the know-nothing investor

My days as a trend follower were over. Even if I tried to make money out of the markets as a trader, probably trend following would not be the best way to do it, specially in the post-crisis of 2008.

It was time to have statistical data on my side and this meant to have a geographic diversified multi asset portfolio with periodic rebalancing for a very long time. The truth is that long-term investor in the long run will beat the majority of short-term traders (here and here). But how long is it to invest in a long term basis? For me I thought about my retirement so I decided to invest for a period never less than 30 years.

I had quit trying to get rich in two or three years, instead it would take me 30 years but at least I wouldn’t get broke in the process.

Nevertheless, 2012 had taught me two lessons that needed to be quickly addressed to achieve good performance in the markets:

• Brokerage costs were a substantial part of my losses.
• Every Time I had a profitable trade I would pay 28% of it in profit taxes.

In 2013 I changed to an international broker, based in US, which guarantees minimum fees and on profit taxes I decided that my portfolio would only buy and for rebalance purpose I would only use fresh money instead of selling winners to buy loosers. At first it will be easy, after my portfolio gets bigger in value it will get more complicated, but I’ll use dividends money and if needed I will sell. But is like that old saying “dying and paying taxes later the better” and with this simple tax planning it will allowed me to legally escape paying taxes for a long time.

The last thing to decide was what kind of financial instruments I would use to make my long term portfolio and here I quickly restrain my option to two: exchange tradable funds (ETF) or mutual funds.

Based on my conviction on having a portfolio with lower expense ratio as I could, I opted for ETFs.  Although ETFs don’t seek alpha their associated costs are cheaper than those in mutual funds. ETFs only purpose is to track an index, a commodity or a bundle of assets, so they don’t have active management like mutual funds. Besides all cost associated with buying, selling and owning shares, in mutual funds you also need to pay the people that actually run the fund. They can be quite good and excel the performance of whatever benchmark they are following but then you also need to excel and choose the right ones. If you don’t choose a correct amount of right ones probably you will end annihilating any alpha possibility. On the other hand, if I failed as a stock picker why I should I be good at picking mutual funds?  Past performance are not a good indicator of future returns and If you don’t choose the right ones or the management teams start to have worst performances you will need to turnover your portfolio and that will erode your portfolio’s value in taxes and other fees associated.

But how are the performance of those management professionals, that year after year try to beat the market, creating in your portfolio an extra-value? Not great, especially in the long run as you can read here in this great article of Rick Ferri. To resume it, I just want to mention this paragraph: “Maintaining consistently high performance is so difficult for fund managers that less than half (10% to 20%) of the top quartile funds were even able to stay in the top half over the next five years. Approximately 30% to 40% of funds in each category finished in the top half after accounting for funds that go out of business, merged with another fund or changed style categories.”. Of course this tend to get worse as time passes by.

So I realized I could done the same amount of harm to my money as professional and I decided for ETFs.