Source: Standard & Poor’s Indices Versus Active Funds Scorecard (SPIVA) 2014. Index used for comparison: US Equities — S&P 1500 Index; International — S&P 700 Index; Emerging Markets — S&P/IFCI Composite; US Fixed —Gov. Short, Global Fixed — Barclays Global Aggregate. Outperformance is based upon equal weight fund counts. Index returns do not include payment of any sales charges or fees an investor would pay to purchase the securities they represent. Such costs would lower performance. Past performance is not an indication of future results. More recent performance may alter these assessments or outcomes.
A similar version of this article appears in the Winter 360 Insights Newsletter.
It all begins with markets. But what are capital markets? What functions do they serve in our economy and society?
By definition, markets allow investors to provide capital in exchange for the potential creation of wealth. In society, markets play a critical role. Here’s how: Investors provide capital and bear risks. In exchange, they receive compensation for taking on risks. This is how wealth is created.
Successful investors know that in the real world, not all risks are worth taking and that they should only bear risks for which they are adequately compensated. For example, investors will not be commensurately compensated for risks that are unique to a single company or single industry, as these idiosyncratic risks can be eliminated (costlessly!) through diversification. (Diversification neither assures a profit nor guarantees against loss in a declining market.)
This common sense logic leads us to the first role markets play: Markets let investors diversify away idiosyncratic risks. Simply put, modern capital markets (post-1960s) make the compelling case for the benefits of portfolios over individual stocks.
When we think about the existence and role of Intermediaries in capital markets, we get to the second role markets play in society: Through intermediaries, markets can allow investors to diversify more easily and efficiently. Modern capital markets allow investors to let intermediaries (for example: mutual funds) diversify away certain risks at low cost.
The third role of markets is around information: Markets allow investors to collect and trade on information. New information is continuously and rapidly reflected in market prices for all securities. Investors trade on this information — all at relatively low costs. Many active managers, market timers and stock pickers charge high fees while proclaiming that they can outguess the market. They invest to uncover any information in an attempt to find mispriced securities.
An unintended consequence of many investors constantly scouring the market for mispriced securities ironically creates an efficient marketplace for all investors. The larger outcome: Markets become informationally efficient over time. Simply put, on average, market prices contain fair, although not perfect, information for investors.
As the chart above shows, most active money managers consistently fail to beat the market, providing us strong evidence that you can trust markets to work and lean on prices — and let the market work for you, a cornerstone principle of Loring Ward’s investment philosophy.
Wharton professor and publisher, Jeremy Siegel, has done amazing work looking at real returns of U.S. Indices going back to 1802. The chart below makes a case for the wealth creation ability of the market and of capitalism, generally. Whether you look back 20, 40, 80, or 200 years, here are some trends we see through history:
- In the long-run, the real value of the equity premium over other investments clearly exists (although not without additional risk), and we can think of no reason why this might change in the future. As long as people continue to need goods and services, businesses will exist to fulfill this demand and will continue to thrive.
- Through world wars, civil wars, political unrest, natural disasters, over 50 recessions, depressions and various crises, the market has marched steadily upward, with each “all time high” eventually surpassed by yet another.
- Over the long run, gains from stocks have significantly hedged inflation along with bonds.
Last but not least, economists tell us that markets allow us to smooth out our inter-temporal consumption over time. This means that when you use markets to create and grow wealth, you are no longer constrained to consume or spend based solely on your paycheck. Instead, markets allow greater freedom for wealth to be transferred across time to consume whenever you want to, rather than based only the timing of your earnings. This logic applies most powerfully to retirement planning: markets enable us to save now in anticipation of our future financial requirements in retirement. After all, stocks and bonds are claims on future cash flows that you could either use for current consumption or, to keep and sell in the future, as needed.
Highly competitive global financial markets offer us social value in the form of the following abilities:
- Trusting prices
- Knowing, through historical evidence, that market timing and stock picking just do not consistently work
- Allowing diversification of portfolio risk at lower cost over time
- Enabling investors to balance risks and rewards
- Investing in risky assets to obtain higher expected returns
- Deferring consumption until later, as needed
Intermediaries in markets can give you the ability to tap into these social values without having to experiment or pay high fees. We know that markets work. Instead of trying to beat or outguess the market, we help you harness the power of markets and allow the long-term growth potential of global markets to work for you.
All investments involve risk, including the loss of principal and cannot be guaranteed against loss by a bank, custodian, or any other financial institution.
Stock investing involves risks, including increased volatility (up and down movement in the value of your assets) and loss of principal.