Dieting, Exercise and Investing. What's the Lesson?

How do you succeed at dieting, exercise and investing?

Are these unrelated? Not really.

Success at all three requires discipline, consistency and a program that you can stick to over the long term.

So how does this relate to investing? As advisors, we have adopted an investment philosophy that can be adhered to over the long run. It is rational, and provides our client’s with peace of mind, so they can stick with it.

In the past few weeks, the financial world has provided further evidence of why our approach makes sense, which gives us even greater confidence in our long term philosophy regarding stock investing. The markets have been very volatile since July, and our clients with stock investments have incurred losses, as have most others. But there is a distinct difference in approach.

We recognize that we cannot predict the future. We do not believe that we can identify which fund or money managers will do the best over the long run. Thus, we have adopted a philosophy which recognizes this.

A few weeks ago, Fidelity Magellan replaced the manager of this very large mutual fund, after years of underperformance. Over the last 10 years, this fund, once the largest in the world, ranked in the 95th percentile (1 being the best), trailing its benchmark and the S & P 500 by approximately 2.7% per year.

Fidelity, and this manager, have vast resources and a huge, global staff to assist in the research and stock picking for this fund. Despite all these resources, Fidelity’s staff was unable to outperform or come close to its target benchmark on a consistent basis, or even a majority of the time. The lesson: it is hard to pick a good money manager, in advance, that will outperform its respective benchmark, on a consistent basis over a long period of time.

The second example has been a number of reports of hedge funds reporting huge losses or funds that are simply shutting down, due to underperformance or dissatisfied investors. John Paulson, a hedge fund “titan” was an investment hero in 2008, as he placed huge bets against mortgage and financial stocks, and he was right.

Now fast forward to 2011. The WSJ reported today that two of his funds are down 32% and 47% for the year, far worse than market averages. He has placed huge bets on Bank of America, Hewlett-Packard and China’s Sino-Forest Corp. He has been very wrong in 2011. His funds have also lost billions on investments in gold and gold related stocks. Many of his clients are impatient and not willing to wait for his next great idea.

The lesson: There are many. Making huge, concentrated bets are risky. Sometimes they work, sometimes they don’t. When they don't, and your bets are very concentrated, the results can be horrendous.

Diversification, and not making concentrated bets and predictions, does work, which is why that is one of our core philosophies.

Our next post will further explain our investment philosophy.

Sources: Morningstar, for Fidelity Magellan; WSJ for Paulson information, 10/11/11 online