In the late 1950s and early 1960s, Jerry Tsai’s career was launched into the stratosphere as the performance of the mutual fund he managed, the Fidelity Capital Fund, took off. Tsai, a Chinese-American who was in his late 20s and early 30s when he ran the fund, ushered in a new era for mutual funds with a new category of funds—called performance funds—that sought to massively outperform the overall stock market by investing in high-growth, speculative companies. Tsai relied on studying stock charts and technical indicators to guide his decisions. He bragged about being in and out of stocks at the drop of a hat. He was a speculator. A gunslinger. And he knew it.
Tsai’s rise aligned with the public’s changing appetite for risk with stock ownership. It had been almost 30 years since the Great Depression was ushered in. Almost 30 years since the 1929 stock market crash. A new era was dawning. An era of investors that was willing to bet more on stocks. And the preferred vehicle became the mutual fund.
As the value of stocks catapulted upward throughout the 1950s and early 1960s, investors shifted their focus from owning individual blue chip stocks to owning mutual funds, increasingly those that were more speculative, like Tsai’s Capital Fund.
In 1946 just $13 million was invested in Fidelity’s mutual funds. By 1966, it had $2.7 billion under management. The cash was flowing in.
And Tsai capitalized on it.
In 1965, after the value of his fund rose 50 percent, Tsai resigned from Fidelity to launch his own investment firm and fund.
Tsai set up shop in Manhattan, in a swanky set of offices at 680 Park Avenue, and personally took residence at a luxurious set of suites at the Regency Hotel. And he launched his fund, the Manhattan Fund.
When his fund launched, Tsai had raised $247 million from investors—10 times more than he was expecting. Ironically, the same month the fund launched proved to be the peak for the stock market.
Performance of Tsai’s fund from the start was lackluster at best. Investors, despite this, continued to pour in money. Over the next two years, $250 million of additional money was invested in the fund.
In the fall of 1968, at its height Tsai shrewdly sold his investment firm, pocketing a cool $27 million, and becoming a rich man.
His fund, meanwhile, went on to lose 90 percent of its value over the coming years, along with its investors’ money.
Short-term investment performance can be misleading. The worst investment managers, at times, outperform. The best investment managers, likewise, at times, underperform.
In a study conducted by investment legend Joel Greenblatt he showed that 97 percent of the best investment managers in the world spent at least three years in the bottom half of performance and 47 percent spent at least three years in the bottom 10 percent of performance1. For periods of time these investment managers—the best of the best—look like dogs. Likewise, for periods of time, dogs look like stars.
Don’t pay too much attention to short-term performance.
What matters in investing is long-term performance. You want to focus on long-term performance. Take any period of less than five years with a grain of salt.
As Warren Buffett said to investors in his investment partnership about grading his investment performance: “While I much prefer a five-year test, I feel three years is an absolute minimum.”
Make sure you’re grading your investments’ performance on the same timeline. What matters is that whoever is investing your money is taking the right approach. If they are, your investment performance will bear out over time.
As investment columnist Jason Zweig said, “If you’re not prepared to stick with a fund through at least three lean years, you shouldn’t buy it in the first place. Patience is the fund investor’s single most powerful ally.”
Impatience
Investors in the late 1990s forgot about patience. By the end of the ‘90s, forty percent of investors’ money was being switched in and out of stock mutual funds annually. Investors were chasing what was hot and shunning what was cold. Just like they did in the 1960s, with Jerry Tsai.
One of the hottest funds in the late 1990s was Alexander Cheung’s Monument Internet Fund. In mid-1999, after earning a 117.3 percent return in the first five months of the year, Cheung predicted his fund would gain 50 percent a year over the next three to five years and an annual average of 35 percent “over the next 20 years.” Investors, at this show of extreme confidence, threw $100 million into his fund over the next year. Anyone who did, lost up to 80 percent of their money by the end of 2002.
Another hot fund, Alberto Vilar’s Amerindo Technology Fund, rose an incredible 248.9 percent in 1999. At the time, Vilar ridiculed anyone who doubted internet stocks, saying, “if you’re out of this sector, you’re going to underperform. You’re in a horse and buggy, and I’m in a Porsche. you don’t like tenfold growth opportunities? Then go with someone else.” Anyone who invested in his fund at the end of 1999 lost nearly 90 percent of their money.
Patience
Being patient with your investments is of supreme importance, if you’re taking the right approach. The best investment managers, remember, will underperform at times—sometimes for multiple years.
In the late 1990s this was the case with Warren Buffett, who refused to speculate in internet stocks. He had underperformed the overall stock market for years, and people at the time were calling him washed up. They thought he had lost his touch. When the internet bubble popped in the early 2000s and the stock market crashed, Buffett went on to outperform for years.
Those who remained patient during this period, which was difficult to do, were rewarded.
What’s important is measuring your long term investment performance—and disregarding your short term performance.
Indices
In measuring your long term performance you need to measure your investments against something, so you know whether you’re doing good or bad.
Indices, which summarize a collection of data, are a way of doing this. There are indices for all sorts of different categories of investments. Perhaps the best known index, to measure the performance of U.S. stocks, is the S&P 500, which tracks the performance of the 500 largest U.S. public companies’ stocks. There are many other indices—for Canadian stocks, European stocks, bonds, you name it. They are all useful for measuring performance against.
For instance, if you have 100 percent of your money invested in U.S. stocks, it makes sense to measure yourself against the S&P 500 index. If your performance long-term isn’t beating the index, it makes sense to question whether you should just invest in the index (which you can do through an index fund) or change investment managers. Likewise, if you have money invested elsewhere, not in U.S. stocks, you should be comparing those investments—long-term—against their comparable benchmarks.
Most people have no clue how their investments are doing.
They just accept whatever rate of return they get on their investments.
But everything needs to be measured. Otherwise how do you know if you’re doing well?
Index Funds
What most people have found is that most of their money that’s professionally managed underperforms the indices, largely as a result of the investment fees that are paid by investors to the investments managers. These fees have proven to be too big of a hurdle for most professional investment funds to overcome, which is why roughly 90 percent of professional investment managers underperform their benchmarks. Only about 10 percent—a significant minority—outperform.
This is why, today, roughly half of investors have thrown in the towel on professional investment funds and have invested instead in index funds.
Measuring Up
Measuring your investments’ performance against relevant benchmarks is critical. I recommend measuring their performance on a 5-year and 10-year basis. Their performance over these timeframes should, ideally, be better than the indices or, if not, darn close. If they’re not, you seriously have to question switching your investments or the person investing your money.
Bottom Line
You don’t want to be too critical of your investments or the person managing your money over the short term, but you want to be very critical of them over the long term.
Use relevant benchmarks to measure your investment performance against. If you’re not at least matching the benchmarks over 5-or 10-years you seriously need to question the person investing your money.
In investing, small percentages add up. The difference between earning 7 percent versus 6 percent on a single $100,000 investment over 40 years is half a million dollars. So you want to make sure you’re getting the most out of your investments. Stretch the difference in the rate of return to 2 percent (8 percent versus 6 percent) and the difference in the value of the investment is over $1 million after 40 years.
Measuring your investment performance, and getting the most out of your investments and hard-earned money, is of enormous importance.
Don’t just accept what you get. Get what you deserve.
Miller, Warren Buffett’s Ground Rules