Planner's new book builds historical case for passive investing

Noticing how historical context helped his clients ignore the constant pressure of noise and volatility, a financial planner wrote a 500-page treatise on American financial history to offer a bigger picture.

Chartered financial analyst and certified financial planner Mark J. Higgins released "Investing in U.S. Financial History: Understanding the Past to Forecast the Future" last month after spending the past four years reading dozens of books and using "lessons from the past to help clients understand the present, simplify their portfolios, reduce fees and improve performance," he writes in the introduction. History often falls by the wayside as financial advisors and clients navigate spikes and troughs in asset values and try to beat benchmark returns with hot picks.

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Many advisors "rely only on their personal experience and education, which were focused primarily on recent experiences (perhaps extending back 50 years at most)" and get "distracted by the constant noise in securities markets, which is often little more than random," Higgins, a longtime consultant to institutional clients who joined Irvine, California-based Index Fund Advisors last year as a senior vice president, said in an email interview. 

"By supplementing my memory with the memories of our ancestors, I found it to be much easier to calm clients' emotions in the wake of market shocks or during the updraft of manias," he continued. "It gave me a unique foundation of knowledge that explained why excess portfolio complexity and active management (and the costs that accompany them) are often to the benefit of investment consultants rather than the clients that they serve. In fact, it is this discovery that led me to Index Fund Advisors. We believe strongly that the excess complexity in most institutional investment portfolios (and the higher costs that accompany it) is usually a detriment rather than a benefit to their expected returns."

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The long-term growth in the U.S. stock market (think annualized returns of 10.3% over the past 66 years in the S&P 500 index) and much lower fees than active management certainly offer a compelling case for passive funds. Other areas of the value an advisor can bring to a client through methods such as tax-loss harvesting, routine portfolio rebalancing or a focus on certain asset classes that active adherents argue are better suited to direct management display some of the subtlety within a persistent debate in the profession.

Past events "such as the Great Recession, bank failures, geopolitical tension and market instability of recent years" may not serve as "a perfect blueprint for what's to come" because of the way that they "have all made investors reevaluate their approach to risk and opportunity cost," said Lule Demmissie, CEO of the U.S. arm of social investing application eToro.

"It has never been truer than now that participation in capital markets is an essential ingredient in building generational wealth," Demmissie said in an email. "But the reality is that it's a much more disrupted world. Therefore, it requires an investor with resilience and agility. The financial advisor that helps coach and hone that skill in their clients is likely to be better suited for the future. The financial advisor that simply tells them to 'set it and forget it in just passive instruments' may not be setting them up for investment resiliency or best performance outcomes."

Regardless of the active-passive discussion, Higgins provides readers with a broad overview of U.S. financial history at the beginning of the book then fills in those themes at length in chronological order from 1790 to the present. Book-jacket praise from investment managers, academics, former government officials and fellow financial writers for the frequent contributor to publications like the Museum of American Finance's "Financial History" and the CFA Institute's "Enterprising Investor" act as a supplement to quotes from preeminent figures in investing whose thoughts on history appear on Higgins' website.

"There are no investors and no senior policymakers I know — and I know many, and I know the best — who have any excellent understandings of what happened in the past and why," Bridgewater Associates founder Ray Dalio once said.

"There can be few fields of human endeavor in which history counts for so little as in the world of finance," economist John Kenneth Galbraith observed. "Past experience, to the extent that it is part of memory at all, is dismissed as the primitive refuge of those who do not have the insight to appreciate the incredible wonders of the present."

"There is no better teacher than history in determining the future," the late Charlie Munger, vice chairman of Berkshire Hathaway, said. "There are answers worth billions of dollars in a $30 history book."

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In an intro that includes a caveat that these are "just a small sample of principles that are explored in this book," Higgins boils down the key themes of American financial history to: "government debt and creditworthiness," "the benefits and risks of fractional reserve banking systems," "principles of economics and innovation," "depressions, inflation, and price stability," "securities markets," and "investment strategy." A "fear of obsolescence" often hinders "investment professionals from abandoning overly complex strategies that were clearly not optimizing results," Higgins writes.

"This experience has also convinced me beyond any doubt that embracing investment strategies with less complexity provides a golden opportunity to enhance the value of the investment profession rather than condemn it to obsolescence," he writes. "Not a day has passed over the last four years in which I have not read, written or thought about how to share this story."

Over the six-part, 31-chapter book, Higgins covers topics like Alexander Hamilton's influence as a founding father, the First Bank of the United States, the Panic of 1873, the Great Depression, the 2008 financial crisis and the pandemic. 

Asked why investors and the industry at large seem to forget the enduring legacy of many past economic crises, he said that the problem is "less a matter of forgetting the lessons and more a matter of having a complete lack of awareness of the lessons." That "loss of collective memory is tragic" because "events that seem, in the moment, to be unprecedented" are not when considering the country's financial history, Higgins said.

"The last four years provided a perfect case study to reveal the value of studying financial history," he said. "People who looked back far enough saw that almost every event we experienced during and after the COVID-19 pandemic had a close historical parallel. However, people who limited their knowledge of financial history thought everything was unprecedented. It was the discovery of this truth that inspired me to write this book."

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To be sure, many advisors and asset managers do think often about historical parallels, but "the most important" takeaway from Higgins' book is that "people rely too much on the recent past to try to explain what is happening in the present," he added. 

Take the surging inflation of recent years as an example. Many investment professionals cited "the typical path of elevated levels of inflation over the past 50 years or so" when they should have been thinking about those of the post-World War I and influenza period of 1919-20 and the "the late-1960s and 1970s when the Federal Reserve failed to maintain tight monetary policy to extinguish inflation," according to Higgins.

The Fed "repeatedly abandoned tight monetary policy prematurely, which allowed elevated inflation expectations to become entrenched," he said. "Awareness of these two events made it clear that (a) inflation was unlikely to be transitory at the outset, and (b) that the Fed would likely be more aggressive and stay more aggressive than the market anticipated out of fear of repeating the mistakes of the late 1960s and 1970s. Few people were able to see how the post COVID-19 inflation would play out because they were unaware of at least one of these historical events – and most people were unaware of both."