In this episode of Your Business, Your Wealth, Paul and Cory continue their discussion on illusions of investing in the marketplace. Specifically, they focus on the illusion of investing based on the successful track record of asset management firms. Nobody can consistently and predictively outperform the market, not even the highest performing mutual funds. Paul proves this concept by analyzing numerous top performances of asset managers across multiple years and half decades. Finally, Paul speaks to the Dollar Coin experiment he and Cory performed at a recent conference.


  • 01:12 – Introducing today’s topic, Does 20/20 Hindsight Help?: Illusions of Investing, Part 2
  • 02:11 – Paul recaps the last episode of the podcast, how wealth managers cannot predict and outperform the market
  • 03:01 – Illusion Number Two: track record investing
  • 04:18 – Paul analyzes data from the top thirty equity stock-based mutual funds
  • 06:39 – Why people choose asset managers with better track records
  • 09:16 – Analyzing top asset manager performances from 2012 – 2017
  • 10:21 – Paul provides one final example of top asset manager performances
  • 12:50 – Paul interrupts the podcast to provide the audience with a special offer
  • 13:55 – The Dollar Coin Exercise
  • 17:47 – Emotions and rationalization
  • 20:52 – Why past performance cannot guarantee future results



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“Legends Are Made” Copyright 2017. Music, arrangement and lyrics by Sam Tinnesz, Savage Youth Music Publishing SESAC and Matt Bronleewe, UNSECRET Songs SESAC

Full Episode Transcription

Paul 0:00

But at the end of the day, even their prior success can be attributed to nearly random chance in the fact that people are just trying to beat the market in a way that is not likely that they’re going to be able to do so. Welcome to your business your Well, we’re your hosts, Paul Adams and Corey Shepherd teach founders and entrepreneurs how to build wealth beyond their business balance sheets.

Unknown Speaker 0:43

This is how

Cory 0:47

Hello and welcome to your business your wealth. I’m Corey Shepherd, president of sound Financial Group and co host of this show with Paul, I have a whole Armory in my beard atoms are right To wrap for that was Paul just like Chuck Norris, I only have a beard underneath my beard Adams. Sorry, I couldn’t, I couldn’t do just one. In case you’re just jumping in, we’re in part two of a series called illusions of investing. And they’re set up so that you can just keep listening right here. If you’re just jumping in, no need to stop. But once you’re done, definitely go back and start from the beginning because some there’s some great content there. And we’re really recapping a series of conversations that Paul and I had when we first met, where he helped me uncover some things about what I was doing for my family and then by proxy for my clients that weren’t quite leaving us in the best place possible. So it’s it was the best strategy ever forgetting me to join him in our in our long term relationship now because it quickly became a moral imperative for me to not be doing what I was doing in the way I was doing it and to join forces with And get this message of academic investing scholarship out to the world. So with that, I’ll turn it over to Paul for part two of illusions of investing.

Paul 2:11

So in our last episode, we covered the idea that active managers, there’s zero academic evidence that they can consistently or predictably outperform with the market was going to do anyway. Now, that in and of itself, if you’re just tuning in to this episode, you will want to go back and listen, because there’s a significant amount of research around that that we pulled apart in that last episode. But one of the things that people do all the time is that once they’ve been exposed to that, they say, yeah, Paul, I get it. The average asset manager doesn’t do a great job. But I don’t choose the average asset manager, the asset managers I choose. They are the ones who have performed above average over time, and me and my existing advisor only pick those fund managers. And that leads us to illusion number two, which is track record investing. That’s the use of performance history, from some asset manager to best determine what their future performance is going to be. The illusion is that if we find funds that did well in the past, that’s going to be a reliable indicator of them being able to do so in the future. And that would seem to make sense in our world of pattern recognition. The fact that our ancestors figured out when the buffalo were moving through the area or when the migration of the birds would occur or what would cause crops to grow. We are wired with pattern recognition. And you would think that that pattern recognition would pay off in the performance of an asset manager it pays off when you hire an employee. If an employee did well at their last role, it only seems to make sense they would obviously do really well at their next role because they have what They have performance history. And then we blanket lay that on top of asset managers attempting to speculate, and perhaps even gamble in the market with your money as they attempt to beat the market, which so often doesn’t occur. And let’s look at some actual data. So for those of you just listening, I’m going to do my best to cover this in a way that is continues to be entertaining and engaging, despite the fact that you don’t see some of the data that’s on my screen. And you can always go back to YouTube and catch the actual graphics later, but I’ll do my best to pull it apart for you make it easy for those of you listening to the podcast. So here’s what we’re looking at. We took the top 30 equity funds meaning stock based mutual funds that had the best rate of return from 1998 through 2007. And those top 30 stock based mutual funds did 17.2% Now keep in mind These top performing mutual fund managers are compensated incredibly well, they are considered the best of the best at what they do compensated millions and millions of dollars to be the best at what they do. And we’re going to see how they shape up well, if we compare them to all stock based mutual funds that were invested in US equities, it was 6.92 and the Standard and Poor’s 500. Over that 10 years 1998 through 2007. Did 77.23 versus 17.2. So these folks outstrip the s&p 500 by over 10% more than doubling the rate of return to the standards and Poor’s 500. And you would think, man, that that is pretty impressive. Now, the funds that survived that 10 year window of time was 2718. And you would think Well, my gosh, then Paul, these asset managers must have done incredibly well in the following 10 years. Well, let’s take a look. Those same asset managers did 5.44% over the following 10 years. Now, here’s a quick pause. We don’t want to judge them in absolute performance, meaning there was a it was a different decade 2008 through 2017. So it only stands to reason that there might be bigger pullbacks in performance simply and only because of things like the mortgage crisis.

Now before I show you what these equity managers did these stock based mutual fund managers did the next 10 years. Let’s pause here for a moment and reflect Why do people choose these asset managers with better track records is they think that the idea rests on the reason they outperform the Standard and Poor’s 500 by nearly double was because of some unique view on the market, proprietary trading something they knew that so Somebody else didn’t know. And as a result that caused their outperformance. That’s why people tend to chase returns into those asset managers that did well in the past. But let’s look at what they actually did in the following 10 years now, the following 10 years is a very different 10 years. We have the mortgage crisis in the following 10 years. But the key is this, we’re going to look at how these managers did compared to the standards and Poor’s 500 index, because if they did know something unique, it’s not just a matter of them outperforming all the average mutual funds, but also they should have been able to stay ahead of the s&p 500. Now during this window, those top 30 asset managers did 5.4% while the s&p 500 by itself, no help, no asset manager did 10.39%. So let me say that a little bit differently, the same asset managers that over perform to over Double in the prior decade. The s&p 500 return now are nearly half of the s&p 500. The s&p 500 return for the following decade. And they also underperformed the average us equity mutual fund that survived through that window, which now because more funds have been added since 1998, is now over 4600 mutual funds for the remaining study years.

Now, here’s what some people could say as well, Paul, that that’s a 10 year period and that 10 years is very different than the next 10 years. So why don’t we just take the same decade in five year increments, okay, same decade, five year increments in the second half, top 30 asset managers including 2008 in the mortgage crisis, did 6.28% while the s&p 500 manage to get 4.5% While all the average of all US equity mutual funds did 1.32, once again, stellar performance by the top 30. They outperform the s&p 500 index and they crushed the performance of the average us equity fund. Now from 2012. Through the remaining period 2017 was fairly good times in the market. Let’s see how our top 30 asset managers did. Well, from 2013 to 2017. They once again repeated performance not too dissimilar from our last study of 4.99%. Well, then you might ask, Paul, what did the s&p 500 do over that period of time? 16.25, meaning the s&p 500 returned nearly four times what the best asset manager for the prior half decades, decade had done, these top 30 managers got crushed. returns. And the average us equity fund, if you had just like covered your eyes up and blindly selected the average us equity fund, you would have done 12.8%. This is a huge differential. And what it starts to prove is that these asset managers that did well in the past tend not to do well in the future. I’m going to give you one more look at this. This one’s much more visual. And I’ll do my best to make it simple for those of you just listening to the podcast, but we have the top 25% of all equity mutual funds, meaning we did back testing all the way back to 2004. We get this out of University of Chicago and their work along with dimensional fund advisors 2004 through 2008. If you just took the top 25% of performers for that five year period 2004 through 2008 only 28% outperform The index over the following five years. And that’s after we took only the top 25%. But you can see, as you look down the list in all of these little five year windows, where we took from the prior five years, the top performers and then tested them over the next five years, what you see is that on average, only 21% outperformed the market. And that was after taking only the top 25%. So what we start to see is that even if we have really great track record investing from some of these asset managers, we have zero correlation with their ability outperform the future. This is a big, big deal. And not something that the mutual fund companies ever go around and market Why would they? Because then you’d have to go in, look at their track record and necessarily go Hey, what mutual funds Did you drop off the back of the bus like we talked about in the last time Episode. And by the way, that’s all stock based mutual funds. If we did the same thing with bond based mutual funds, we don’t get that different result. Even if we take just the top 25% of them, only 28% outperform the market in the following five years, even after taking the top 25% To start with, meaning, taking the upper echelon and performance for the last five or 10 years, is not likely to be able to be a repeat performance in the subsequent years. And I know that could be a little bit shocking. And we’re going to talk about in a minute, the randomness of that and a unique thing that we’ve done when we’re either invited in to speak for a group of people or if we when we do one of our events, and we illustrate to people how random this asset management game is. And we’re going to come back with that right after this message from sound Financial Group.

Hey, everybody, I had to interrupt our show for just a moment to share with you something new. We’ve done designed a new white paper that we think is going to add new value in the way that you think about money. It’s three of the biggest mistakes we see people make in six ways to fix them. Now for some of you, you might not want the white paper, you might be ready to have a conversation with us. And that is okay, you can email us at info at SF GWA. Calm that’s info at SF GW a.com. Find us on the web at your business, your wealth calm. And anytime on any of our social media platforms, send us a message and we can get you this white paper. But in the meanwhile, if you want to just skip over the white paper, have a philosophy conversation with us. We’re happy to do that with you. Just let us know, philosophy conversation in the subject line. And if you want this white paper, just put white paper in there, I will immediately get out to you this white paper on the three biggest mistakes that we see people make and the six things that you can do to fix them. And now, back to our show. Welcome back. Now you may wonder if you’re watching this on YouTube, why there is a big Coyne in the middle of your screen. And it’s because I’m going to walk you through an exercise that we do inside of live events we’ve been brought in to speak to a group, or we’ve done one of our own client events to illustrate the point of the randomness of returns, even with super competent asset managers. So I want you to picture big ballroom. And we tell the audience that in the middle of their table, usually hidden underneath the flower arrangement or something like that. We have placed a bunch of dollar coins. Yes, they still make them. So we put those dollar coins out on every single table. And then we begin having clients compete as asset managers. Like you may notice that there is almost never an asset management firm that markets a new mutual fund that has zero performance history. And you may wonder why that is? Well, it’s in part because the major mutual fund complexes will take new assets Managers give them several million to manage. And by managing that several million dollars, they’re given the opportunity to beat the benchmark index with this relatively small amount of money. And they line them up against other newly minted CFOs and MBAs. And then they say, can you beat the market, if you can’t, no big deal, but you will lose your job and the assets inside your fund are going to go to somebody else. And so by the time three years rolls around, that asset manager has a bunch of money under management. And despite these being fully filed, and running mutual funds, they just haven’t been marketed yet, which makes the disappearance of the returns as we talked about in the last episode. That much easier. Now, we have everybody stand up. And we let them know that if you flip heads on your coin, you have beat the index that year, which by the way, is not that different, of the actual likelihood For an active asset manager to beat the index they’re being compared to. So we have them flip, and sure enough, half the room will get tails on average and half the room will get heads. If they got tails, they need to sit down and hand their coin to somebody who did beat the index. And then we move on to year two. Now about half the room is standing and they flip again.

And about half that group gets heads and half the room gets tails and the people that get tails have to hand their money to whoever’s closest to them who’s still standing, who’s a quote unquote, successful asset manager. And we go again, and you kind of picture in your head, a room with 100 to 500. People slowly winnowing down. And as the room windows down, the asset managers that are still around now have more and more money under management by the time we get to the end of our third turn, or in this case, our third year of performance. We kind of highlight some of the answers. IT managers in the room, and what a good job they’re doing. And they’re going to be interviewed on Forbes and Money Magazine and ink. And they’re going to be out in front of everybody with their expertise. Now, if I’m having some fun, I’ll even hand the microphone to a member or two of the audience and say, Would you please share what your technique is and the way you’re flipping the coin. And if you get people really competitive, they will even a random event like coin flipping, they will begin to invent narrative about how they’re doing what they’re doing to game or theory, or theorize their strategy for flipping a coin. Now, we all know as we witness this, and we talk about it on this podcast that it’s like, that’s just ridiculous, Paul, except what we all do is invent explanations. And by inventing explanations, that’s our rational side. We have this irrational behavior we can sometimes be in but then we eventually explanations for why we’re in the maybe irrational behavior. And that becomes rationalization I’ve heard heard it said before that we’re emotional creatures that rationalize our decisions, not rational creatures with emotions. So now as people are flipping their coins, the stakes are getting a little higher. You know, if there’s 100 people in the room, there’s $100 a stake and those personalities come out in the room that are competing for this, this prize of being able to take home all the coins, not too different than the asset managers compete. But now they’re out in the open marketplace and we watch fund after fund get closed as people have to sit down. Now our record for this was a woman about 67 years old, who flipped the coin a total of 16 times in a row heads and everybody’s cheering and having a blast. Of course she’s got this big pile of coins in front of her and just for fun, we had her she had already had everybody else sit down by the end of flipz but then we had her keep going to see what would happen. And we got 16 heads in a row all together. And then, you know, the audience’s, you know, cheering for her all that. And then she, everybody sat down and she sat down.

And what I said to the room was, you know if the universe is big enough, and we talked about last episode about thousands and thousands and thousands of mutual funds that have been opened and closed, over 60,000 have been opened all together. It is merely a matter of random chance in statistical probability that there would be something like the fidelity Magellan fund. This is nothing against that particular fund. But you’ll watch these asset managers have an amazing streak and then they slowly fall apart. And having had a chance to interview somebody on the inside of one of these large mutual fund companies, who was a partner in that firm and he said This is off the record, which is why I’m not disclosing anybody’s name. But he said it was amazing. I explained this concept to him. And I said, Now that you understand this concept, let me ask, as the mutual funds performances were waning, what did the asset management teams say? And the guy said, Oh, they had all kinds of reasons. Because trading, it happened in the marketplace differently, or because the flash traders were in the market, or because they now had more assets than they’d had in the past. They weren’t able to buy and sell as efficiently all that. And all that can be true. But at the end of the day, even their prior success can be attributed to nearly random chance in the fact that people are just trying to beat the market in a way that is not likely that they’re going to be able to do so. And we wonder why, literally on every single statement you have from any investment company, it says passport, performance is no guarantee of future results. And the reason it says that is because it’s true. In fact, Stephen Sharpe can ski who is upcoming on our podcast here, he has got some amazing feedback and research report. This is not only his past performance, no guarantee of future performance, they’re not even lightly correlated. Meaning that these active managers don’t have the ability to outperform the market. And even if they outperform the market, it’s unpredictable. And it’s unpredictable that they could have any kind of repeat performance. You see, what we want for all of us you’re listening is to just be able to think through and not follow the Rockstar asset managers. As we get later in this series, we’re going to talk about portfolio building and literally give you some tools that you can execute with. But when it’s all said and done, all of the asset managers that have a quote unquote good story about their performance are not likely to be able to repeat that performance. And yet when are you likely to be attracted into an investment like that is after they’ve already had the performance, the very time they’re least likely to repeat that performance. So hope you guys have enjoyed this episode today and as always, from Corey, myself, everybody at sound Financial Group. We hope that this episode of your business your wealth has been a contribution to you being able to design and build a good life.

Unknown Speaker 22:36

This is

Cory 22:37

how legends are made.

Transcribed by https://otter.ai

This Material is Intended for General Public Use. By providing this material, we are not undertaking to provide investment advice for any specific individual or situation, or to otherwise act in a fiduciary capacity. Please contact one of our financial professionals for guidance and information specific to your individual situation.

Sound Financial Inc. dba Sound Financial Group is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance. Insurance products and services are offered and sold through Sound Financial Inc. dba Sound Financial Group and individually licensed and appointed agents in all appropriate jurisdictions.

This podcast is meant for general informational purposes and is not to be construed as tax, legal, or investment advice. You should consult a financial professional regarding your individual situation. Guest speakers are not affiliated with Sound Financial Inc. dba Sound Financial Group unless otherwise stated, and their opinions are their own. Opinions, estimates, forecasts, and statements of financial market trends are based on current market conditions and are subject to change without notice. Past performance is not a guarantee of future results.

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