Weekly Commentary: A Reminder That There is No Free Lunch to Investing

July 24, 2018

Weekly Commentary July 20, 2018

A Reminder That There is No Free Lunch to Investing

By Tim Courtney, Chief Investment Officer

One of the primary principles of investing is that there is no such thing as a free lunch. Just as you can’t expect to sit on the sidelines and win the race, you can’t simply reduce the risk in your asset portfolio and expect to make generous returns.

Investing requires patience and discipline to capture returns. A corollary to this principle is that if something seems too good to be true, it most likely is. Below are three examples of strategies that sound good (and can be valid), but a closer look at the costs and risks involved is warranted.

1. Momentum investing: The strategy of investing for momentum1 centers on buying assets that have done well and selling those that have under performed. Studies have shown that momentum in returns exists2, but whether higher returns from momentum investing can be captured is up for debate. In the past, capturing momentum has proven elusive because of trading costs and taxes from the frequent and short-term nature of the required trades. In addition, the constant need to time multiple trades correctly is a heavy burden for the strategist to bear. In many cases, as soon as you think you’re about to capture momentum, the trend reverses. Bitcoin is a great recent example of this3.

There are a relatively few (but growing) number of momentum funds available and even fewer with track records longer than three or four years. A recent Exencial evaluation of these funds showed that nearly all of them were unable to capture a return higher than that of their lower turnover (less frequently trading) growth stock strategy cousins.

2. Rebalancing: This strategy is usually defined4 as a regular, but not too frequent, restructuring of a portfolio’s weights back to a target. A 2014 Vanguard study5 estimated that rebalancing can add 0.35 percent annually to investment returns. It sounds easy and worthwhile, right? Well, rebalancing is fairly counter-intuitive and in some ways is the mirror opposite of the more easily understood momentum strategy. This is because true rebalancing forces you to sell out of sectors that are performing well and buy into areas of the market that have not been performing as well. In this way, you are making a sacrifice by potentially giving up some short-term gain in order to accrue higher expected returns down the line. This is not so easy. Rebalancing takes discipline, but history shows investors have been rewarded for doing so.

3. Taking loans from your 401(k): Similar “free lunch” thinking can be applied to loans, specifically taking loans from your 401(k)6. While this might sound like a good deal – after all, you get to borrow from yourself rather than a third-party and potentially set your interest rate lower than what a bank might offer you — there’s a hidden catch.

As seen in the chart below, a recent analysis conducted by Exencial found that if an average 25-year-old puts $100 per month, plus gets an employer match of $100 per month, into a 401(k) that gets invested at 8 percent, that account will end up with about $431,000 in savings by the time they are 60 years old. On the other hand, if that same 25-year-old diverts their typical 401(k) contributions toward paying off a one-time “self-loan” of about 7,000 over five years, the total amount earned by age 60 will drop to less than $320,000. That’s nearly a quarter of the potential savings, gone.


Source: Exencial Wealth Advisors 401(k) loan study

Participants may be better off taking a loan from and paying higher interest to a bank because of the loss of compounded growth in the 401(k). Of course, some specific circumstances can change this outcome, but it is anything but a slam dunk decision to take a loan from a 401(k).

A healthy investment strategy, just like maintaining a healthy body, requires discipline. In investing, just like with many things in life, the more difficult path often ends up being more rewarding. When you hear about a strategy that sounds like a free lunch, a closer look is probably needed.


1 Investopedia – Momentum investing
2 Seeking Alpha – Momentum investing is supported by academic research
3 Yahoo! Finance – Bitcoin USD
4 Investopedia – Rebalancing
5 Vanguard March 2014 – Quantifying Vanguard advisor’s alpha
6 The Balance – 7 things to know about 401(k) loans before you take one


PAST PERFORMANCE IS NOT AN INDICATION OF FUTURE RETURNS. Information and opinions provided herein reflect the views of the author as of the publication date of this article. Such views and opinions are subject to change at any point and without notice. Some of the information provided herein was obtained from third-party sources believed to be reliable but such information is not guaranteed to be accurate. In addition, the links provided within are for convenience only and the provision of the links does not imply any sponsorship, endorsement, or approval of any of the content. We do not guarantee the content or its accuracy and completeness. The content is being provided for informational purposes only, and nothing within is, or is intended to constitute, investment, tax, or legal advice or a recommendation to buy or sell any types of securities or investments. The author has not taken into account the investment objectives, financial situation, or particular needs of any individual investor. Any forward-looking statements or forecasts are based on assumptions only, and actual results are expected to vary from any such statements or forecasts. No reliance should be placed on any such statements or forecasts when making any investment decision. Any assumptions and projections displayed are estimates, hypothetical in nature, and meant to serve solely as a guideline. No investment decision should be made based solely on any information provided herein and the author is not responsible for the consequences of any decisions or actions taken as a result of information provided in this book. There is a risk of loss from an investment in securities, including the risk of total loss of principal, which an investor will need to be prepared to bear. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will be profitable or suitable for a particular investor’s financial situation or risk tolerance. Exencial Wealth Advisors, LLC (“EWA”) is an investment adviser registered with the Securities & Exchange Commission (SEC). However, such registration does not imply a certain level of skill or training and no inference to the contrary should be made. EWA may only transact business in those states in which it is registered, notice filed, or qualifies for an exemption or exclusion from registration or notice filing requirements. Complete information about our services and fees is contained in our Form ADV Part 2A (Disclosure Brochure), a copy of which can be obtained at www.adviserinfo.sec.gov or by calling us at 888-478-1971

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