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Why Investors Do What's Bad For Them

Investors don’t do what’s good for them. Typically, over and over again, they buy high and sell low. It’s the same with active vs. passive investing. Studies show two thirds or more of active long-only money managers underperform the index they are hired to beat – and that is before fees and taxes!

So why then don’t more investors just place their assets in passive vehicles like the SPDR S&P 500 ETF (SPY), relax and go off to enjoy the rest of their lives? The answer is as old as human nature. Groucho Marx didn’t want to be a member of any club that would have him. So, too, with well-heeled investors. They want to be part of what they consider the exclusive “smart money club.”

Some top performing money managers, such as Stanley Druckenmiller, closed their funds. Hedge fund consultants and others who siphon wealth from high-net worth investors often boast that they can get their clients entry into closed managers. What a great marketing ploy. I think I’ve seen that trick performed by more than one restaurant maître d’!

But individual investors of all wealth levels need to accept that there is a caste system in the world of investments that excludes them. Until then, they will keep being tempted to look for – and be sold – entrance into the rarified world of the Smart Money Club.

Complicating this situation is the fact that an investor’s portfolio is not a few pounds of excess weight but rather their hard earned precious nest egg! And does anyone trying to protect a most precious treasure feel comfy choosing auto-pilot? That sinking sense of just letting go and letting others worry, is exactly how passive is often viewed.

If ‘stay the course’ is the mantra of indexing, those investors who listened feel cheated. Investors, who retired in 1999 and placed their retirement monies into passive vehicles, still have less than when they started!

Adding insult to injury, the financial media’s 24/7 drum roll keeps investors searching for that next fabulous investment/stock/money master! Everyone wants to jump on the bandwagon for easy money.

Much-anticipated IPOs such as Yelp, which surged some 64% on its first day of trading–along with Zynga, LinkedIn, Dunkin Brands and others–provide another example of the caste system that hurts individual investors. Generally it’s been shown that individual investors tend not to come out ahead on hot IPOs.

In a recent dialogue inside the investor online community, investors faced a depressing reality. Some comments: “Where you do find active management outperforming the benchmark, it is both for short time periods and it is across all managers, whereas you’ll be invested in specific managers. There are fund specific risks you’re not compensated for as well.

Take the Fairholme Fund, which was one of the few outliers where active management outperformed over the long term. Who knew the key guy there would hire [a family member], who in turn forced out some great investment talent, and made an impressive series of terrible investments?”

As an advisor, you should know better. The smartest advisors are able to convince their clients that whether passive or active, outcomes that meet the investors’ goals matter most. First and foremost, you need to have a candid and transparent assessment of ‘how’m I doing?’ Once the financial industry drops the manipulative sales focus and adopts a client-centered, outcome-based approach, both advisors and investors will win.

IPI is a 20-year old membership organization that connects 1,100 ultra-high-net-worth investors to one another inside an online community and at events throughout the year, seeking to change the way investors work with advisors, and advisors work with investors, for the benefit of both.