How to Easily Outperform Financial Advisors, Robo-Advisors & Index Investors

Financial freedom is what we all want.

We talk to people about their finances all the time and most people just want to know that their money is there, and they can live their life the way they want, but very few Canadians actually get there. Why?

Most Canadians are not financially secure because of sub-optimal investments and focusing on the wrong risk.

In my latest blog post, YouTube video, and podcast episode I’m going to show you how to outperform all these methods:

• How to easily outperform financial advisors, robo-advisors, and index investors.
• Why is good performance important for your life?
• What rate of return do you need to become financially independent?
• What are the 4 performance drags that reduce investment returns?
• What is the Asset Allocation Loss Ratio (AALR)?
• Why is it easy to outperform financial advisors?
• What is wrong with the investment industry definition of “risk”?
• Why is it easy to outperform robo-advisors?
• Why is it easy to outperform index investors?
• How can you learn to think properly about investing?
• What are the secrets to outperforming?

Financial Freedom & Financial Security

• Why do few Canadians:
  • become financially independent when they want?
  • retire with their desired retirement?

Sub-optimal investments.

Focusing on the wrong risk.

Why is good performance important?

Modest Retirement Plan – Married

Age 35, married, earn $50,000 each. Retire at 65 on $40,000 each in today’s dollars.

Save for 30 years. 3% inflation. Both get maximum government pensions (OAS & CPP).

Balanced Portfolio – 5%/year

• Magic number: $3,000,000
• Invest $34,000/year.
• Impossible!
• Invest 34% of gross income!

Equity Portfolio – 8%/year

• Magic number: $1,550,000
• Invest $13,000/year.
• Invest 13% of gross income.
• Maximize RRSP.

Risk of a Fear-Based Mindset

Need to invest $21,000/year more to make up for 3%/year lower return of a balanced portfolio.

Why You Need a Growth Mindset

You cannot retire comfortably on a 5%/year return of a “balanced” portfolio.

Comfortable retirement requires 7-8%/year returns of an equity portfolio.

70-90% of retirement income over 30 years is growth after you retire.

You need growth after retirement. 

Nightmare

 Typical financial advisor meeting
* No retirement plan.
* Moderate risk tolerance.
* Balanced portfolio.

You cannot retire comfortably with a balanced portfolio.

4 Performance Drags

This post is about performance. How to get the maximum reliable long-term return. It is not about risk-adjusted returns. It’s about getting a high enough return to achieve your life goals in your Financial Plan.

You can EASILY Outperform Financial Advisors, Roboadvisors & Index Investors because they use the 4 performance drags:

1)  Fixed income / bonds – Forced bond investing (FBI).

2)  Home country bias.

3)  Riding the brake – Investing too conservatively.

4)  One-idea investing – “Honey I shrunk the universe”.

Short-term thinking vs. Long-term total return investing.

Invest for maximum reliable long-term total returns.

1. Risk of Bonds to Your Retirement

To retire comfortably, bonds are dead as an effective investment. 

Short-Term Risk vs. Long-Term Risk

Focus on the right risk. Long-term risk affects your life.

What is the Asset Allocation Loss Ratio (AALR)?

The Asset Allocation Loss Ratio (AALR) is the difference between the expected return of a portfolio and a broad index.

“Asset Allocation Loss Ratio” (AALR) reduces your returns.

Sub-optimal asset allocation.

Asset Allocation Loss Ratio (AALR)

20% bonds = 1%/year loss in your long-term returns 

2. Home Country Bias

• In every country, they think investing in their own country is safer.
• This is dumb in every country (except possibly US).
• Iceland investors had 80% invested in Iceland countries (before 93% crash).

Last 15 years:

Country Index Return $1,000 grew to

Canada TSX60 9.4%/year          $3,830

US S&P500 15.3%/year        $8,510

Global MSCI World 12.6%/year        $5,960

3.       Riding the brake – Investing too conservatively.

Focusing on short-term risk.

Short-term thinking is the risk.

Any method to reduce short-term volatility probably reduces long-term return.

Sub-optimal investments.

Many methods:

• Balanced or asset allocation or target date funds.
• Income investing. GICs, bonds or income funds.
• “Low Volatility” funds.
• “Smart Beta”.
• Conservative stocks: Infrastructure stocks, dividend investing, real estate stocks, home country bias, etc.

4. One-idea investing – “Honey I shrunk the universe”.

• Reduces your universe of available stocks to one subsector.
• Dividend stocks only – Mostly Canadian dividend stocks.
  • Dividend investing is a brain fart.
  • A dividend – Selling some of your investment.
• Tech stocks – 25 years ago. Nortel stories.
• Trendy ideas:
  • Low volatility.
  • Smart beta.
  • Pot stocks.
  • Crypto.

Why is it easy to outperform financial advisors?

Conventional wisdom is they underperform because of fees, but there is a bigger reason.

They don’t even try to outperform. They try for: “Reasonable return with less risk”.

• They use the 4 performance drags.
• Especially bonds, home country bias & riding the brake.
• Performance drags are bigger effect than fees.
• Bad market timing. Buy more of last year’s winner.
• Focus on short-term risk.
• Focus on market fluctuations, not your retirement goal.
• “Compliance advice” leads to Forced Bond Investing (FBI).
• Marketing reasons. Don’t want to lose a client in a down year.
• All do “risk tolerance” so you don’t invest too aggressively.
• Few do financial planning, so you don’t invest too conservatively to achieve your life goals.
• Underperform because: “Reasonable return with less risk”.
• Effective investing: Maximum reliable long-term total returns

Why is it easy to outperform robo-advisors?

• They don’t even try to outperform. They try for: “Reasonable return with less risk”.
• Robo-advisors are big investment companies, not financial planners. They are more likely to lose a client because of a 30% 1-year market decline than 10 years of lagging the index. So, they focus on market fluctuations, not your life goals.
• This makes them use “performance drags” that typically reduce their returns by at least 1-3%/year.

• They used forced bond investing (FBI).
• Often home country bias & riding the brake.
• Story of aggressive engineer that “gamed” the risk tolerance questionnaire. Still forced to take 20% bonds.
• Story of 2016 Trump election & robo-advisor lagging index by 10% in 6 months from low volatility & smart beta ETFs.

Why is it easy to outperform index investors?

You would expect an index investor to invest entirely in 1 or 2 broad index ETFs, such as MSCI World, MSCI ACWI (all-cap), or S&P500 to get the index return. This is probably maximum diversification and pure indexing. Instead, most invest in a few indexes that are usually a more conservative or non-optimal asset allocation.

• They use bonds & home country bias.
• Common asset allocation ETF:
  • 25% bonds, 25% Canada, 25% US, 25% International
  • 25% bonds = 1.25%/year loss in long-term return.
  • Dramatically overweight Canada.
  • Underweight US (highest growth country).
• One broad index might be smart (global or US).
  • Get close to full index return (less a small tracking error about .5% for global equity index ETFs).
  • MSCI World or MSCI All-cap (ACWI) is the broadest diversification.
    • Adding more ETFs is over-weighting some areas, not more diversification.
  • 3+ ETFs is likely a sub-optimal allocation with lower long-term return.
• Lower fees, but AALR is usually larger than fee savings.

How can you learn to think properly about investing?

• Look for maximum reliable long-term total returns.
• Stocks (equities) are the highest growth asset.
• Risk tolerance is a learned skill.
  • Study stock market long-term history.
  • Learn about past market crashes – Size & length.
  • A proper equity portfolio is reliable long-term.
  • Worst 25-year return of S&P500 in modern stock market is 8%/year. (calendar returns since 1930)
• Turbulence tolerance – Short-term risk vs long-term risk.
  • Don’t jump from the plane. Flying is fastest way to get there.
• Need a method you are confident in long-term.
  • E.g. Broad index or All Star (world’s best investors).
• We invest for “above index returns” with an elite portfolio manager that finds the world’s best investors that all have 15 to 30-year track records beating the index after all fees. Most fund managers lag, but just like any field, there are some amazing people that outperform. We try to beat the global equity index after all fees, including ours, so that our fee-for-service financial planning advice is purely value-added.
• We are confident our portfolio manager will match or beat the index over time. 100% of my personal investments are with the same portfolio manager and same All Star Managers as our clients.

What is “investment risk that affects your life”?

• Risk of not achieving the life you want.
  • If your Financial Plan includes an 8%/year rate of return to  have the retirement you want, then risk is the risk of a 30-year return below 8%/year.
• Long-term risk:  <8%/year return
• Short-term risk: Short-term decline
• Long-term risk affects your life.
• Growth-focused, optimistic view of your life.

Long-term risk is the right risk to think about.

Risk Tolerance – A Learned Skill

The ability to do nothing when your investments go down.

Stock Market Predictions

I do not know what will happen this year.

I do know that 25 years from now, the stock market will be 7-17 times higher than today.

What are the Secrets to Outperforming?

1. Invest 100% in global or US equities. (0% AALR.)
2. Get all the return of bull markets. (Don’t forecast.)
3. Buy more stocks when on sale. (Beats the market.)
4. Avoid the 4 performance drags.
5. Be confident in long-term growth.
6. Above index investing – All Star Fund Managers.
7. Leverage. The most effective method to grow wealth.

Ed