The Almighty Portfolio

What if the two things investors desperately need… are the very things they’re most likely to reject?

Here is a great study which highlights that if you want to outperform, you have to accept greater volatility than the market and have a long-term time horizon.

Ironically, the very two things most investors lack.

In essence, an active investor who was clairvoyant (i.e. “God”) and who knew ahead of time exactly which stocks were going to be long-term winners and long-term losers would likely get fired many times over if they were managing other people’s money.

The study assumes that the Clairvoyant knew which stocks would be the best performers in five years.

So the Clairvoyant would invest now and then readjust his portfolio in five years time based on what he/she knew would be the best performers five years hence:

So the standard deviation and Sharpe Ratio suggest that this portfolio will be way more volatile than the market even though the returns will be dramatically higher.

So would the average investor invest in this portfolio or be able to stomach the volatility?

Probably not. We are reminded of the legendary Peter Lynch, who from 1977 to 1990 managed the high-flying Fidelity Magellan Fund.

Under his management, the fund averaged an astounding annual return of 29%.

It would seem all you had to do was ride along with Lynch and you would earn phenomenal returns. But guess what? That didn’t happen.

According to Fidelity Investments, the average Magellan Fund investor actually lost money during Lynch’s tenure there.

No doubt you’re asking why? How?

The answer comes from Lynch himself who found that the volatility of the fund coincided with his investors redeeming and reinvesting.

In essence, they traded his fund as if it were individual stocks.

The problem was they sold after a drawdown and then bought back in after it had run up again.

It is almost certain those investors didn’t think they were trading. They just got conflicting information.

Probably from the shiny white toothed dolly birds on CNBC doing what they always do — looking great but offering nothing intelligent. In fact, being counterproductive.

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And so after viewing the idiot box, they freaked out and dumped their shares.

Then when things were going well and the CNBC giggling bimbos were giddy with excitement they reinvested. It translated into the majority of his investors actually losing money.

Nuts when you think about the fact that his fund was the best performing fund for over 20 years. All they had to do was pretend they were dead and they would have compounded at an astonishing rate.

Consider that $100,000 invested with the Magellan fund compounded at 29% annually for 20 years would be worth approximately $70.76 million.

Now you may begin to appreciate the saying…

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