Movement Capital charges a flat fee, not a percentage of assets like most advisors. An advisor’s job is to help clients reach their financial goals. High fees increase the distance between a client and their goals. A flat fee, in my opinion, is a much fairer approach to investment management.
Consider two hypothetical investors with $1,000,000:
The flat-fee client saved $700,000 over a thirty year window. Movement Capital charges a flat $3,000 for investment management up to $1 million.
In addition to flat fees, Movement only uses the lowest cost investment funds. The average expense ratio for funds that advisors use is 0.50%. The average expense ratio for funds that Movement uses is 0.07%. For the above example, that would mean the client would save an additional $100,000+ over thirty years.
The investing world is made to seem complex so that some advisors can justify their high fees. Investing is simpler than it seems. There are two broad types of things you can invest in: stocks and bonds. Stocks represent ownership in a company and a stock’s value comes from its future cash flows. Bond investors lend their money to a government or corporation for a fixed amount of time in exchange for regular interest payments. Simply put, stock investors are owners and bond investors are loaners.
Over the long term, stocks have historically outperformed bonds and cash. However, you have to take on a significant amount of risk to capture long-term stock returns. The graphs to the right show the historical relationship between risk and return. Would you worry if you invested $1 million and lost $500,000 the next year? Most people would, and it’s why most people shouldn’t pursue an investment strategy 100% focused on stocks. Paradoxically, bonds can be as risky as stocks in the long-term. Since bonds typically return less than stocks, high bond allocations lower the chance you’ll meet your financial goals. Stock and bond allocations are a careful balance of an investor’s age, time horizon, and personal feelings about risk.
Humans are reliably unreliable. We often use the flight or fight part of our brain when confronted with an obstacle. This instinct doesn’t work in investing. A better solution is to defer decision making to data-driven models.
Research shows that forecasters have no idea what they’re talking about. In 2007, Wall Street’s top strategists estimated what the the S&P 500 would do in 2008. On average, they forecasted the S&P would finish 2008 at ~1640. It closed the year at 903; the forecasters were 45% off the mark. As humans, we want to feel like we’re important and our efforts are worthwhile, but we spend little time understanding if our actions actually add value. Spending a day reading investing magazines might feel beneficial, but can likely do more harm than good. Studies have shown additional information actually detracts from future performance, concluding that people tend to become overconfident with more information.
In a variety of fields, researchers have compared simple models vs. their industry experts. Studies ranged from assessing wine quality, estimating the probability of business success, estimating the likelihood of passing basic tests for the military, and so on. In 136 academic studies, simple models beat or matched the forecasting ability of experts 94% of the time. Models reliably outperform experts because they’re not prone to behavioral biases. Systematic models drive all Movement Capital portfolios.
A shipbuilder doesn’t build a ship for calm seas. They know that storms infrequently happen and build accordingly. Investment portfolios need to be constructed in a similar manner: positioned for the best but prepared for the worst. The majority of stock market gains have come from a small number of big winners. The chance of picking these winners in advance is next to zero. Investors can increase their probability of success by investing in diversified funds, not individual securities.
Homeowner’s insurance offers protection after a bad event. Likewise, diversification lessens the impact of a massive investment loss. Diversification can be a frustrating strategy in the short run since you’ll always lag behind the top performing asset in a given year. However, in the long run, a diversified strategy puts a higher probability of success on your side. Charlie Munger said:
``It's waiting that helps you as an investor, and a lot of people just can't stand to wait.``
Take two years of hypothetical investment returns: +50% followed by -50%. The average return is 0%, but the investor’s actual return is far different. $100 would grow to $150 after +50%, but then fall to $75 after -50%. This equals a compound return of -25%. The difference between average and compound returns is called the “volatility tax”. If you lose 10% of your money, it takes 11% to get back to even. If you lose 25%, it takes 33%. There’s an asymmetric relationship between losses and the gains necessary to get back to even.
Consider two hypothetical investment options as shown on the right. One has an average return of 4.7% and the other 4.4%. Most people would guess the first option returned more money. Not the case. A less volatile return path, despite having a lower average return, resulted in higher total returns.
Trend following strategies are based on the concept of momentum. Momentum in finance refers to the tendency of investments that have done well in the past to continue doing well. Researchers documented the momentum effect in 1993. Eugene Fama, winner of the 2013 Nobel Prize in Economics, said the following about momentum:
``The premier market anomaly is momentum. Stocks with low returns over the past year tend to have low returns for the next few months, and stocks with high past returns tend to have high future returns.``
Trend following has historically shown the ability to generate positive returns when traditional assets like stocks and bonds do poorly. Movement Capital portfolios use a systematic trend following model for a portion of client stock exposure.
The average U.S. investor has 79% of their stock exposure in U.S. stocks. The average Canadian has 59% of their stock exposure in Canadian stocks. People tend to invest more in their own local markets because it’s the comfortable thing to do. This is called home country bias. Staying close to home and ignoring the rest of the world is the wrong decision to make in today’s globalized world.
Between 1899 and 2017 the value of the U.K. stock market (the world’s biggest economy in 1899) went from 25% of the global stock market to just 6%. US investors shouldn’t look in the rear-view mirror and concentrate their investments in U.S. stocks just because that was the right thing to do decades ago. Instead, they should look forward, admit that they don’t know what the future will hold, and globally diversify their portfolio.
The average investor significantly underperforms the assets they actually invest in. This “behavior gap” between fund and investor returns is a function of bad behavior causing people to stray from their investment plan. The biggest obstacle for investors isn’t a downturn in stocks – it’s their own emotions.
Pro athletes don’t focus on what it feels like to come in first place. They focus on what they can control: their process. You can’t control the pace of economic growth, when the next recession will happen, or where interest rates will go. You can control how much money you save, how diversified your investments are, and your investment costs.
Historically, inflation has averaged ~3% per year in the U.S.. Sometimes inflation rapidly increases, like when it averaged 10% per year in the U.S. in the 1970s. Imagine if you bought a 10-year U.S. Treasury bond in 1968 that paid 5% a year in interest. Inflation at the time was ~3%, so you were making 2% after inflation. During the 1970s that bond actually lost money after inflation, since you continued to receive 5% in interest but inflation rose to more than 13%.
Traditional stocks and bonds struggled in the inflationary 1970s. They are just as vulnerable now as they were then. Movement Capital uses inflation-linked bonds and local currency international stocks to protect against inflation.
The two most commonly quoted benefits of the exchange-traded fund (ETF) structure over mutual funds are their lower cost and higher liquidity. In my opinion, both are moot points. There are plenty of low cost mutual funds, and long-term investors rarely need intraday liquidity. That being said, Movement Capital does primarily uses ETFs in client accounts. This is because they are much more tax efficient and rarely distribute capital gains to ETF owners.
Imagine two investors. One invests in a mutual fund that realizes 10% in capital gains. The other invests in an ETF that pursues the same strategy as the mutual fund. At the end of the year, the mutual fund will probably distribute the capital gain to the investor. The ETF likely lowered their tax liability through the creation/redemption mechanism.
Lower fees = massive savings
Stocks > bonds > cash
Models outperform experts
Diversification is necessary – but difficult
Compound (not average) returns matter
Trend following reduces risk
Home country bias is real
Investing is a behavioral battle
Inflation hurts traditional portfolios
ETFs are more tax efficient than mutual funds
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