Peaceful Wealth – The $100 Billion Question (Is Your Investment Strategy Robbing Your Retirement?)

How much money, time and energy do you spend each year trying to beat the market?

Don’t duck the question. Have you every calculated the expense ratios, trading costs, tax implications, bid-ask spreads, wrap fees, front-end loads, back-end loads, sales commissions, surrender charges, management fees, newsletter subscriptions, magazine subscriptions, books and software purchases, or any of the other direct costs you pay to try and beat the market?

How much time do you spend reading articles, newsletters or books on secret trading strategies or hot market forecasts? Have you ever logged the number of hours you spend watching expert commentators discuss the market, the economy, the Fed, the credit crisis, International economic conditions or any number of other investment related stories of the day?

And how about the hours and energy you personally expend thinking about (or worrying about) all your investment options in an attempt to decide what is the right course of action to achieve your financial goals?

Be honest now, do you have any idea what it costs you each year to try and beat the market?

Professor Kenneth French of Dartmouth has, and the number is staggering. In his paper titled “The Cost of Active Investing”, Professor French discovered investors collectively spent $99.2 Billion in 2006 and $100 Billion last year trying to beat the stock market.

$100 Billion! A mind-blowing number.

We’re not talking about making any money. $100 Billion was the amount of hard earned savings investors in the U.S. stock market spent trying to achieve superior returns as compared to simply investing in a passive index that, by definition, provides investors with market returns.

I know your next question. Was it worth it? Did investors get what they paid for?

You know what the answer is, but will you embrace it?

On both fronts the answer for the average investor is a resounding no!

No, the $100 Billion did not buy the average investor superior returns. DALBAR, Inc. found the average investor underperformed the S&P 500 by an annual average of 7.33% from 1988 to 2007.

No, the average investor will continue to spend ludicrous amounts of money, time and energy attempting to beat the market. The $100 Billion spent to beat the market in 2007 dwarfs the $7 Billion investors spent in 1980.

What about you? Do you want to be average and continue to spend and worry your way through another year of unfulfilled promises and expensive lessons delivered on the silver platter of your broker or insurance agent’s broken business model of investing? Have you run your numbers and compared your costs, your risks and your performance to the appropriate benchmarks to calculate if you are winning or losing the race to fully fund your retirement and outlive your money?

The longer you wait, the more dearly it may cost you. Professor French argues investing in today’s market is not a zero-sum game. The definition of a zero-sum game is an equal amount of winners and losers. If there were no costs involved, the highly competitive and free market capitalism of the U.S. stock market would be a zero-sum game. But when you start the game by shelling out $100 Billion a year to actively pursue winners you immediately make investing a negative-sum game resulting in even more losers.

And the more you spend and the harder you fight to win, your chances of winning become even smaller. Why? Because the pool is getting smaller and costs (and risks) are increasing each year. Professor French calculated that the percent of money invested in index funds has more than doubled since 1986, totaling 17.9 percent of the market. The pool of investors who remain actively spending their savings, time and energy tying to beat the market is shrinking, meaning each one personally bears more of the costs and more of the risks in an every increasing negative-sum game.

Not a pretty picture, especially with your retirement and financial well-being on the line.

So what should you do?

It all comes back to asset allocation and pursuing an investment strategy designed to meet your return objectives, time horizon and reward vs. risk comfort zone.

Do not pay for a bunch of “really great mutual funds” or lots of hot, sector specific stocks, commodities and ETFs under the premise of diversification. Do not waste your precious time and resources trying to forecast markets, uncover hidden gems or bet on potential “ten baggers” by acting on hot stock tips.

Learn how markets work or trust the hard work to someone who does. You, or your financial advisor, must understand modern portfolio theory, structured asset class allocation, the Fama/French 3-factor model, efficient market hypothesis, risk analysis, regression analysis and portfolio optimization.

You want to insure your portfolio is ideally designed for both the market and for your specific circumstances. It must embrace modern financial asset class allocation models and reject active management to insure you maximize your return potential and your value.

Any portfolio containing an actively managed “house” fund or any actively managed mutual funds with front-end sales loads (A shares), back-end sales loads (B shares), high expense ratios (your portfolio totals should be under 0.45%), annuities or management fees exceeding 1.0% is one you should carefully and critically examine to insure you understand your impediments to long-term returns, your risks and just how much of your money is transferring out of your pocket and into the pocket of your sales representative.

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