July 21, 2008
Smart Advice for the HuffPost Investor: Is This the Time to Dump Stocks and Sit On The Sidelines (Part 3)?
Many readers had a strong reaction to my advice that you should determine your asset allocation, invest in a properly allocated portfolio of low cost index funds and stay the course during these turbulent times.
Here are some excerpts from those who disagreed with my views. Beneath each excerpt, I have set forth some information for your consideration.
Time has clearly proven that for many people for many reasons variations of buy and hold whether indexed or not run into several problems.
Time has actually "clearly proven" the opposite.
Investors who had an appropriate asset allocation and who invested in a globally diversified portfolio of low cost index funds have prospered.
Check out this data of average annualized returns for a 60% (stocks)/40% (bonds) portfolio of passively managed funds. To avoid any claim that I am "data mining", I am going to use 3, 5 10, 25, 35, 50 and 80 year periods, ending December 31, 2007:
Years Annualized Returns
3 8.29%
5 12.78%
10 8.16%
25 11.26%
35 10.94%
50 10.63%
80 8.89%
It is more than a little frustrating to have someone compare anything about the 1970's to today, especially media.
Are you talking about the end of capitalism as we know it?
Do you believe that 442 industries in 192 countries, with over 60 million employees, sales of over $36 trillion a year and net profits of over $2 trillion a year will stop growing?
If these are the assumptions that cause you to ignore 80 years of historical data, then I would be a loss to recommend any investment alternatives that would suit your view of the world's economy.
I'm staying in cash for awhile.
If you will need more than 20% of your cash within 5 years, you should not be in the market at all. Instead, you should invest in FDIC insured CDs or U.S. Treasury bills, notes or bonds.
If you are suggesting that you have the risk tolerance to assume some market risk, but are waiting for the market to "bottom out", the data indicates that your efforts at market timing will likely significantly reduce your returns over time.
Don't dump stocks but cash in your 401k's now.
Your 401(k) plan is an important part of your retirement portfolio. If you follow this misguided advice and are under 59 1/2 years of age, you will be taxed on the distribution at your ordinary income rate, and you will be assessed a 10% penalty. In addition, you will decimate your retirement nest egg.
I bought Southwest Air stock right after 9/11/2001. Sold in 2003. Made out pretty well, thank you.
Planning to buy B of A and JPMorgan/Chase now
I also bought IGT, which makes slot machines. It only took me a couple months to rake in substantial gains from those.
Are you also going to tell us about the stocks you picked that lost money?
The record of "stock pickers" is dismal. By picking a small number of stocks, you are increasing your volatility by as much as 100%, but your expected return is the same as if you bought an index fund with a comparable risk.
This seems like the perfect storm for an investor: Much more risk, with no greater expected return.I wouldn't have one U.S. dollar in your portfolio and it would be spread with physical holdings of gold, silver, and mining stocks and Asian currency.
The U.S. is approximately 42% of the world's economy and remains the world's largest economic power. U.S. stocks may or may not outperform other geographical sectors in the future. No one knows.
is approximately 42% of the world's economy and remains the world's largest economic power. U.S. stocks may or may not outperform other geographical sectors in the future. No one knows.Smart Investors do not make any assumptions that have no data to support them. Instead, they own a globally diversified portfolio that takes into account the contribution of each country to the world's economy.
Take it from me, an American in his eighth decade...
SELL now, before it's too late.
I am not prepared to "take it" from you. But I do not recommend that anyone limit their portfolio to U.S. stocks. My recommended portfolios assume that you can sustain market risk and that you have determined an appropriate asset allocation. The make-up of your portfolio is a globally diversified portfolio of stocks, using low cost index funds, and an index fund for the bond portion of your portfolio that benchmarks the Lehman Bros. Aggregate Bond Index.
If you have data indicating that there is a better way to keep pace with inflation and taxes, I would like to see it.
The average investor would do better to just settle for cd interest than invest in the stock market at all.
You are correct. The "average investor" earns only one-third of the market returns that are hers for the taking. The culprit here is the securities industry which touts its purported expertise in market timing, stock picking and manager picking and the media which inundates investors with a steady drumbeat of confusing economic news. Investors who rely on these sources for investment guidance would be better off investing in CDs.
Intelligent, well-informed, investors understand that Smart Investing is very easy. They don't lessen their returns with expensive advice from "market beating" brokers or advisors.
The views set forth in this blog are the opinions of the author alone and may not represent the views of any firm or entity with whom he is affiliated. The data, information, and content on this blog are for information, education, and non-commercial purposes only. Returns from index funds do not represent the performance of any investment advisory firm. The information on this blog does not involve the rendering of personalized investment advice and is limited to the dissemination of opinions on investing. No reader should construe these opinions as an offer of advisory services. Readers who require investment advice should retain the services of a competent investment professional. The information on this blog is not an offer to buy or sell, or a solicitation of any offer to buy or sell any securities or class of securities mentioned herein.
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July 14, 2008
Smart Advice for the HuffPost Investor: Is This the Time to Dump Stocks and Sit On The Sidelines (Part 2)?
I received a spirited reaction to last week's column in which I advised investors to stay the course. Here is an example:
Mr. Solin, while your advice is "tried and true" one could also assert it is tired and trite. These are times much unlike any we have ever seen.
Is this reader right? The markets continue to fall. The economic news seems to be endlessly negative. Is there any light at the end of this dark tunnel? Are we really confronting times "much unlike any we have ever seen"?
I have one guiding principle when it comes to evaluating investment advice. I ask myself whether those giving the advice have an economic interest in their opinions.
The media loves bad news. It sells newspapers and increases ratings. A recent study by the Business and Media Institute noted that current financial coverage is more negative than coverage of the 1929 stock market crash. The study found that "[D]uring the week of the 1929 stock market crash, daily news stories reported positive news more often than negative by a 4-to-1 ratio. The week that the Bear Stearns fall occurred, coverage was the complete opposite. Negative stories on ABC, CBS and NBC outnumbered positive 6-to-1."
The securities industry is the real beneficiary of bad news. By some estimates it generates over $645 million a day from commissions and bid ask spreads. Activity is its closest ally. Investors who buy and hold are its financial enemy.
Financial pundits thrive in volatile markets. Their "expertise" is in great demand. After all, how will investors know what to do without guidance from these experts?
Let's take a look at their track record.
An article in the New York Times published October 17, 1974, at the end of a two year market decline, reported that the majority of Americans shared the views of prominent economists that we were headed for a major depression.
In the ensuing 5 years, a globally diversified portfolio of passively managed funds allocated only 60% to stocks and 40% to bonds had annualized returns of almost 19%.
In August, 1973, when the Dow was at 875, the cover story of Business Week proclaimed the "death" of equities. Investors in the same 60/40 portfolio realized annualized returns of 9.42% over the ensuing 5 year period.
In September, 1990, 58% of 50 prominent economists predicted an imminent recession. A 60/40 portfolio achieved annualized returns of 13.01% over the next 5 years.
Is this history applicable? Naysayers keep repeating the mantra that the current economic conditions are unique. Are they right?
The stock market crashed seven times in the 19th century. The panic was not limited to United States. Markets in Germany and France suffered similar fates.The 20th century ushered in far more volatile markets. In addition to the Great Depression of 1929, the markets imploded at least 7 times. The markets in Japan tanked in 1990, markets in the United Kingdom crashed in 1992, the entire Asian markets collapsed in 1997, the Russian markets dropped dramatically in 1998 and the burgeoning markets in China had a major correction in 2007.
The markets have absorbed the Pearl Harbor attack, the Cuban missile crises, the assassination of John F. Kennedy, the invasion of Kuwait, and the September 11 attacks on the World Trade Center.
The lesson learned from this history could not be clearer: Investors who did not panic prospered.
I fully understand the anxiety and even panic of investors in these turbulent times. However, there are lessons to be learned from behavioral finance, which examines why investors behave the way they do.
These studies show that investors are more likely to regret taking affirmative action than not taking any action at all. This makes perfect sense. Acting rashly out of fear or panic is far more likely to cause harm than letting those feelings pass and reflecting carefully on an appropriate course of conduct.
Dumping stocks in bad times is probably the worst investment decision you can make. Eugene F. Fama and Kenneth R. French have had a greater influence on portfolio management than anyone. Their seminal paper, "The Cross-Section of Expected Stock Returns" (Journal of Finance, June 1992), changed the way we think about the real source of stock market returns.
Another study by Fama and French found that expected returns on bonds and stocks are higher when economic conditions are weak and lower when conditions are strong.
We have extensive data indicating that the markets reward those who determine the right asset allocation for their investment objectives and tolerance for risk, and who invest in a globally diversified portfolio of low cost index funds. These investors buy and hold. They do not try to time the markets. They understand that sitting on the sidelines for even a relatively small period of time can cost them a significant portion of their market returns.
The views set forth in this blog are the opinions of the author alone and may not represent the views of any firm or entity with whom he is affiliated. The data, information, and content on this blog are for information, education, and non-commercial purposes only. Returns from index funds do not represent the performance of any investment advisory firm. The information on this blog does not involve the rendering of personalized investment advice and is limited to the dissemination of opinions on investing. No reader should construe these opinions as an offer of advisory services. Readers who require investment advice should retain the services of a competent investment professional. The information on this blog is not an offer to buy or sell, or a solicitation of any offer to buy or sell any securities or class of securities mentioned herein.
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July 07, 2008
Smart Advice for the HuffPost Investor: Is now the time to sit on the sidelines?
Question: Isn't this the time for you to tell would be investors that it is not an investors market and they need to keep their money on the sidelines?
Answer: It is never the time to give that advice. Individuals who can stay in the market for a minimum of 4 and half years should always be in the market. The key is to be sure you have the right asset allocation.
If you can't stay the course for that long you should invest in FDIC insured CDs, money market accounts or Treasury Bills.
Investors with a longer time horizon run a meaningful risk when they jump in and out of the markets. The markets move in a random manner. Trying to predict the highs and lows is risky business. All we really know is that, over time, the world's markets increase in value.
One study looked at gains and losses in the markets over a 10 year period, consisting of 2516 trading days. Over this time period, only 20 trading days made up 100% of the returns! I don't have the ability to pick those 20 days. No else does either.
Rather than telling investors to stay out of the market, I would advise them to determine their asset allocation. They can do this by taking a free and interactive asset allocation questionnaire at www.smartestinvestmentbook.com. They should then invest in a globally diversified portfolio of low cost index funds, readily available from well-known fund families like Vanguard and Fidelity.
In relationships, absence sometimes makes the heart grow fonder.
The reverse is true for investors. You never want to be absent.
Question: Do you see ETFs as advantageous as index funds?
Answer: ETFs are becoming very competitive with index funds. They often have lower expense ratios and may even be more tax efficient.
Some problems with ETFs include the cost of the bid-ask spread and the necessity of having a brokerage account, requiring the payment of commissions when you buy or sell them.
However, for investors living in areas outside the United States where low cost index funds are not readily available, I view ETFs as a viable alternative.
One alternative for these investors is an ETF that tracks the performance of the world's markets. The iShares MSCI ACWI Index Fund (NASDAQ: ACWI) tracks an index of 2,884 different stocks from developed and emerging markets in every investable market in the world.
The views set forth in this blog are the opinions of the author alone and may not represent the views of any firm or entity with whom he is affiliated. The data, information, and content on this blog are for information, education, and non-commercial purposes only. Returns from index funds do not represent the performance of any investment advisory firm. The information on this blog does not involve the rendering of personalized investment advice and is limited to the dissemination of opinions on investing. No reader should construe these opinions as an offer of advisory services. Readers who require investment advice should retain the services of a competent investment professional. The information on this blog is not an offer to buy or sell, or a solicitation of any offer to buy or sell any securities or class of securities mentioned herein.
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July 01, 2008
Smart Advice for the HuffPost Investor: Ten simple steps to level the playing field for investors.
These are clearly tumultuous and troublesome times for investors. The volatility of the markets would be bad enough standing alone. It is compounded by the mendacity of some brokers and advisors who profit from giving investors poor--and even misleading--advice.
Poor advice is the norm of brokers and advisors who claim they can "beat the markets".
Misleading advice is all too common. The recent announcement of a suit filed by the Secretary of the Commonwealth of Massachusetts alleging that UBS affirmatively deceived its retail clients into buying auction rate securities, when it knew the market for them was tanking, is the latest in a series of Wall Street scandals.
Here are ten simple steps that would go a long way towards protecting investors. If the SEC and Congress really cared about its constituents, it would enact them. All it would take is the political will to place the interests of its real constituents above those of the insurance and securities lobbies:
1. Ban all actively managed funds in 401(k), 403(b) and 457(b) plans.
2. Ban all annuities in 401(k), 403(b) and 457(b) plans.
3. Require all 401(k), 403(b) and 457(b) plans to have Target Retirement Funds (where the underlying funds were primarily index funds), and low cost index funds covering the domestic stock market, the international stock market and the domestic and foreign bond markets.
4. Require all 401(k), 403(b) and 457(b) plans to fill out a simple form, approved by the Department of Labor, that sets forth all costs incurred by the plan. Require the plans to post this form on the internet for easy access by all plan participants.
5. Outlaw "revenue-sharing" in all 401(k), 403(b) and 457(b) plans.
6. Require all brokers and advisors to give investors a standard risk assessment questionnaire and to advise them in writing if the risk of their investments deviates from the risk profile indicated in this questionnaire.
7. Require all statements from brokerage firms and advisors to disclose the costs and risk of their clients' portfolios, as follows:
The "cost equity" of your portfolio year-to-date is --%. This means that, before you can make a profit, your portfolio will have to earn at least that return.
The risk of your portfolio, as measured by standard deviation, is --%. Based on your risk profile, your standard deviation should range from --% to --%
8. Require all statements from brokerage firms and advisors to state the following:
The overwhelming data indicates that, over the long-term, index funds are very likely to outperform actively managed funds of comparable risk. There is similar data indicating that neither we, nor anyone else, can pick stocks, time the markets or pick mutual fund managers who can "beat the markets" over the long term with any persistence.
9. Abolish the mandatory arbitration system imposed on all investors who do business with a member of FINRA and permit them to seek redress for broker misconduct in the Courts, with a jury of their peers.
10. Require a ticker to run continuously underneath the musings of talking heads on television who give stock picking advice which says: "There is no data indicating anyone can accurately pick which stocks that will outperform other stocks over the long term."
The views set forth in this blog are the opinions of the author alone and may not represent the views of any firm or entity with whom he is affiliated. The data, information, and content on this blog are for information, education, and non-commercial purposes only. Returns from index funds do not represent the performance of any investment advisory firm. The information on this blog does not involve the rendering of personalized investment advice and is limited to the dissemination of opinions on investing. No reader should construe these opinions as an offer of advisory services. Readers who require investment advice should retain the services of a competent investment professional. The information on this blog is not an offer to buy or sell, or a solicitation of any offer to buy or sell any securities or class of securities mentioned herein.
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June 23, 2008
Smart Advice for the HuffPost Investor: Everyone is telling you It's a "no-brainer" to invest in your 401(k) plan because of the employer match. What if everyone is wrong?
(The following is an edited excerpt from my new book, The Smartest 401(k) Book You'll Ever Read, used by permission, Perigee Books/Penguin Group [USA] Inc.).
With 401(k) assets plunging as the markets continue their downward spiral, employees are looking at their 401(k) statements with a sense of dread. Few, however, challenge the conventional wisdom that investing in these plans is a "no brainer" because of the employer match.
I agree with most advisors who believe the corporate match of a 401(k) and 403(b) plan is too good to pass up. Investors probably should contribute to these plans - at least the minimum amount necessary to obtain the maximum employer match. However, I'm more concerned than most about future developments that could make any investment in retirement plans a bad choice.
I don't know about you, but I find the government to be pretty scary. Recent events have demonstrated that it has very broad power to have a serious impact on our rights.
The possibility of retroactive legislation that could sharply reduce, or even eliminate, the benefits of current retirement planning cannot be discounted. The ability of the government to pass retroactive tax legislation going back as much as ten years has been sanctioned by the Supreme Court, which has referred to this disturbing conduct as "customary practice."
Don't take my word for it. In its brief to the Supreme Court supporting the power of the government to take away your money retroactively, the Justice Department had this chilling observation: "The taxpayer must be prepared for such possibilities."
Are you prepared for the possibility that the government could retroactively impose a new tax on distributions from your retirement accounts? It could happen. If it does, it could seriously erode the benefits of participating in these plans.
In addition, looming darkly over your retirement planning horizon is the uncertainty of the ordinary income tax rate at your retirement. It cannot be predicted or quantified. What we do know is that by investing in a tax-deferred plan you have surrendered your right to be taxed at the historically more favorable long term capital gains rate.
Even if tax rates stay the same, it's by no means a foregone conclusion that your post-retirement tax rate will be lower than your pre-retirement rate. Here are some variables that could adversely affect your tax rate:
You are likely to be single at some point in retirement. If so, your status as a single filer could put you in a higher bracket.
You may decide to work in retirement, to supplement your income or just because you may find it satisfying to do so.
You may not have the same tax breaks in retirement that you presently have--like your deduction for mortgage payments.
When you add to these potential problems the lack of liquidity of retirement plans, the limited and often poor choice of investment options available to plan participants, and the high fees buried in these plans, you begin to question the unbridled enthusiasm of financial planners and the financial media for investing in these plans.
I fully understand the hype. These plans are great for employers, for the mutual fund and insurance industries, for brokers and for annuity salesmen.
There are ways to maximize your retirement savings within these plans. I discuss them in my book. If Congress served the needs of its constituents, instead of the powerful lobbyists for the securities and insurance industries, it could easily legislate the changes that would provide much needed disclosure and protection to plan participants. Nothing would make me happier than to make books like mine unnecessary.
The views set forth in this blog are the opinions of the author alone and may not represent the views of any firm or entity with whom he is affiliated. The data, information, and content on this blog are for information, education, and non-commercial purposes only. Returns from index funds do not represent the performance of any investment advisory firm. The information on this blog does not involve the rendering of personalized investment advice and is limited to the dissemination of opinions on investing. No reader should construe these opinions as an offer of advisory services. Readers who require investment advice should retain the services of a competent investment professional. The information on this blog is not an offer to buy or sell, or a solicitation of any offer to buy or sell any securities or class of securities mentioned herein.
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June 15, 2008
Smart Advice for the HuffPost Investor: The Lenny Dykstra Controversy: Fair or Foul?
Is famed ball player Lenny Dykstra the new financial guru? He claims that his stock picking skills have returned over 90% for each of the last three years. A very impressive track record!
No less an authority than Jim Cramer anointed him as "One of the great ones in this business."
The controversy over Dykstra was fueled by an article in Forbes that indicated that many of Dykstra's stock picks appeared in lists published by another stock picker. Dykstra, who was not known as "nails" for his timidity, promptly labeled the story "a smear job."
Let's take a closer look.
Being labeled by Jim Cramer as a "great one" is a mixed blessing. According to an in-depth study by Barrons, Cramer's stocks picks woefully lagged the markets in the two year period measured. His picks returned 12% vs. returns of 22% for the DJIA and 16% for the S&P 500.
But does all this really matter?
Roger Ibbotson lacks Dykstra's ball playing expertise, but his standing in the financial community cannot be debated. His is a Professor of Finance at the Yale School of Management and the founder of the highly respected firm of Ibbotson Associates that was recently acquired by Morningstar. He is the co-author of the standard reference for information on investment market returns.
According to a study he co-authored, stock picking is not a skill to be valued by investors because, on average, asset allocation explains "...100 percent of the absolute level of return."
Nevertheless, let's give Mr. Dykstra the benefit of the doubt and assume that he is a great stock picker whose stocks really did return 90% for the past three years. This is the beginning of the analysis and not the end.
A successful stock picker is able to select stocks that will outperform an index of comparable risk. Let me give you an example.
Let's assume that you knew Mr. Dykstra in October, 2002 and you followed his stock picking advice for five years, until September, 2007. During that time, he picked the following stocks:
Dell
Berkshire Hathaway
Wal-Mart
Home Depot
Brilliant, right?
Not exactly.
All of these stocks significantly underperformed the S&P 500 during this period.
Over longer periods, very few stocks (none of the ones mentioned above) outperform the relevant index.
And it gets worse.
Studies have consistently shown that the risk of holding positions in individual stocks is twice the risk of buying the index.
What does all this mean for the average investor?
If you rely on stock pickers, you are taking twice the risk to achieve the same expected return of the index. The chance of your stock picking guru being able to pick stocks that will outperform the index are exceedingly slim.
So is the Dykstra controversy fair or foul?
Neither.
It is irrelevant.
The views set forth in this blog are the opinions of the author alone and may not represent the views of any firm or entity with whom he is affiliated. The data, information, and content on this blog are for information, education, and non-commercial purposes only. Returns from index funds do not represent the performance of any investment advisory firm. The information on this blog does not involve the rendering of personalized investment advice and is limited to the dissemination of opinions on investing. No reader should construe these opinions as an offer of advisory services. Readers who require investment advice should retain the services of a competent investment professional. The information on this blog is not an offer to buy or sell, or a solicitation of any offer to buy or sell any securities or class of securities mentioned herein.
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June 08, 2008
Smart Advice for the HuffPost Investor: Investing in commodities. Smart move or fool's gold?
Question: Is now the right time to invest in commodities?
Answer: With oil prices reaching record highs almost daily, it is no wonder that assets in commodities funds have exploded to $260 billion.
Adding commodities as a separate asset class to your portfolio can be justified if doing so reduces risk, increases returns or acts as a hedge against inflation.
Unfortunately, the data on whether it accomplishes any of these objectives is conflicted.
One private study used the Goldman Sachs Commodity Index (GSCI) and reached these conclusions:
- There was no excess return over T-Bills from adding the GSCI to portfolios;
- There was no reduction in the volatility of a stock and bond portfolio when the GSCI was added; and
- Adding the GSCI did not improve protection against inflation.
However, there is some historical data indicating that adding commodities to a broadly diversified portfolio of stocks and bonds increased returns and lowered risks. One study found that, over a 20 year period, a mix of energy, real estate and metals and mining funds, achieved these goals.
If you are persuaded by the positive data on commodities, you could consider index funds like the iPath Dow Jones AIG Commodity Index Fund (DJP) or the iPath GSCI Total Return Index Fund (GSP).
DJP is less volatile and more diversified. GSP has a large percentage of its assets invested in oil and gas (which explains why is up 24.05% in the past year!).
Personally, I am content with the commodities exposure I receive by owning a broadly diversified domestic index stock fund. I do not have exposure to commodities as a separate asset class in my portfolio and I do not recommend it for inclusion in the portfolios of my clients.
Question: What are the past performances of these world index stock and bond funds and compared to what ? Are you assuming that all emerging and all world markets in aggregate will go up with time in the future as the U.S. market did in the past ?
Answer: For the period 1986-2007 (when the most reliable data is available), the world portfolio generally under preformed the Smart Investor portfolios which are set forth in The Smartest Investment Book You'll Ever Read.
For example, a 60% (stocks) and 40% (bond) portfolio consisting of a mix of the Vanguard Total Stock Market Index Fund (VTSMX), the Vanguard total International Stock Index Fund (VGTSX) and the Vanguard Total Bond Index Fund (VBMFX) had an annual return of 10.09% during this period. The world portfolio had an annualized return of 9.87.
The Vanguard portfolio had 100% domestic bonds. The world portfolio has a majority of its funds invested in foreign bonds. During this period, domestic bonds out performed foreign bonds.
Let's put these returns in perspective.
One study showed that, for the 20 year period from 1986 through 2006, the average equity investor earned only 4.3% on her investments. During that same period, the S&P 500 had an annualized return of 11.8%.
I am making no assumptions about the direction of either the foreign or the domestic markets. Historical data tells us that the global markets in the aggregate have increased in value in the past. We also know that broad asset class diversification is a critical element to investing success.
Investors who believe that global diversification of the stock and bond portion of their portfolios is preferable to a portfolio of globally diversified stocks and domestic bonds would be well advised to consider a world portfolio.
Either choice would have yielded a return more than 200% better than the returns of the average equity investor, who was following the advice of her "market beating" broker or advisor.
The views set forth in this blog are the opinions of the author alone and may not represent the views of any firm or entity with whom he is affiliated. The data, information, and content on this blog are for information, education, and non-commercial purposes only. Returns from index funds do not represent the performance of any investment advisory firm. The information on this blog does not involve the rendering of personalized investment advice and is limited to the dissemination of opinions on investing. No reader should construe these opinions as an offer of advisory services. Readers who require investment advice should retain the services of a competent investment professional. The information on this blog is not an offer to buy or sell, or a solicitation of any offer to buy or sell any securities or class of securities mentioned herein.
Posted by Dan Solin | Link | Comments (0) | Add a comment
June 02, 2008
Smart Advice for the HuffPost Investor: A Billion Dollar Idea. My Gift to the Securities Industry. Any Takers?
Question: Why is investing so complicated?
Answer: Because the securities industry benefits from convincing you that you need the assistance of its "investment professionals" to deal with this contrived complexity.
Smart Investing is really very simple:
Determine your asset allocation. Invest in a globally diversified portfolio of low cost index funds. I provide details in my blog, It's So Easy Your Broker Could Do It!, available at: http://www.huffingtonpost.com/dan-solin/its-so-easy-your-broker_b_56296.html.
In my book, The Smartest Investment Book You'll Ever Read, I set forth four portfolios: Low Risk, Medium-Low Risk, Medium High Risk and High Risk. One of them is suitable for the vast majority of investors. Each one involves the purchase of only three index funds: a broad domestic stock index fund, a broad international stock index fund and a short or intermediate term bond index fund. I call these "Smart Investor" portfolios.
Based on historical data, these simple portfolios have outperformed 95% of professionally managed money.
Tens of thousands of readers got the message and made these changes to their portfolios. But they represent only a drop in the bucket of hyperactive, returns chasing investors, egged on by their "market beating" brokers and advisors.
Recently, investing just became even easier for Smart Investors.
Barclay's has launched the iShares MSCI ACWI Fund (ACWI). This fund seeks investment results that correspond generally to the price and yield performance, before fees and expenses, of the MSCI All Country World Index. It has a very reasonable expense ratio of 0.35%, compared to the 1.50% expense ratio of many hyperactively managed funds.
One fund. Broad exposure to the world's markets. No need to buy a domestic fund and an international fund. Now Smart Investors need to purchase only two funds instead of three.
It is not perfect. It holds only 694 stocks from the 2,736 stock index. But it provides global exposure to the world's markets in way that was previously unavailable to all but the most sophisticated investors.
Both Vanguard and Northern Trust have announced plans to launch similar funds.
While world index funds are a step in the right direction, Smart Investing is still too complex for most hard working Americans. They have to buy two or three funds, and resist the sales pitch of "investment professionals" who try to lure them into expensive, underperforming, hyperactive funds. Then they have to rebalance their portfolios periodically to preserve the integrity of their asset allocations.
Here is my billion dollar idea for the securities industry.
What if an enterprising fund family, who really cared about the financial health of its clients, marketed four Smart Investor ETFs? One would correspond to each of the four risk profiles that fit most investors.
These ETFs would consist of an all world index fund, like the iShares MSCI ACWI Fund, and a bond index fund that benchmarks the Citigroup World Government Bond Index. These Smart Investor Funds would rebalance automatically.
With the availability of these funds, investors would purchase only one fund. If their investment objectives or tolerance for risk changed, they could purchase another fund with a different risk level.
These investors would have a globally diversified portfolio of stocks and bonds, with very low expenses. Based on historical data, the returns of the average investor would increase by a whopping 200%-300% over the long term.
These funds would be bad news for "investment professionals." Their services would be redundant. No complexities to unravel.
But it would be good news for beleaguered, confused and victimized investors all over the world.
Any takers?
The views set forth in this blog are the opinions of the author alone and may not represent the views of any firm or entity with whom he is affiliated. The data, information, and content on this blog are for information, education, and non-commercial purposes only. Returns from index funds do not represent the performance of any investment advisory firm. The information on this blog does not involve the rendering of personalized investment advice and is limited to the dissemination of opinions on investing. No reader should construe these opinions as an offer of advisory services. Readers who require investment advice should retain the services of a competent investment professional. The information on this blog is not an offer to buy or sell, or a solicitation of any offer to buy or sell any securities or class of securities mentioned herein.
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May 25, 2008
Smart Advice for the HuffPost Investor: A Hot Tip On Hedge Funds!
Question: What's going on with hedge funds these days?
Answer: There are over 8000 hedge funds. Wealthy investors have poured over $1 trillion into them. Stories of outsized returns fill the financial media.
The hard data tells a much different story.
Exhaustive studies of the performance of hedge funds have found that investors could generate the same or better returns by investing in an S&P 500 index fund. One study of 1917 funds found that only 17.7% beat this benchmark.
The promise of huge returns drives investment in these funds. The possibility of disastrous losses is rarely discussed. The foundation of all returns is risk. Hedge funds that deliver big returns are taking big risks. The markets are not a one-way street.
The SEC is quick to take action when funds engage in illegal activity, but what is it doing to protect investors in these funds? Nothing. Currently, hedge funds are not even required to register with the SEC.
Recently, the founder and chief executive of the International Management Associates hedge funds was found guilty of money laundering and fraud. The collapse of these funds costs investors, including some well-known NFL players, more than $150 million.
A number of other hedge funds have imploded. You will recognize the names of some of the investment banking firms that ran them: Bear Stearns, Dillon Reed, PNP Paribas and Russell Investments. Fraud was not an issue with these funds. They just lost billions of dollars (in the aggregate) of investors' money and closed down or restructured. Others are sure to follow.
Presumably, these funds were run by some of the best and brightest that Wall Street could recruit.
Here's my "hot tip": Just say "no."
Question: Do you "cherry pick" your numbers to bolster your arguments for passive management?
Answer: Active managers need to "cherry pick" their numbers to justify their existence. Passive managers rely on exhaustively documented, long term data.
When the financial media reports on the performance of actively managed funds, they do not take into consideration the returns of those funds that went out of business due to poor performance. The next time you see a report on the "average performance" of actively managed funds, you should be aware that this data omits the poor performance of up to 35% of the total number of these funds that are no longer around.
Studies of actively managed funds reveal the following:
- Over a long term period (10 years or more) less than 5% of active managers will equal or exceed their benchmark.
- Superior active fund managers are unlikely to repeat their performance in subsequent periods;
- A ten year study of the performance of the endowment funds of over 2500 colleges and universities showed a consistent pattern of under performance, when measured against a comparable portfolio of funds passively managed by Dimensional Fund Advisors.
- The average investor in an actively managed fund significantly underperforms both the returns of that fund (because investors jump in and out of funds, usually at the wrong time) and the relevant benchmark.
If investors believe they can beat these odds, they are certainly free to pick actively managed funds or portfolios of stocks.
However, they should be aware that they are gambling and not investing.
The views set forth in this blog are the opinions of the author alone and may not represent the views of any firm or entity with whom he is affiliated. The data, information, and content on this blog are for information, education, and non-commercial purposes only. Returns from index funds do not represent the performance of any investment advisory firm. The information on this blog does not involve the rendering of personalized investment advice and is limited to the dissemination of opinions on investing. No reader should construe these opinions as an offer of advisory services. Readers who require investment advice should retain the services of a competent investment professional. The information on this blog is not an offer to buy or sell, or a solicitation of any offer to buy or sell any securities or class of securities mentioned herein.
Posted by Dan Solin | Link | Comments (0) | Add a comment
May 19, 2008
Smart Advice for the HuffPost Investor: The Secret to Obtaining “Endowment” Returns.
Question: I found the analysis of Vanguard's Managed Payout Funds to be a touch strange. Comparing these funds to the Strategic Equity Fund is a bit of a stretch. The philosophy of these investments are as dissimilar as the proverbial "Apples and Oranges." Also, we're always advised to invest for the long term. Dan neglects to point out that the Strategic Equity Fund has an average annualized gain over the past 5 years of 13.75%. Finally, Dan should acquaint himself with the concept of the university endowment, something that until now was unavailable to the individual investor. A check of the investment record of the Yale Endowment might have been a good idea before dismissing the Managed Payout Funds out of hand.
Answer: I realize this is not a question, but it does raise some serious issues that merit a response.
My use of Vanguard's Strategic Equity Fund was not intended to be a comparison to Vanguard's new Managed Payout Funds. I used that fund solely as an example of "the peril of relying on hyperactive management."
The promise of "endowment" returns is premised, in part, on the ability of the active managers to achieve superior returns. My point was that this is the same promise of the Vanguard Strategic Equity Fund. Sometimes active managers achieve their goals, but most of the time they don't. I have no way of knowing which category the active managers of the Managed Payout Funds will fall into, but the odds are seriously stacked against them.
I am familiar with the performance record of endowment funds. It is underwhelming. The average rate of return for endowment funds for the period from 1987-2002 was 9.17%. During this same period, the S&P 500 index had an annualized return of 10.87%. The returns of a globally diversified portfolio invested in a 60% (stocks)/40% (bonds) of passively managed funds run by Dimensional Fund Advisors (DFA), was 8.85%, with less risk.
In 2006, the average return of endowment funds was 10.7%. The return of the S&P 500 index was 15.73%. The return of a 60/40 portfolio of DFA's passively managed funds was 15.10% .
I fail to see the allure of "endowment" returns.
You are correct in noting the stellar returns of the Yale endowment fund. It has returned an annualized 17.2% over the ten-year period ending June 30, 2006. What you fail to mention is that this fund is in the top 1% of large institutional investors. There is no assurance (and little statistical likelihood) that Vanguard's Managed Payout Funds will achieve this level of performance.
David Swenson ran Yale's endowment fund. He is a vigorous proponent of index funds for individual investors noting that, when you take all relevant factors into consideration, it is a "virtual certainty" that investors in hyperactively managed funds will underperform the markets.
The stark reality is that endowment funds as a group would be better off if they fired all of their hyperactive managers and invested in a globally diversified portfolio of low cost index funds. Maybe that is why trillions of dollars of institutional money is invested in this manner.
Individual investors would be well advised to do the same and to avoid actively managed funds that promise "endowment like" returns.
Question: How, if at all, should an investment strategy vary between my tax-advantaged accounts (IRA or 401k or similar ), and my non-tax advantaged savings?
Answer: Your asset allocation should be the same for your taxable and non-taxable accounts. Unfortunately, the selection of funds for some of your non-taxable accounts can be challenging. Most 401(k) plans do not offer a broad choice of low cost index funds or target retirement funds. Many plans that do offer target retirement funds offer ones that are composed of hyperactively managed funds.
One often over-looked decision is which assets should be placed in non-taxable and taxable accounts. As a general rule, assets that generate returns taxed at ordinary income rates should be placed in non-taxable accounts. These would include bonds, real estate investment trusts and tax inefficient funds, in that order. Most hyperactively managed funds are tax inefficient.
In your taxable account, you want to have assets that you intend hold for a long time, like stocks and index funds.
A far more complex issue is how much of your assets should be in tax deferred accounts at all. While the financial media and many financial advisors extol the virtues of 401(k) plans, they can be a trap for the unwary and many employees would be better off if they refused to participate in these plans. I deal with this subject in detail in my new book, The Smartest 401(k) Book You'll Ever Read (Perigee Books), which will be published next month.
The views set forth in this blog are the opinions of the author alone and may not represent the views of any firm or entity with whom he is affiliated. The data, information, and content on this blog are for information, education, and non-commercial purposes only. Returns from index funds do not represent the performance of any investment advisory firm. The information on this blog does not involve the rendering of personalized investment advice and is limited to the dissemination of opinions on investing. No reader should construe these opinions as an offer of advisory services. Readers who require investment advice should retain the services of a competent investment professional. The information on this blog is not an offer to buy or sell, or a solicitation of any offer to buy or sell any securities or class of securities mentioned herein.
Posted by Dan Solin | Link | Comments (2) | Add a comment
