Here's How to Beat 80% of the Stock Market Pros Without Even Trying

Investors often have a fascination with complex portfolio strategies, sometimes overlooking simpler options that could yield better outcomes. This trend is highlighted in recent research from Vanguard, which examined the asset allocations of rollover Individual Retirement Accounts (IRAs). Rollover IRAs come into play when investors transfer funds from their previous 401(k) accounts. Typically, these accounts are allocated to cash by default.

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In June 2024, Vanguard researchers surveyed more than 500 investors who had completed rollovers in 2023. These investors had between six to 18 months to move their rollover IRAs from the default cash allocation into other investment options. However, many remained invested in cash. The reason behind this, according to Vanguard's findings, was more often due to ignorance rather than deliberate decision-making. A significant 68% of investors were unaware that the default allocation for their rollover IRAs was cash, as shown in the accompanying data.

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Vanguard's calculations suggest that younger investors, particularly those under 55, could have significantly larger retirement portfolios if they were more proactive in managing their rollover IRAs. For instance, by moving their funds into an appropriate target-date fund instead of leaving them in cash, these investors could see an increase of at least $130,000 in their portfolio value by the time they reach age 65.

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One would assume that financial advisers would guide their clients on such simple yet impactful decisions, but that’s not always the case. Many financial advisers, according to the study, tend to focus on more complex strategies, even when straightforward solutions may offer better results. This tendency arises from a common trait in human nature, where we often equate complexity with superiority. Ted Lamade, managing director of the endowment team at the Carnegie Institution for Science, explains this behavior.

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In his essay "Take Something Away," Lamade argues that advisers, in an attempt to improve or upgrade their clients' portfolios, often layer on additional investments, asset classes, or securities. While this might appear to add value, it can lead to portfolios becoming unnecessarily complicated. Lamade describes scenarios where advisers may recommend expensive hedges to guard against a market crash, or suggest complicated options to manage volatility, or even advocate for leverage to boost returns in a low-interest-rate environment. These strategies may be intended to keep up with other investors or chase higher returns, but they often come at a cost.

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The problem with adding layers of complexity is that it can make portfolios more vulnerable. Investors may lose track of what they own, reduce their portfolios' liquidity and transparency, and end up paying higher fees for the added sophistication. Lamade points out that this complexity also tends to force investors into making decisions they had sworn to avoid, often during the worst possible times—such as in moments of market panic.

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Lamade proposes a simple solution: do more with less. Instead of constantly adding complexity to your portfolio, he suggests removing unnecessary elements. In his essay, Lamade writes that we live in a world with too much information, too many choices, and too many distractions. To improve portfolio performance, he believes the answer may lie in simplifying, not complicating. While Lamade doesn’t give specific instructions on how to implement this strategy, his advice seems to imply that investors should focus on the basics.

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A conclusion one might draw from this is that a sound strategy for most investors could be to invest in a broad index fund and hold it over the long term. This approach is straightforward and, based on historical data, tends to outperform more complex strategies. Over time, a buy-and-hold strategy with an index fund has a high likelihood of outperforming most active managers.

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To illustrate this point, the author recalls speaking to an investment group 40 years ago, where they predicted that investing in a broad stock-market index fund and leaving it untouched for the long haul would outperform 80% of active managers over the next 40 years. Reflecting on this prediction today, it turns out that the forecast was more than accurate. Based on data from investment newsletters tracked by the author's auditing firm, only 8% of newsletters that were tracked in 1984 have managed to outperform an index fund over that period. Additionally, 8% were ahead of the market when their editors stopped publication. The remaining 84% either failed to beat the market or ceased publication after falling behind.

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Similar statistics can be found in the mutual fund arena, where the majority of actively managed funds underperform compared to simple index funds. This underscores the notion that simplicity often trumps complexity in the world of investing. For most investors, sticking to a basic strategy of holding an index fund can prove to be far more beneficial than pursuing sophisticated and convoluted portfolio strategies.

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In summary, while complex strategies may seem appealing, the evidence suggests that simplicity—such as investing in index funds and maintaining a long-term perspective—can often lead to better results. Financial advisers and investors alike would do well to remember that sometimes, less is more.

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