Barry Ritholtz: How to Beat 90% of Fund Managers Over the Long Haul

Ritholtz, creator and host of the “Masters in Business” podcast, discusses banishing self-defeating investing behavior as well as making smart decisions in his new book, “How Not to Invest: The Ideas, Numbers, and Behaviors that Destroy Wealth — and How to Avoid Them.”

Ritholtz, whose firm manages more than $5 billion in client assets, asserts that “uncertain” and “unknown” are often conflated, causing misunderstanding and even investing mistakes.

In the interview, Ritholtz identifies who’s “responsible for more wealth destruction than any other player.” It’s the permabear, he says, “the most dangerous clown in the circus.”

Here are excerpts from our conversation:

THINKADVISOR: What trends do you expect in wealth management this year?

BARRY RITHOLTZ: For years, I assumed that the fiduciary side of the business would run roughshod over the broker side. And I’ve been consistently wrong all through the ‘90s and into the 2000s.

But after the financial crisis and Bernie Madoff and a lot of other issues, what we’ve seen during the past decade is that the fiduciary side is becoming dominant. And that trend is only accelerating.

The UBS’s and Morgan Stanleys have gone to a hybrid model — they’re no longer selling “the stock of the day.” They’ve moved more toward the fee-based wealth management model as opposed to the transactional model.

Attempts to make [all advisors] fiduciaries failed under the first Trump administration. You didn’t hear a lot about it under Biden. And I don’t expect to hear much about it under the current Trump administration.

But investors are voting with their feet: They tend to be moving toward more index-driven type of investing, though there’s definitely a dalliance with private equity and private debt.

It’s taken a long time, but it feels like the fiduciary [client increase] is a trend that’s picking up speed.

Investors who hold index funds broadly “may be more likely to hold the rare and outsized winners that drive most of the market gains over time,” you write. Why?

There’s a tiny bunch of companies that net-net are the big drivers. The only way to make sure you own these is, effectively, to own all of the companies.

An index that’s market cap-weighted guarantees you’ll be holding the best performers in a proportional weight to their market cap and their gains.

“If you own an index, you own not only the winning companies but the companies that are in the process of becoming the winning companies,” you write. Please elaborate.

Investors spent decades chasing the hot mutual fund manager, which fund to own, and which sector rotation to jump into. But none of those strategies have proven themselves over time.

In fact, the academic literature overwhelmingly [shows] that 92% to 94% of all fund managers underperform, after fees, over a 10-year period.

“Markets thrive on uncertainty. It’s their reason for being,” you write. Please explain.

Wall Street and pundits, in general, are very careless — dare I say lazy — with their choice of words. Uncertainty does not mean the same thing as unknown, and there is a tendency for us to conflate the two.

The future is inherently unknown. That unknown is not the same as uncertain.

The psychological definition of uncertainty is that when something bad happens, we lose the ability to lie to ourselves. [Before that], we feel pretty confident that we know what’s coming in, say, the next three or 16 months.

That confidence allows people to want to borrow money to buy a house or car [for example].

But when something bad happens that we’re unprepared for, like the financial crisis or the beginning of the pandemic, we lose the ability to lie to ourselves. We don’t like to admit how little we actually know.

Talk about how having a variant perspective works to one’s advantage as a stock market investor.

If it’s on the front pages of The Wall Street Journal or The New York Times, it’s more or less priced into the markets.

An example of a variant perspective is [observing] what’s out there [and its potential repercussions] that people haven’t noticed or else they have noticed but they’ve completely disregarded it.

For instance, when real estate, one of the biggest drivers of the economy, rolled over and collapsed and there was a ton of financial engineering and leverage on top of that, it was obvious that something bad was going to come.

Yet, all through 2006 and most of 2007 the market kept going higher and higher.

What’s a more recent example?

My variant perspective concerning the Magnificent 7 and AI: It’s not so much about the Magnificent 7; it’s about the other 493 companies that will be the biggest beneficiaries of AI because they’ll all become more efficient, more productive and more profitable.

“The permabear is the most dangerous clown in the circus ... responsible for more wealth destruction than any other player,” you write. How come?

To be a permabear is to bet against human ingenuity, and that’s been a losing bet for most of history because history has shown advancement upon advancement. In the modern era, it’s been even faster.

“All forecasting is marketing, plain and simple,” you write; and “Listening to media recommendations can be disastrous.” Please elaborate.

We’ve proven time and again that we’re really bad at forecasting about this or that sector or stock or when the Fed is going to cut interest rates.

So why do we forecast? Turns out it’s really good marketing.

But two things about that are very dangerous. First, the people that make an outlier forecast and get it right, begin to make outlier forecasts frequently because if you’ve gotten it right, you get book contracts [and prominence]. And you want that dopamine hit again.

The other thing that’s dangerous is that when someone who’s made an outlier forecast gets it right, [the media and public] have a tendency to believe in their future forecasts.

There are people who consistently forecast the end of the world, and that’s been a pretty money-losing bet.