of time; (2) stimulate the rapid adoption of communication technologies that enable remote work; (3) spark a wave of early retirements that gave younger workers bargaining power to insist on making remote work permanent; and (4) lead to inflationary supply chain disruptions and government stimulus subsidies that would ultimately force the Fed to raise interest rates dramatically?

All of these factors led to dramatic share price declines among office REITs, which generally saw declines of 50% to 75% from pre-Covid levels. We would argue that if that virus never got out of the lab, probably none of these things would have happened. And we would surmise that nobody in early 2020 who followed or traded office REITs was talking or even thinking about this potential sequence of events. And if they were, they would have been called crazy.

Even the best investor can get it wrong analytically from time to time. And nobody can reliably predict random or low probability events. Rational investors therefore look to create well-diversified portfolios that take advantage of the historical tendency of the stock market as a whole to deliver attractive compounded returns, without betting their entire future on a small number of investments that may or may not perform well.

When to take risk?

The transition from the defensive to the offensive is one of the most delicate operations in war. - Napoleon

The logic of diversification does not mean investors should not seek out attractive opportunities that have the potential to deliver strong or potentially exceptional long-term returns. Investors should seek to fill a portfolio with an array of these opportunities, especially those with diverse characteristics, such that the likelihood of success or failure for each investment is to a large degree independent. (A portfolio of ten stocks in the same industry, for example, is not really diversification at all because they may all be similarly reliant on the same macroeconomic scenario playing out.)

We believe in stock picking but also see merit in having some, if not substantial, low-cost passive index exposure at the core of one’s investment portfolio. Even Warren Buffett, a known critic of diversification in investing, has offered this advice to typical investors.

When venturing out from passive approaches, such as simply owning an S&P 500 index fund, we favor a comprehensive approach that looks at the potential for loss and the potential for gain simultaneously.

When purchasing a stock, there are really two fundamental questions an investor must ask: how is this company positioned to perform in the future?; and how is this business priced to perform in the future?

At 76research, we try to spot investment opportunities where the long-term business prospects appear strong and where the share price understates this potential, in terms of growth but also in terms of downside risk. It is in these scenarios that it makes sense to move capital away from generic market risk (which can be obtained from passive investments) to company-specific risk or direct stock ownership.

(4) Don’t get played

Common sense is one of the best weapons we have to avoid making investment mistakes. Every investment opportunity should be approached with healthy skepticism, if not cynicism, when it comes to assessing the motivations of others and the degree of realism behind their claims.

Common sense is genius dressed in its working clothes. - Emerson

It is very difficult to outperform the stock market over sustained periods of time. Let’s put this in perspective.

We were able to find a mutual fund that as of September 2023 ranked in the very first percentile in the Morningstar “Large Blend” category (roughly representative of the S&P 500) over a 15-year period. In other words, out of 669 funds in the category over that time frame, this particular fund would have been among the top 7 or so best performing. The relevant index for this category returned on average 11.1% per year on a compounded basis. This very exceptional fund returned 12.5%.  

In other words, one of the very best funds in the category over a 15-year period (among the top 1%) only outperformed the index by less than 1.5% per year.  

Over time, a performance gap like this can actually be meaningful. In the case above, we calculate it is the difference between a 486% total return versus a 383% total return over the 15-year time frame, due to the power of compounding. But consider this in the context of promises of extraordinary investment results you might hear via email or on the radio (talk of doubling or tripling your wealth in a month and other nonsense).  

Anyone promising explosive investment results through the stock market is, in our view, lying to you. Just ask yourself, if this individual could reliably turn one dollar into two or three in a short time frame, why is he trying to make money by offering this magical ability to you? Wouldn’t it just be easier for him to take his own money and do it himself? He would become a billionaire in no time.

The same logic applies to financial advisors and other types of money managers who want you to keep your assets with them (for a potentially hefty fee). There are some decent ones out there, but there are many who are happy to over-promise and under-deliver.

It’s in the nature of things that you aren’t going to have a whole lot of screamingly successful professional investors. You’ve got a great horde of professionals taking croupier’s profits out of the system, most of them by pretending to be professional investors.  And that is in the nature of things, too. - Charlie Munger, speaking at a Berkshire Hathaway shareholder meeting

We must acknowledge that when we first came across Charlie's comments, we were not exactly sure what a “croupier” was, but having researched the matter, can share that it refers to the dealer at a roulette table. The idea is that these individuals are merely skimming off the system without actually helping the participants.

Investors need to have reasonable expectations about what kind of returns are realistically achievable and sustainable through the stock market. When someone is promising you more than that, it may be a good idea to run, not walk.

(5) Know thyself

The most famous of the Delphic maxims at the ancient Greek Temple of Apollo, the expression “know thyself” has been interpreted and reinterpreted throughout history. One of the original understandings of the phrase is that it meant we should all understand our limitations. For purposes of investing, this is especially important.

One of the hardest things about investing is not just knowing what to do but actually doing it. Investing has the potential to become an extremely emotional activity. Markets are both rational and irrational. Panics and crises happen. Losing money is painful, depressing and frightening. If you invest in stocks, it is also inevitable. Only Bernie Madoff’s clients were accustomed to a more or less straight line up (at least for a while).

In addition to understanding their long-term financial planning priorities, such as maintaining adequate liquidity for emergencies and adverse personal developments, investors need to have a strong handle on their own risk tolerance.

Everyone has a plan until they get punched in the mouth. - Mike Tyson

While a certain level of stock market exposure may make sense theoretically, if a period of volatility leads to unacceptable personal stress or worse, an emotional decision to abandon the investment program could lead to a very bad ultimate outcome. This applies to one’s overall allocation to the market, as well as individual position sizing.

While it is one thing to grin and bear it when the market as a whole sells off, risk tolerance for individual stocks can be a different matter. Investors should limit individual position sizes to levels where a substantial or even total loss is acceptable.

An under-discussed element of investing is leaving yourself room, both financially and psychologically, to add to your overall exposure to the market or to individual securities in periods of weakness. Panics and sell-offs can represent some of the best investment opportunities, as large swaths of the market are indiscriminately liquidated and the metaphorical baby is thrown out with the bathwater.

In calm times, investors should have a grip on their own risk tolerance and a sense of how they realistically will behave if conditions worsen. This can help them not only avoid selling at the bottom but also to take advantage of bargains when they present themselves, which naturally occur when market sentiment is very poor.

In the midst of chaos, there is also opportunity. - Sun Tzu, The Art of War

Our experience with financial advisors is that the best ones act almost like therapists and prevent clients from making bad decisions in difficult situations. Good financial advisors are also adept at optimizing for taxes and mapping asset allocation to a long-term financial plan.

If an investor chooses to work with a financial advisor, the emphasis should be on developing a sensible financial plan rather than leveraging any particular fund-picking or stock-picking expertise the advisor may claim to have. If anything, an investor may want to view extravagant claims in those areas as a red flag not to trust this advisor with his hard-earned money in any capacity.

76research Model Portfolios

Investors looking to derive the most benefit from our investment research efforts should consider subscribing to one of our thematic Model Portfolio packages.

As a Model Portfolio subscriber, you will receive:

• Continuous access to our top recommended investments and position weights (typically 10-15 securities per portfolio).

• Monthly portfolio reviews with detailed analysis and discussion of positions.

• Alerts on portfolio changes and insights into important news and developments on holdings.  

We currently offer three Model Portfolios:

• American Resilience

• Inflation Protection

• Income Builder

The 76research American Resilience Portfolio is designed to provide exposure to businesses that operate with competitive advantages in structurally attractive markets. The objective is to identify businesses that can survive and thrive across different macroeconomic environments and whatever geopolitical crises may unfold. The holdings are intended as long-term investments to drive portfolio compounding with minimal need to realize taxable gains. Emphasis is placed on critical markers of business quality such as barriers to entry, physical scarcity of assets, balance sheet strength, effective capital allocation and durable long-term demand drivers. These assessments are paired with careful consideration of valuation, risk and embedded expectations.    

The 76research Inflation Protection Portfolio emphasizes business models that are expected to perform well on a relative basis in periods of elevated inflation. Holdings are typically drawn from industries based on supply constrained real assets, including commodity and energy businesses, or companies that otherwise demonstrate superior pricing power. The portfolio may from time to time include certain ETFs when broader asset class opportunities emerge that align with the theme. Drawing from an investable universe of expected inflation beneficiaries, specific holdings are chosen based on valuation and general business quality, growth and risk considerations.

The 76research Income Builder Portfolio is intended for income-oriented investors and is managed to generate an overall yield that is materially higher than broad equity indices. The portfolio primarily includes stocks with above average dividend yields from a cross section of industries and may also include ETFs that offer exposure to fixed income instruments. While investments are screened for their income and income growth characteristics, specific holdings are chosen based on valuation and general business quality, growth and risk considerations.

76research Model Portfolios provide investors with a resource to construct and actively manage their own portfolios, giving individual investors an ability to bypass two layers of fees (financial advisory fees and fund management fees) and, potentially, two layers of conflicts of interest. Investors may choose to implement these model portfolios directly or selectively draw upon the ideas presented to assemble their own collection of direct holdings.

Is the era of actively managed funds over?

Model Portfolios provide an opportunity for individual investors to construct their own investment portfolios with several advantages over traditional fund-based approaches, such as actively managed mutual funds.

Financial advisors like to promote actively managed funds for a number of self-serving reasons.  

Often, there are various fee-sharing arrangements such that the financial advisory firm and the individual advisor directly profit from a client’s decision to invest through active funds. Advisors also like to promote their own familiarity with and access to active funds, including illiquid private funds, as some kind of value-added capability.  

Whereas financial advisors (once called stockbrokers) used to help clients build up their portfolios security by security, this practice has been drastically reduced as brokerage firms became increasingly concerned about protecting their brands from the irresponsible recommendations of some of their brokers. To the credit of these firms, retail brokers are ultimately salespeople, charming and persuasive, but often lack the training or experience necessary to guide the development of portfolios in any credible way.

While stock picking has been de-emphasized, just recommending that clients buy various passive products doesn’t work for financial advisors, either. Telling a client simply to buy the S&P 500 does not really help advisors justify their fees, which can approach 1% of assets under management. Passive investments also deprive advisors of various indirect revenue generation opportunities associated with actively managed products.  

On the other hand, active mutual funds provide financial advisors with a vast menu of opportunities that are difficult for clients to navigate. This necessitates paying up for the advisor’s “expertise.”

The active mutual fund menu, however, is not necessarily that appetizing.

Arguably the most important resource for mutual fund investors, Morningstar publishes an annual “U.S. Active/Passive Barometer,” which contains a wealth of data on the performance of various classes of mutual funds relative to passive alternatives over multiple time frames. The results are not pretty.

In general, actively managed funds have failed to survive and beat their average passive peer, especially over longer time horizons; one out of every four active funds topped the average of their passive rivals over the 10-year period ended December 2022. - Morningstar

Active funds fared particularly poorly in large cap stock categories, where individual investors generally have the most exposure. Over the 15-year period ended December 2022, only 9.3% of U.S. Large Blend funds (a category that largely resembles the S&P 500) outperformed the index. Interestingly, if not comically, only 3.0% of U.S. Large Growth funds outperformed. The odds of choosing a fund that will outperform its benchmark over a long period of time are, statistically speaking, quite low.

To make matters worse, the dismal relative performance of active mutual funds is on a gross basis. It does not even take into account the inferior tax efficiency of active funds. Active funds often exhibit high levels of portfolio turnover that can generate significant annual capital gains distributions. It is not uncommon for active funds to saddle investors with large taxable capital gains distributions, even in years when the funds deliver negative returns.

Why do active funds underperform?

In 1973, Princeton economist Burton Malkiel published the first edition of A Random Walk Down Wall Street, which would become an all-time classic. Malkiel proposed that the stock market was basically efficient, such that professional fund managers were basically no different from monkeys throwing darts. Some do better than average, some do worse than average, but as a class active managers tend to do worse than average because of management fees and other frictional costs.

Experience conclusively shows that index-fund buyers are likely to obtain results exceeding those of the typical fund manager, whose large advisory fees and substantial portfolio turnover tend to reduce investment yields. - Burton Malkiel

We would add to this explanation that the incentive system in the asset management industry actually discourages fund managers from trying too hard to beat the market. Knowing they will be compared to these benchmarks, fund managers often carefully structure their portfolios to mimic the performance of the indices, by, for example, making sure industry weights are comparable.  

The more a fund looks different from its index, the greater the risk of lagging it. Substantial, as opposed to mild, underperformance can be catastrophic and lead to major outflows, if not the collapse of the fund. In many cases, funds with strong track records that were built on differentiated positioning in the early years then switch gears and settle for mediocrity. The priority becomes simply to retain, and not jeopardize, the significant asset base that has been accumulated as a result of prior success.    

There is even a term for deviation from mediocrity—tracking error, the difference between fund performance and the index (italics added for emphasis). Successful stock pickers are invariably free thinking, independent-minded individuals with a competitive streak. Yet, for reasons of commercial logic, the asset management industry often seeks functionaries who will keep close tabs on what other people are doing in an effort to conform to them. These mindsets are incompatible.

Financial advisors themselves often have minimal interest in recommending a differentiated fund that veers significantly from its benchmark index. They know a client is more likely to abandon them if they are put into such a fund and it happens to perform poorly. Here again, the commercial logic of the money management industry elevates the pursuit of mediocrity.  

The direct investing alternative

A direct investing approach, utilizing low-cost passive instruments such as index funds and ETFs, along with a carefully curated portfolio of individual securities, has certain structural advantages over pooled funds.

Investors are able to engage in tax optimization strategies directly, managing the realization of losses and gains in a manner that fits their own circumstances. A direct investing approach, guided by model portfolios, also offers the advantage of greater liquidity and flexibility.

In many instances, active fund managers are constrained in their ability to implement their desired portfolio actions because of the sheer size of the asset base they manage. A multi-billion dollar fund often operates like a cruise ship, with any desired changes in direction put into effect in the most gradual way.

An individual portfolio could have the exact same holdings as a large fund but, like a small motor boat, can turn on a dime. Whereas a large mutual fund might take weeks or months to add or exit a holding without causing significant market impact, securities held within an individual portfolio can typically be purchased or sold with essentially instant liquidity.

An additional consideration is that direct ownership of securities gives one total control over proxy voting. When invested in actively managed funds, investors forfeit this opportunity to weigh in on corporate governance matters that are brought to a shareholder vote at annual meetings and on other occasions.

Many investors today find the ESG-based and otherwise politicized shareholder voting practices of many if not most asset managers incompatible with their own beliefs and priorities. By directly holding securities, investors can vote as they see fit, while also not lending financial support to asset managers who are operating in a manner they might find objectionable.

After decades in the business, it is with some disappointment that we do not have more encouraging things to say about professional money managers. But our interest is more in helping American families achieve their dreams, rather than protecting the reputations of the “croupiers.”  

About Trish Regan and Rob Hordon

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