Investing: The Wealthy's Secret to Success: Investment Strategies Unveiled

Are you ready for an enlightening discourse on the intricacies of passive and active investing? We're pulling back the curtains on the performance stats and diving deep into what makes these two investment approaches tick. We'll pick apart the foundation of index funds and go toe-to-toe with the common misconceptions surrounding active management.

Think investing is a solitary road? Think again. The investment world is a web, interconnected by the choices of millions. In the second part of our discussion, we throw light on how the actions of fellow investors can leave you staring at a significant loss. No stone is left unturned as we tackle the deceptive nature of incomplete information and the ripple effect it has on those outside the industry. 

Finally, we put passive investing under the microscope, laying bare the pitfalls and how media manipulation can alter investment outcomes. We debunk the myth of the "helpless" investor, underlining the power of understanding your investments and the concept of diversification. In our final chapter, we expose the strategies embraced by the wealthy. It's time to level the playing field and learn how to apply these principles to build our own financial fortresses. Roll up your sleeves and join us on this exciting journey as we demystify the world of passive versus active investing.

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Transcript

Speaker 1: 0:00

Well, folks, welcome back to Ditch the Suit. Steve Campbell here with Travis Moss. This is our Neverending series. At this point, as we've told you, we're just going to keep going with it. In our last episode, we talked to you about really along the paths of people looking to try to figure out how should I invest. We laid the groundwork that there's usually typically two schools of thought. You have passive investing versus active management. Travis laid out, I thought, a pretty compelling case as to why passive investing may not be the best way. But in this one now we want to actually start to talk about does passive investing actually outperform active investing? I want to turn it over to you, travis, if we had to make the case does passive investing outperform active investing? Where do we want to start?

Speaker 2: 0:45

Well, we're going to teaser here. We are actually going into some performance stats next episode. I'm going to set it up so that you have framework for the performance stats, because we've got to talk about this. Argument always comes down to what, on the 10-year and on the 20-year, 90% of funds outperformed or underperformed or something like that. It's all these very well-rounded numbers and very compelling statistics. Let's talk about how we come up with the statistics in the first place. First of all, what are we comparing? When we're talking about an index fund, that's akin to a robo-advisor. It's a preset formula. Again, it doesn't matter on the prices.

Speaker 2: 1:31

If you go back and look at part of the reason why people got washed out over the last 18 months on bonds, when you put your money in a mutual fund, you know what the mutual fund is not going to do, especially if it's an index fund. It's not going to turn around to you and say bad time when you buy bonds. You know, when you buy the bond, if you're going to lose money or make money on it, assuming that it matures, gets to maturity, you pretty much know what you have. So a couple of years ago, people were actually paying anywhere from a 10 to a 16% premium and their bond index funds. Why was that happening? Well, because people were shoving money into it and it's indiscriminately buying. If you were active, you would actually be making it truly active. So this is where the active part there's a nuance to it. It's active in the sense that somebody's making decisions on how, essentially, an algorithm is put together or how a formula is put together, but then it's just a formula and nobody looks at it again. So we've got a formula that nobody's looking at it again. So nobody says, hey, we shouldn't be buying that stuff. This is really dumb. People are going to get wiped out. They're making their fee, so they don't care. They like, put money in there, we'll keep making our fee.

Speaker 2: 2:44

But the point there is is that we've got kind of a formulaic robot, if you will, that's buying the investments, just grinding through them, right, and we don't even compare the robots to each other. We just say index funds be actively managed funds. Which indexes be actively managed funds? How many indexes be actively managed funds? That's what I want to know, because the actual index funds that you buy, not the figurative index, but the actual funds that you buy. When you say that funds underperform their index? How many index funds outperform the index, this theoretical index? Right, because we're going to go with performance and there are some big spreads in performance between different index funds, huge spreads. There are good ones and there are bad ones. So, first off, if we're going to compare things and say one group of things is doing worse than the other group of things based on, let's say, the percentages or the averages, we're going to take one and say the average fund, and then the other one, we're going to say the index, as if they're all the same. So first we got to make sure the fight is fair. What are we actually comparing?

Speaker 2: 4:00

If I go to the grocery store and I go up to the produce, how many people like Steve, when you go through the grocery store, do you just grab the first tomato that you see or do you look at the tomatoes? Can I look at them? Yeah, because you don't get something moldy right or something busted or something nasty looking and it's got slime all over or whatever. The problem is right. You look at the produce and you go.

Speaker 2: 4:20

Listen, sometimes I go and I want to buy a tomato. I don't buy anything because they all look rough, right. The lettuce is all wilted. So I don't buy any of that. And sometimes I go and I'm like, hey, that looks pretty good, but 75% of the stuff I don't even consider because it doesn't look right to me. So now we're going to say that all indexes are the same. We're not going to compare them at all, and we're going to say, okay, whatever the theoretical perfect index is, we're going to compare everything else to it, even though there is no theoretical perfect index. There's only stuff that you can buy that represents it. So we're not really being perfectly honest here about what we're comparing.

Speaker 1: 5:01

Well, that's great too, because, again, going back to our previous episode, people will many times throw their hands up in the air and say you can't outperform the market, it can't be done. So you just buy the index. But what you are doing which is kind of what we did in our AI series, which, if you're new to digital suits, go check out that can AI actually help you build a financial plan. The information is only as good as whoever put it in, and so I think what you're talking about with these indexes is information had to be input, which was an active decision as to what makes up that index. So, even though you're saying you can outperform it, it's not this magical, just investment that appeared. Somebody had to make decisions. So, as you kind of dive deeper into that, keep walking people through kind of this thought process to help them understand. If you want to challenge this, I'm all for it, but let's keep laying the groundwork then, as to where we're trying to take people as part of this conversation.

Speaker 2: 6:00

So the next challenge and we're going to get into the numbers that make us up again in the performance, but the next challenge is is that the studies can only include public equity funds or public mutual funds. Right, because you can have fixed income and stuff in there, but they're public funds and that's a key word, the public. This is again, if you don't know what to look for, you don't know if you're being duped. A public fund is a fund with a ticker that you can track online. You can track the performance online and in reality, though, mutual funds actively manage mutual funds or even index mutual funds. Put them all together. Put the mutual funds. Those are actually registered investment companies.

Speaker 2: 6:41

They make up a tiny portion of the overall investment managers in the country and in the world, like I'm talking, maybe less than a percent, tiny, tiny fraction of the actual managers out there, and we're doing a comparison between the public ones and a Theoretical index that isn't even consistent, like within its own ranks, right, but so somehow we're coming, we're extrapolating and we're saying this is what the index should have done, right, even though nothing that is behind it actually is consistent with that performance. So then we look forward and we say, and we're going to compare that to publicly managed or publicly available mutual funds and we're going to draw the conclusion that Enough of them do not beat the index to make it look good, even though and then we're gonna say active management can't outperform passive, even though Hundreds of thousands of investment managers are left out of the study, like literally hundreds of thousands we're talking thousands of mutual funds. We're talking hundreds of thousands of advisors that are left out of the study.

Speaker 1: 8:00

Doesn't seem.

Speaker 2: 8:01

Cherry picking doesn't sound a little bit like cherry picking Yep, and they don't disclose. I'm not disclosing it. I said public, so to the average investor, like that's everything you know, public. Or I say active managers okay. So it just sounds like that's, that's the whole group. It's a tiny fraction of the group.

Speaker 2: 8:21

Mutual funds are also generic portfolios, so people think of mutual funds as an investment. It's not. It's a portfolio manager with a portfolio. You give your money to the portfolio manager. He goes and buys stuff. The issue with mutual funds is he's not buying stuff for you, though. He's buying stuff based on money coming in out of the fund, based on a million other people putting money in and out of the fund, or however many people are investing in it.

Speaker 2: 8:42

Right, index funds have almost no impact from the flows. Remember I was talking about the bond funds. You give money to the fund. The fund goes and buys the bonds. Right, you take money out. The fund sells the bonds. They don't care what the price is. It doesn't matter. There's no strategy to it. Right, it's, it's, it's formulaic. But then you've got active managed funds.

Speaker 2: 9:06

If I give a an actively managed mutual fund, when these public funds my money, they put it in. Now they're doing all kinds of investment strategies. There's certain companies that they want to buy. There's certain amounts of the companies they want to buy and they start doing good. And then what happens? Everybody goes look at how good that funds doing. It's beating the index. So then other people want to invest in it. So other people bring their money and the fund goes from maybe at half a billion dollars in size when it was doing really good, and now it's 200 billion dollars in size.

Speaker 2: 9:35

Well, guess what's changed? How the fund can run, what can buy? Because now it, if it has a mandate where it can't own, actually own the companies is investing in, it's got to spread its money across more ideas. So the fund is actually changing because other people want in on it. So what you had when you found it, when it was really good, has changed because of other people.

Speaker 2: 9:57

And then the market starts to get crazy and people start to get scared because of what they say in the TV and people go and say give me my money back.

Speaker 2: 10:04

Well, now the fund is forced to sell things that if it was just you, if you were the only owner of the fund, you would not be selling. But it's not up to you because other people want to damn money back, so they're gonna sell off stuff that you would never have sold off yourself had you had the, had you had the right not to. Basically, so now you've gotten larger than average losses, not because of what you were doing, not because of what the market's doing, but because of what other people are doing. That's a and that there's a difference between a publicly managed fund and An investment manager that's managing a portfolio specifically to for you that is not influenced at all by what other people are doing, and those that group of people is completely left out of this calculation. So you're getting the generic stuff Right that is designed just to make fees I as opposed to the stuff that is designed just for you. Yes, they make fees, but it's fundamentally different and they're left out of the comparison and they're getting unjustly labeled because they're quote active.

Speaker 1: 11:15

Hey, at Ditch the Suits, we're all about bringing you great resources and you're obviously here because you love podcasts. Well, what if we told you that I, one of your co-hosts at Ditch the Suits, has now launched my own podcast? If you like the tone of obviously you've learned in this episode, I try to always bring kind of the heart of the issues that we bring, to bring it full circle as to how to apply it to your life. Well, if you want to head over and check out the One Big Thing podcast, it's an inspiration and encouragement podcast where my job is to help you, as a listener, really move the ball forward, to take you from inspiration to transformation. So, if you like podcasts, be my guest, head over to the One Big Thing podcast today and take a listen.

Speaker 1: 11:55

There's a lot to digest, even just kind of, with that, because what basically you're saying is to the individual consumer who is raising their hand saying I need help, please tell me what to do. They are seeking out information but getting inaccurate or incomplete data backwards, which then they're making judgment calls on which may be limiting or reducing their ability to do what they originally wanted to do, which was just make money over time so that they could take care of their family, live their life. So this is where the conundrum is breaking down. You are more than money. It's about your life, but money is a major component. You are getting incomplete data but because you're not in the industry itself, you're not able to sift through that data. So when you read statements like outperform compared to it would be like trying to explain to me what you do in your job and me just nodding along being like that's great. I mean, I wouldn't even know what questions to ask.

Speaker 1: 12:57

When you don't know what questions to ask, you end up taking information and maybe taking action on it, but it's an incomplete story. So I know, when we talk indexes and numbers and stats, man, it can be so overwhelming to somebody who's like I don't really maybe know if I understand what we're talking about. But what you're trying to basically do is say it's not a fair comparison of. All we're doing is comparing apples to oranges, but packaging in such a way that you think we're comparing, doing two different kinds of apples and I loved your analogy. I think you said it in our last episode. We're grouping things together in an inappropriate way but writing in such a way that we're making it seem like this is always what happens, and so individuals are confused, and Travis and I are here to acknowledge that we understand why, because even us on this investigative journey of trying to understand what in the world is on the internet today, when it says how to invest, it really is a lot of crap that's not actually helping you. A lot of it's copycat too, steve.

Speaker 2: 14:00

A lot of it is somebody wrote an article and I got a lot of clicks of somebody just copied it and when you trace it back they're all referencing probably very similar source material which wasn't properly argued, which is easy to accept. So where they go in.

Speaker 1: 14:17

People don't also understand this about the power of media today. If you're on LinkedIn, for example, which is a professional platform where people share information and news, if you see an article that's got, you know, 15,000 likes, the assumption is that this must be a great article, that's an authoritative piece. But what you don't realize is that someone may have paid a third-party Application to force feed likes to that article. That, when you actually do, do this as a fun example.

Speaker 1: 14:48

Yeah, if you ever see an audio if you ever see an article that has, you know, thousands and thousands of likes and reshares, click on the likes and start to go through the list of who the people are that are actually liking it. And what's crazy Is it's like, when you actually look under the hood, it's not your neighbor and all these co-workers and all these people. It's bots. It's trolls. It's people in other countries that it. This is what's hard about trying to sift through media in 2023. You want truth, but truth many times takes work, effort and investigation on your end. So what Travis and they're trying to do is give you the tools to sift through All this information so that you can make the best decision for your family.

Speaker 2: 15:37

Yeah, we actually, we know somebody owned a business that they want to become kind of social media influencer on their business and they hired a company out of India to put thousands of likes on every social media post. And you, as, like you said, you as a consumer, your most people are not going through the 2000 posts and and and questioning who are all these people? You just go, wow, you know, look at how popular they are, and so it's very easy to trick people into and then, once, once they're tricked, it's very easy to Build upon that right, because we're always looking for the next hot thing, right. But think about it like this One of the things that's happening with all mutual funds, all mutual funds, is the average investor, I think, is being damaged because of others.

Speaker 2: 16:30

So you're being damaged because of what other people are doing, the reactions that other people are having, not understanding what they're doing. Right, you're in the fund, you're very happy You're making money. Somebody forces money in there, forces the fund to start investing differently. Now, you're not making money. You're in the fund, you're very happy. People start yanking their money out, forces the fund to start sign off Not very happy. It's impacting you. Right, you're in an index fund and you thought that you were going to be doing you know a certain way and that index, for some reason under poor forms other indexes by 3%. Right, you're now that's that's more driven by regular market economics typically, but there are some active decisions that's happening in there, but you're being impacted a lot by others and you're being damaged by others.

Speaker 2: 17:13

You are losing performance because of others. They're telling you that you're helpless. There's nothing you can do about it, which is just foolishness. Anytime somebody tells you you're helpless, you probably need to like get away from that person, right, because very few people are helpless. But you're being damaged by others for the benefit of others and you're like well, who benefits from this? The investment Companies that sold you the lie in the first place? Right that once. Who are telling you you can't do any better without us. There's no way you can do this. You have to have index investing, right? Or the ones that are telling you that you know this is a good investment. Well, what is a good investment within it? Right? Or that there's a difference between and I understand there is a difference in growth and value. But back to our thing. It's on the higher the beholder and yes, there's some statistical differences that you can kind of draw a line and make it obvious, but there's still an awful lot of sub. You know subjectivity as Motley Fool said, you could be both a growth and a value. So how does that even work? You know there's going to be, you know, some subjectiveness, from company to company, investment firm to investment firm, index to index. And think about it like this From you go into that, you go to the store.

Speaker 2: 18:31

You're in college. You go to the store, you buy a bunch of food. I remember being in college and I was so proud of myself and called my mom. I'm like I went to the grocery store and bought groceries first time ever. I'm like I'm so proud of myself. She's like good for you. Well, you're an adult now, congratulations. But you buy all your favorite food stuff. You have to stick it in the fridge or whatever. And then your roommate comes home and he's been on a bender and he's got the late night munchies and it wipes out your supply. Okay, it's not that you didn't buy food, it's that somebody else ate it on you. You know, that's a good analogy. I see you laugh. That's like a good analogy for what we're talking.

Speaker 2: 19:06

And the last argument that I'll leave with and then I'll simmer down diversification. People will say but I'm more diversified in the index fund. You are not. An index fund is no more diversified than an actively managed mutual fund. The reason why is it's a portfolio. You get the average performance of the portfolio. You get one thing, that's all you get. You cannot go into the index fund and decide what to sell and what to buy. You have no control over that. You have the average of the performance of the underlying holdings. What do you get with an actively managed fund? The average of the underlying performance of the holdings, of the underlying I'm sorry, the average performance of the underlying holdings.

Speaker 2: 19:47

It's a one-to-one comparison. You are no more diversified in one versus the other Just because you own 500 stocks in one and 100 stocks in the other one. That actually doesn't make you more diversified, because a lot of those 500 stocks are correlated, meaning they have perfect correlation. They go up and down at the exact same time. Therefore, you don't have diversification. Diversification is an idea that I want things that go up and down at different times and different paces, and stuff that helps me smooth out the ride. You're not more diversified just because you have 500 stocks versus 100. That's a complete fallacy. Again, somebody's eating out of your refrigerator. It's just silliness, but it's easy to just. It sounds so good. I can just buy one thing instead of my hands. Travis, I don't have to be challenged by you anymore.

Speaker 1: 20:46

You think about it this way. The big story is you can't beat the market. At least you made a decision that you can't beat the market. You become a passive investor. Every time the market has a major downturn. You write it all the way down and you're reminded that you just can't beat the market. When the market takes back off, you're told you just can't beat the market.

Speaker 1: 21:10

My question to you is it's the same story no matter what happens, but it makes you feel good because at least you're doing something. If we're saying that there's potentially a better way, then we want to be able to back up why we see it this way, just so that you have a frame of reference for understanding that there is so much information that's out there. That's very confusing, going through and getting the truth as to. You probably just rocked a lot of people's worlds by saying that just because you own a number of different mutual funds doesn't make you any more diversified than owning individual stocks. That's going to be counterintuitive to, maybe, what somebody was taught by a colleague or read in a book. The reason we have to have this conversation is the number of people that are searching passive investing and maybe missing the mark a little bit.

Speaker 2: 22:03

You know you just made a couple more really good points that made me think. So I'm not quite off my soapbox yet. One of the questions you got to ask is do I want to beat the market? There's a lot of mutual funds that are compared to an index.

Speaker 1: 22:18

They're not trying to beat the index.

Speaker 2: 22:19

Let's say that you're trying to get 90% of the market return and only 75% of the risk. You're trying to smooth the writeout for people and give a little bit off at the top to have more consistency. Why are we comparing that then to the index? What index are we actually comparing it to? Again, is it a growth fund? Is it a value fund? Is it a blend fund? Is it a small fund? Is it a large fund? How do you even compare? You categorize it, but how do you categorize a strategy to an index?

Speaker 2: 22:52

It's really really, really hard when you start digging in this to actually justify what people are being sold. My last question to people is if you think nobody can beat the market, how do the rich keep getting richer? Because they're beating the market? Because if everybody can only do average over the long run, nobody's moving, Nobody can get, nobody can go up. If you're all average, why do some people end up with a lot more? You could say, well, because I just let it be average the longest. There are people that make up incredible ground very fast, and how do they do it? It's not all luck. There are people out there that make a lot, that understand how money works and make a lot of money through investing, but they're just not doing the same things that the person who's out there saying, well, we can't make anything more than average. I guess we'll just stick with the index. There's something different happening.

Speaker 1: 23:50

Well, I gotta assume, if you're in digital suits, you probably have an inner desire to be anything more less than average. You have a desire to be the best, to do your best. Stick with us for this next episode, because I think it's going to be helpful too. Okay, if you're telling me that there's something that rich people do, how do I build a frame of reference that's going to get me to that point? As always, though, as you stop by digital suits, don't forget, folks, that not only can you listen to digital suits on every major podcast platform, you can actually watch alongside with Travis and myself, on NQR YouTube channel. That's NQR media. It's our YouTube channel. Watch all these episodes, as well as our other flagship shows with NQR. The one big thing our throat college planning. Get over there, check it out. Stick with us for this next episode. I think it's going to bring a lot of this home for you.