The Smartest Investment Book You'll Ever Read by Daniel R. Solin

You can?t beat the market, but you can beat the system

Tue, 10 Oct 2006 09:02:00 GMT

Right now, in America, more than $7.5 trillion is being invested the wrong way. By people who believe that they, their brokers, their investment advisors, mutual fund managers, and stock market analysts can predict the future. They can't.Fortunately, there's a better way to invest. As I demonstrate in my new book, The Smartest Investment Book You'll Ever Read, by following just four simple steps, you will earn investment returns that outperform 95% of mutual fund managers over the long term. You don't have to study the markets or understand complicated stock market analysis. And there is no need to follow the ups and downs of the market or to pay any attention to the financial media.It's a simple and stress-free way to invest. Best of all, you can implement my plan in 90 minutes or less per year without any broker or advisor.

Chapter 1

Tue, 10 Oct 2006 09:04:00 GMT

An Unbelieveable Chimp Story

There is a chimpanzee in a remote region of Sierra Leone that routinely performs open-heart surgery. His success rate is higher - and his mortality rate lower - than many of the finest heart surgeons in the world.I made that up.But if you read that report in the newspaper, you would think that either:1. That chimp is really extraordinary; or2. Those heart surgeons are not very good.If the story were true, and you needed a heart operation, you might seek out the chimp and avoid the heart surgeons.The Financial Times of London annually runs a contest, pitting a neophyte investor against market analysts.In 2002, a five-year-old London girl chose stocks randomly from one hundred pieces of paper listing companies on the Financial Times Stock Exchange. Her results were compared to those of a top financial analyst and those of a woman who used the "movement of the planets" to choose her portfolio.Over a period of one year, the little girl won handily. Very handily, as a matter of fact. Her stocks gained 5.8 percent. In stark contrast, the portfolio of the professional analyst lost 46.2 percent. The analyst was also bested by the financial astrologer, whose stocks lost only 6.2 percent.The little girl celebrated by going to McDonald's. I suspect the analyst continued to dine at more expensive establishments.There are some excellent peer-reviewed studies that demonstrate that the stocks most highly rated by financial analysts consistently underperform the market.Those reports are fact.Either the little girl is very good, the analysts are very bad or the much touted skill of stock picking is not something that any smart investor would want to bet the farm on.And the chimp? Well, he still doesnot perform open-heart surgery.

Library Journal, 2006

Fri, 13 Oct 2006 03:59:00 GMT

Solin (Does Your Broker Owe You Money?), an attorney specializing in securities arbitration, follows in the steps of financial luminaries such as Burton Malkiel and John Bogle in his praise of passive or, as he terms it, smart investing. He advises readers to adopt passive investing to obtain better returns, proposing investment of funds in low-cost index funds that attempt to match stock and bond market indexes by buying every security in a particular index such as the S&P 500. He argues that 95 percent of investors do not beat market averages because of excessive costs in the financial services industry and that history has proven that most professional managers cannot consistently outperform the overall market. Solin does a great job of keeping his advice simple; his guide can be read and digested in a couple of hours. Especially helpful are his inclusion of four different risk-level model portfolios based on Vanguard and Fidelity index funds and an in-depth asset allocation questionnaire to help readers determine their personal investment mix. All public libraries should consider this straightforward guide for their investment collections.- Lawrence R. Maxted, Gannon Univ., Erie, PAUsed with permission, Library Journal, 2006.www.libraryjournal.com

Publisher's Weekly, 2006

Tue, 07 Nov 2006 09:14:00 GMT

[most investment books] made investing so complicated, and made it seem like you needed so much help to do it. I wanted to write a book that explained that investing is really very, very simple, and I wanted it to be written in a way that would be understood by everybody and would demystify the process."- Dan Solin from Publisher's Weekly, November 6, 2006View Article

Metro - New York, 2006

Tue, 07 Nov 2006 09:17:00 GMT

"It's so simple, it almost seems counterintuitive," Solin said. And after a 20-minute conversation with Solin, Metro - now armed with a new investment strategy - actually agreed.- Metro, November 6, 2006View Article (see Page 10)

Consumerism Commentary, 2006

Wed, 15 Nov 2006 10:16:00 GMT

"Is this, as the title claims, the smartest investment book you¼ll ever read? While the quality of past books I¼ve read does not predict future selections, I can say it¼s the smartest so far."- Flexo, Consumerism Commentary, November 13th, 2006 View Article

Kirkus Reviews, 2006

Wed, 15 Nov 2006 10:20:00 GMT

"A no-nonsense, no-fuss guide for investors of all experience levels and financial resources."- Kirkus Reviews, November 1, 2006View Article

Free Money Finance, 2006

Wed, 15 Nov 2006 10:22:00 GMT

"I just finished a great little book (I say little because it's a bit smaller than a regular book in size and is only 150 pages), but it's full of great investment advice, principles, data, facts, studies -- you name it. The book is The Smartest Investment Book You'll Ever Read: The Simple, Stress-Free Way to Reach Your Investment Goals." - Free Money Finance, November 07, 2006 View Article

Miami Herald, 2006

Mon, 27 Nov 2006 04:40:00 GMT

It's tightly written, always on-point and not weighed down with anecdotes and aphorisms, and could be just the instruction book that you were looking for, but never received with that thick pension package from your company's HR department. -Miami Herald, November 27, 2006View Article

Reference Links

Tue, 05 Dec 2006 08:57:00 GMT

Academic Wealth Management Does Your Broker Owe You Money?

The Boston Globe

Sun, 03 Dec 2006 09:26:00 GMT

It's tightly written, on-point, not weighed down with anecdotes and aphorisms, and could be just the instruction book that you're looking for. -The Boston Globe, December 3, 2006 View Article

San Diego Union-Tribune, 2006

Sun, 03 Dec 2006 11:00:00 GMT

"I also recommend Solin's new book, The Smartest Investment Book You'll Ever Read, which is even skinnier than Quinn's. Solin, who is a securities arbitration attorney, does a great job of boiling down what is truly essential for most investors."-San Diego Union-Tribune, December 3, 2006View Article

Fox amp; Friends Interview

Tue, 19 Dec 2006 09:03:00 GMT

Invest in YourselfStress-free way to reach your investment goals. See the video here:(Video no longer available)http://www.foxnews.com/foxfriends/

Townhall.com, 2006

Thu, 21 Dec 2006 08:55:00 GMT

"...his most valuable feat is explaining in easy language how investors can diversify their portfolios among the major investment categories." -Lynn O'Shaughnessy, December 12, 2006 View Article

Update From the Eye of the Storm

Thu, 21 Dec 2006 02:57:00 GMT

It has been an exciting six weeks since the publication of The Smartest Investment Book You'll Ever Read .I have made a number of television appearances to promote the book, including The Early Morning Show on ABC and Fox & Friends. I have been interviewed on countless radio programs.Clearly, there is a wide audience for the sane, common sense, academically based, message in my book. This has been extremely gratifying.I continue to be amazed at the misinformation which inundates investors. Let me give you one glaring example:For the period January 1984 through December 2002 - a period of nineteen (19) years - the average stock fund investor earned 2.57% compounded annually. In sharp contrast, the S & P 500 Index had a 12.22% compound annual return during that same period.Why the disparity?Investors relied on brokers and advisors who told them they could "beat the market" by engaging in stock picking and market timing. These activities run up costs. These costs, plus the inability of these brokers and advisors to deliver on their promises, caused investors to actually lose money during this period, when you consider the effect of taxes and inflation.Here is the bottom line:Market returns are superior returns;Every investor can easily achieve market returns;No broker or advisor is necessary in order to achieve market returns.The vast majority of investors would fare far better selecting one of the portfolios recommended in my book and becoming Smart Investors instead of victims.You are seeing the beginning of an investor revolt as the light bulbs are going on all over the country.My thanks to all of you for your support of my book. Together, we can empower thousands and thousands of investors to live a better, happier and more fruitful life.What could be more satisfying?

New Study Validates Smart Investing Approach

Fri, 01 Dec 2006 11:51:00 GMT

St. Louis Post-Dispatch, December 1, 2006 St. Louis business columnist, David Nicklaus, cites a new university study which validates the core message of my book, The Smartest Investment Book You'll Ever Read. Here's an excerpt:"If you want to irritate a stockbroker, start extolling the virtues of no-load mutual funds. He'll no doubt respond that most people aren't savvy enough to choose funds by themselves, and if they want his valuable advice, they'll be willing to pay a load, or sales charge, for the funds he recommends. It's a fair point, if the broker is providing unbiased advice. However, a new study casts doubt on whether clients get what they pay for."Full article here:

Exchange Traded Funds: A Wolf In Sheep's Clothing?

Sat, 06 Jan 2007 09:45:00 GMT

Recently, a reader of The Smartest Investment Book You'll Ever Read went to a seminar given by a major brokerage firm. The firm extolled the virtues of Exchange Traded Funds (ETFs). This is good.However, they told the attendees at this seminar "...that they (on a quarter-year basis or so) make adjustments to their allocations depending on how the markets are doing. For instance, if small-cap stocks are doing good & US bonds are doing bad, they will take some of the profit they made from small-cap stocks and reinvest it into US bonds. Essentially, they aren't trading stocks and bonds like what you see with mutual funds, but they are trading index funds (buy low, sell high)."This is bad. Very bad.The underlying assumption in this "strategy" is that the firm can accurately time the market by buying low and selling high. As readers of my book well know, there is no evidence that anyone can do this with any consistency.In addition, this "strategy" runs up costs, which reduces returns.There are other problems with using (really misusing) ETFs in this manner. These include costs incurred by the bid-ask spread and tracking issues. For two excellent articles discussing these and other issues, see:http://www.efficientfrontier.com/ef/104/stupid.htm; and http://www.altruistfa.com/etfs.htm.The brokerage firms are fully aware of these serious flaws in their '''strategy', yet they fail to disclose them to eager investors. Instead, while appearing to embrace passive investing, they use this as bait to capture assets, so that they can then trade ETFs in the same discredited way they trade stocks.The result is predictable: The brokerage firms are in a win/win. Investors are needlessly at risk and none the wiser.

Canadian Investors Are Becoming Smart Investors!

Sat, 13 Jan 2007 10:32:00 GMT

I am excited that the Canadian Edition of my book is receiving such a warm and enthusiastic reception in Canada. The book is in the double digits on amazon.ca as I write this blog.Canadians are becoming Smart Investors even though they dont have the same choices as their American neighbors. As I point out in my book, U.S. investors can purchase low cost index funds with expense ratios as low as 10 basis points (0.10%), while similar funds in Canada carry management expense ratios (called MERs) ranging from 0.54% to 2.94%.It was for this reason that the Canadian edition of my book recommended that Canadian investors bypass these funds entirely and implement my plan using low cost Exchange Traded Funds (ETFs). ETFs typically have expenses under 0.30%. However, there are disadvantages to using ETFs, which make index funds a better choice--but only when low cost index funds are available.As I stated in a previous blog, these problems include the costs incurred by the bid-ask spread and tracking issues. For two excellent articles discussing these and other issues, see:http://www.efficientfrontier.com/ef/104/stupid.htm; and http://www.altruistfa.com/etfs.htm.It is a tribute to the tenacity of Canadian investors that they are overcoming these obstacles and staying on the course to become Smart Investors.I hope that the market validation of Smart Investing will encourage Canadian mutual funds to establish pre-allocated, low cost Smart Investor index funds that replicate the recommended asset allocations in the four basic portfolios in my book. An added benefit would be the automatic rebalancing of these funds.If this was done, Canadian investors could simply buy one fund and relax, until their investment objectives or tolerance for risk changed, in which case they would switch to one of the other funds.Canadian investors deserve this option. The mutual fund industry in Canada should give it to them.

National Post, 2007

Fri, 12 Jan 2007 01:20:00 GMT

"... an indexing manifesto that urges Canadians to dump their advisors and go global with their investments." Jonathan Chevreau, January 12, 2007View Article

The Income Trust Debacle

Wed, 17 Jan 2007 09:03:00 GMT

I must admit that I never understood the popularity of Income Trusts among Canadian investors. I wrote the following in Chapter 38 of The Smartest Investment Book You'll Ever Read, which went to print prior to October, 2006:"Given the uncertainty over the tax status of these trusts, their modest rack record and the high cost of owning them, it is difficult to understand the enthusiasm of Canadian investors for these investments."I based this observation in large part on a private study I did that showed that only 40% of income trusts with a three year track record beat the returns of the S&P/TSX index. I was also put off by the high management expense ratios of these trusts (an average of 2.28% vs. an average of 0.30% for the Exchange Traded Funds in my recommended portfolios).Of course, I had no idea when I wrote my book that, on October 31, 2006, the government would announce the imposition of a tax on income trusts, and thereby wipe out $25 billion of market capitalization.The market validation of my book in Canada (it is presently the #1 best selling book in Canada) marks the return of common sense and sanity by investors, fed up with these kinds of losses and eager to wrest back control of their financial lives. The simple four step plan in my book empowers investors to fend for themselves and implement a simple plan that historically has outperformed 95% of money managed by the "investment pros."This new breed of investors understands the difference between hype and reality. They will not be taken in by fancy financial products, with unknown volatility and a sketchy track record.I hope the ranks of Smart Investors continues to swell. Bay Street might not like it, but maybe this growing phenomenon will cause it to change its ways and be responsive to the best interests of those who still rely upon them.

Tricks of the Trade

Thu, 18 Jan 2007 07:33:00 GMT

I get a lot of e-mails with the following message:"Dan, The Smartest Investment Book You'll Ever Read contends that it is really difficult for active fund managers to beat the markets. However, I checked out the funds in my 401(k) plan and most of them have outperformed their benchmark over the last ten years. How do you explain that?"That brings me to the "tricks of the trade."401(k) consultants base their decision whether or not to include a fund in a Plan on the past performance of the fund. So, if I am a consultant charged with the responsibility of selecting funds in 2004, I will look back at the last 10 years of performance and base my decision on the results of that analysis. It is likely that I will only include those funds that beat the market over the previous ten year period.Now, fast forward to 2007. If I look back at the 10 year performance record of those funds it is still quite likely that many of them will have an excellent ten year record because seven of those years were in the original period when these funds were cherry-picked for selection.Actually, it would be more informative to look at the performance of these funds during the shorter period AFTER they were included in the Plan. We know the period before that time was good because that was the basis for the selection.Pretty slick, right? But don't confuse these "tricks of the trade" with the overwhelming data showing how difficult it is for actively managed funds to consistently beat the markets over the long term. In this case, there is smoke, but no fire.

Bangordailynews.com, 2006

Wed, 03 Jan 2007 09:41:00 GMT

The Smartest Investment Book Youll Ever Read" makes a similar case Gambling on the securities markets has much the same allure as playing the slot machines or the lottery.-BDN Staff - January 03, 2007View Article

Some Common Sense--From Maine

Sun, 28 Jan 2007 11:12:00 GMT

In a recent editorial in the Bangor Daily News entitled Beating the Market Is A Risky Business, the editorial writers noted that financial writers who debunk the myths of market timing and stock picking risk the fate suffered by Cassandra, who was locked up as a madwoman because she warned the Trojans about the Greek invaders wooden horse.This has been the experience of Jonathan Clements, the highly respected financial journalist for The Wall Street Journal. According to the editorial, every time he opens his mail he finds that many investors, far from being uncertain, are pretty sure of themselves and pretty sure that Mr. Clements is an idiot. They denounce him in the nasty and profane language that often goes with e-mail.You can access the entire editorial, which kindly mentions my book, at:View ArticleSo far, this has not been my experience. I have been gratified by the hundreds of grateful e-mails I have received from investors who have looked at the data and are convinced that there is a better, more responsible, academically valid way to invest their hard earned assets.Not to say that there has not been some resistance to this message. For example, a few readers have questioned my assertion that, over the long term, less than 5% of actively managed funds beat their benchmark. However, the evidence of the accuracy of this statement is overwhelming and irrefutable. In addition to the study in Chapter 13 of my book, and the many studies you can find at the web page of Index Funds Advisors, www.ifa.com., check out an article that appeared in the Philadelphia Inquirer on October 12, 2004. The financial reporter used Morningstars online fund screener to determine the performance of 1,446 large cap blend funds over a 10 year period. Only 35 (2.4%) of them matched or beat the performance of the S & P 500.You can access the entire article, entitled Beating Index Funds Takes Rare Luck or Genius at:View ArticleAnother common observation is that the four portfolios in my book, which had average annualized returns ranging from 9.06% to 10.86% over a 35 year period, were fine for those investors who dont think they can do better trying to beat the markets. However, what does the data tell us about these investors?According to a study by the respected research firm of Dalbar, Inc., for the 19 year period from January 1984 through December 2002, the average stock fund investor earned a pathetic 2.57% compounded annually. In sharp contrast, the S&P 500 Index had a 12.22% compound annual return during that same period. You can access a report of the results of this study at: http://www.dalbarinc.com/content/printerfriendly.asp?page=2003071601Compare the returns of these hapless investors to the 35 year returns of investors who achieved market returns.Why the disparity?These investors relied on brokers and advisors who told them they could beat the market by engaging in stock picking and market timing. These activities run up costs. These costs, plus the inability of these brokers and advisors to deliver on their promises, caused investors to actually lose money during this period, when you consider the effect of taxes and inflation.When you take an unemotional look at the hard data, it is as obvious as 1, 2 3:1. Market returns are superior returns;2. Every investor can easily achieve market returns;3. No broker or advisor is necessary in order to achieve market returns.For those of you who take offense at this data, thanks for your restraint!

Let's Ask The Fox Why the Hens Are Dying.

Sat, 03 Mar 2007 10:45:00 GMT

As everyone knows, it was a terrible week for the markets. One of the talking heads on TV intoned that volatility has returned to the markets. I am not sure where she has been for the last 80 years or so.

Not to worry. The same people who failed to warn of this impending downturn, and whipped their clients into a stock buying frenzy, now have no end of predictions about the future of the markets.

It is really disturbing to me that investors continue to listen to them.

Here is the most accurate answer you will get to the question that everyone is asking: Where are the markets headed?

I dont know.

And they dont know either, but they wont tell you that.

Here is what I do know.

Over time, the global markets will go up.

Investors should focus on their asset allocation, broad asset and sub-asset class diversification and the use of low cost index funds for both the stock and bond portions of their portfolios. No broker is necessary to implement this simple plan that is supported by overwhelming academic data and followed by over $4 trillion of really smart money.

Investors who did so, and who determined that they had a relatively low tolerance for risk, were allocated 20% to stocks and 80% to bonds. They may not be happy about the recent downturn in the market, but it really didnt affect them in any meaningful way.

As for everyone else, they are using brokers to guide them through these uncertain times.

The fox knows why the hens are dying. But he is not talking.

Let's Ask The Fox Why The Hens Are Dying.

Sat, 03 Mar 2007 10:55:00 GMT

Not to worry. The same people who failed to warn of this impending downturn, and whipped their clients into a stock buying frenzy, now have no end of predictions about the future of the markets.

It is really disturbing to me that investors continue to listen to them.

Here is the most accurate answer you will get to the question that everyone is asking: Where are the markets headed?

I dont know.

And they dont know either, but they wont tell you that.

Here is what I do know.

Over time, the global markets will go up.

As for everyone else, they are using brokers to guide them through these uncertain times.

The fox knows why the hens are dying. But he is not talking.

Canadian Capitalist, 2007

Mon, 05 Mar 2007 09:44:00 GMT

"Newbie investors and active investors should check out the book and better yet consider following the authors advice."Read Full Review

CBS, Early Show

Mon, 12 Mar 2007 01:33:00 GMT

"Dan Solin, author of "The Smartest Investment Book You'll Ever Read," says that most people can make better investment choices on their own..." Click here to watch Dan on the CBS Early Show.

An Award From The Library Journal

Sat, 17 Mar 2007 12:22:00 GMT

I am really excited to report that The Smartest Investment Book You'll Ever Read has been selected by The Library Journal as one of the "Best Business Books of 2006."You can access the entire article (published March 15, 2007) at: http://www.libraryjournal.com/article/CA6422246.ht ml. The excerpt describing my book states:

"A bible for low-cost index investing. Well documented and clearly written, this hammers home the point that investment returns are overly diminished through investment industry costs. Switching to index funds will make most investors more money in the long run. (LJ 9/15/06)."

According to the article, "[A] team of librarians and a business practitioner from around the country have chosen these titles as the best of 2006." My sincere thanks and appreciation to The Library Journal for this award. And to all of you who have taken the time to let me know how you have benefited from the advice in The Smartest Investment Book You'll Ever Read.

An Award From The Library Journal

Sat, 17 Mar 2007 12:23:00 GMT

Smart Advice for the HuffPost Investor

Wed, 21 Nov 2007 01:23:00 GMT

At last, a definitive answer to the question troubling so many investors: Is a market meltdown on the horizon?Since nothing could be more important to my readers, I devote my entire column to this issue. After all, if a financial Armageddon is just around the corner, as so many of you believe, what else could possibly matter?Your questions are thought provoking and stimulating. Please continue to add them as comments to this blog.Question From opines: Over the past 60 years individual stocks have been a sound investment. Prior to WWII, market crashes occurred about every 15 years and small time investors were cyclically wiped out. It has become an axiom of current day pundits to preface their buying advice with a disclaimer to the effect of "barring a market crash". It would be welcome if Mr. Solin would address the possibility of a near term market crash. The enormous overhang of housing debt and falling home prices warrant more than the dismissive "barring a market crash" disclaimer. If, say, he believed a market crash was a 15% possibility, perhaps the best option for the small investor would be to take a 'wait and see' attitude for the moment. For that reason, it would be helpful to Mr. Solin's Huffpo audience if he would devote at least part of a column to whether he foresees a major downturn in the immediate future. It is a scary thought that anyone would rely on my opinion of whether there is a market crash on the horizon and make an investment decision based on my views.My concern is not shared by most "investment professionals" licensed to sell you stocks and bonds. Predicting where the market is headed is the daily grist for their mill. And it is not just individuals who rely on these predictions. Thousands of investment advisors provide predictive advice to trillions of dollars of pension plans and mutual funds. And they make a darn good living doing so.Unfortunately, most of their predictions are dead wrong.They are wrong so often that, when one of them happens to be right, it is big news. Remember Elaine Garzarelli? She was credited with predicting the 1987 market crash and won great acclaim as a market guru for doing so.This superb call apparently used up most of her predictive powers. In the ensuing seven year period, the mutual fund she ran consistently underperformed the S & P 500 index.Nevertheless, I promised you a definitive answer, so here it is:I don't know.No one does. But financial advisors make a lot of money pretending they do. When they are right, it is due to the laws of chance and not to any measurable skill.Not only do they not know, but no one understands why markets crash, much less how to predict them.For those of you who want to delve deeper into the complexities of this issue, I recommend a study entitled: A Theory of Large Fluctuations in Stock Market Activity, by Xavier Gabaix, Parameswaran Gopikrishnan, Vasiliki Plerou and H. Eugene Stanley. It is available for a free download at:http://papers.ssrn.com/sol3/papers.cfm?abstract_id=442940Even a cursory review of this impressive study will demonstrate the complexity of this subject and the folly of trying to predict the next market meltdown.Events that you think would trigger a market crash do not have that effect. After the attacks on the World Trade Towers, the Dow fell by only 7%.Instead of engaging in the fruitless search for a financial psychic, here's the question that investors should be asking:If there is a market crash, how long will it take the markets to recover?This issue is critical to the determination by investors of their asset allocation--the division of their portfolio between stocks and bonds.One study ran what is known as a "bootstrapping" analysis that took source data from July, 1926 through December 2002. Using this procedure, which is imperfect but probably more reliable that any other available statistical measurement, the author was able to simulate 250,000 years (that is not a typo!) of stock returns.The study found that, if the markets lost 30% of their value (which certainly would qualify as a market meltdown), most asset classes would have about a 45% chance of a full recovery within 3 years. Over a ten year period, the probability of a full recovery increased to more than 80%.Investors who cannot withstand short term market volatility--cataclysmic or otherwise-- should not be exposed to significant market risk. This should not be a market timing issue that changes with the latest doomsday prediction. Your asset allocation should remain static, unless your investment objectives or tolerance for risk change.Finally, what about the strategy of assuming a market meltdown in the near term and taking a "wait and see" attitude?The data on this approach is not encouraging.One study looked at the performance of a broad index of domestic stocks from 1963 through 1993. During this extensive period, the average annual gain of this index was 11.83%. However, if investors missed only 1.2% of the total trading days that were the best trading days during this period, their annual returns plummeted to a pathetic 3.28%. Sitting on the sidelines is a form of market timing. The odds are stacked against investors who engage in this practice.Investors would be well advised to stick to the basics:

Don't rely on the predictions of investment professionals who claim to have a crystal ball;
Determine an asset allocation appropriate for your investment objectives and tolerance for risk;
Use low cost index funds to implement your asset allocation

I know it is hard to believe that an entire industry is made up of emperors with no clothes. But you owe it to yourself and to your families to view the data objectively and to be guided in your investment decisions accordingly.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.

LegalTimes, May 7, 2007

Mon, 07 May 2007 05:52:00 GMT

"I hope that light bulb has gone on for you. If not, Solins book (an easy read) is worth 90 minutes of your time. Evenand perhaps especiallyfor high-testosterone litigators."

When the Cure Is Worse Than The Disease

Sun, 03 Jun 2007 08:28:00 GMT

Although most investors do not need any advisor, there certainly are some who do not want to go it alone. However, for these people, the worst advice they can get, in my view, is to seek the services of a typical broker or advisor. It is a lot like saying that, if you don't know much about hens, you should get a fox to protect them.Most brokers and advisors have precious little training in finance, let alone the ability to offer "tax, insurance and estate-planning advice", which is often touted as additional benefits of using them. These professional services, which are the province of properly trained accountants, tax lawyers, insurance agents and estate planning attorneys, are simply a pretense for selling high cost, underperforming, actively managed funds, and other fee generating investments, like hedge funds.So what's and investor to do? As I indicate in The Smartest Investment Book You'll Ever Read, investors should look for a fee only advisor who will focus on their asset allocation and the use of low cost index funds.If you need assistance with your investments, don't make the cure worse than the disease!

Who Wants To Work And Not Get Paid?

Sun, 03 Jun 2007 01:14:00 GMT

Many investors, thats who.Investors who hold a portfolio of individual stocks (usually selected by their broker or advisor) are probably taking more risk than necessary to get the same returns.Of course, since most brokers dont know how to measure risk, these investors dont know how risky their portfolios are, much less how much unnecessary risk they are taking for the returns they are getting.So here are two questions to ask your broker or advisor:1. What is the standard deviation of my portfolio?2. If I invested in a portfolio of low cost index funds that historically has yielded the same returns, would my risk (as measured by standard deviation) be lower?If the answer to the second question is yes, you have uncompensated risk in your portfolio. This is a lot like working and not getting paid.

Putting Lipstick On A Pig

Sun, 17 Jun 2007 10:41:00 GMT

What if you bought a new refrigerator at a retail store and paid $1000 for it? You brought it home but it did not work. You went back to the store and they refused to do anything about it. What do you do?

You go to a lawyer. He sues in Court and argues your case before a jury. While the jury is deliberating, he gets some troubling news. Word has leaked out that the jury has reached a verdict. You won, but they only are going to award you $100.

Without disclosing this inside information, he goes to the lawyer for the store and asks her for her best settlement offer. They offer $150. Would you take it, even you knew you were entitled to much more?

Of course you would.

Thats why the response of the National Association of Securities Dealers (NASD) to the devastating results of a study on the mandatory arbitration system that I co-authored with Edward S. ONeal, Ph.D., is so silly.

Investors who submit their claims to mandatory arbitration have a statistically very small chance of obtaining any meaningful recovery from any major brokerage firm. Indeed, after paying legal fees and expenses, an investor with a $500,000 claim could expect to end up with a paltry $26,000. You can download the complete study at: www.smartestinvestmentbook.com.

The mandatory arbitration system requires customers of brokerage firms to submit all disputes with their NASD or NYSE brokers to arbitration administered by the NASD or the NYSE. The industry you are suing gets to formulate the rules that govern the process!

One of those rules requires that in all disputes over $50,000, one of the three arbitrators be affiliated with securities industry.

This is a system that does not have the appearance of impartiality. Our study indicates that the reality of the process is no better.

And what is the response of the NASD?

They say that the study doesnt consider the 70% of the cases that are settled before a hearing!

But those settlements (for which there is no publicly available data) are clearly influenced by the fact that the lawyers for both parties fully understand the dismal prospects that the investor faces if the case proceeds to a hearing. Much like the example of your refrigerator and the likely jury award.

Trying to justify an unfair process by referring to settlement figures is like putting lipstick on a pig.

It is still a pig.

The Dallas Morning News, July 8, 2007

Tue, 10 Jul 2007 04:57:00 GMT

"My advice: Take this book to the beach. Check out Mr. Solin's blog. Leave the Wall Street prattle behind." View article

Defending Against The Unseen Enemy

Fri, 14 Sep 2007 08:05:00 GMT

Let's be realistic. Reams of data demonstrate brokers can't beat the markets over the long term. They can't time markets, pick mutual funds that will outperform the markets, put you in "wrap funds" that will beat the indexes or select hedge funds or other alternative investments that, on average, will exceed the returns of the S & P 500 index. And the high commission annuities they sell are unsuitable for the majority of investors who purchase them. Nevertheless, millions of investors continue to look for the market guru who can deliver outsized returns. The securities industry thrives by perpetuating this myth. So here are some self-defense tips you can use against the unseen enemy: your broker. If you follow them, you can avoid becoming a victim of conduct that can cost you big bucks.Defense Tip #1 Get a copy of your Account Opening Statement. Many brokers have their clients sign this statement in blank. The broker fills in the required information under "Investment Objective." If he checks the most aggressive box (which is a common practice in my experience), he can do pretty much anything with your account and you will have no recourse. Be sure the "Investment Objective" in your Account Opening Statement accurately reflects your actual objective. If your objective or tolerance for risk changes over time, notify your broker in writing. Defense Tip #2Ask your broker to send you a letter that states the following: "I agree that I will act as your fiduciary and will be guided by the Prudent Investor Rule in connection with my recommendations for your portfolio." Being a "fiduciary" means that your broker must act solely in your best interests. Every Registered Investment Advisor is a fiduciary to his or her clients. Brokers often resist being held to this standard. There is no reason why you should entrust your money to someone who will not act as a fiduciary. The Prudent Investor Rule requires investment managers to exercise reasonable care and skill in making investment recommendations, including the duty to diversify a portfolio, under normal circumstances. Why would you deal with a broker who will not adhere to this modest standard? If your broker refuses to confirm in writing his fiduciary status and willingness to adhere to the Prudent Investor Rule, you are on notice that the continuation of this relationship is at your peril. Defense Tip #3 Ask your broker to measure the volatility of your portfolio using standard deviation. This calculation will give you a good idea of the risks you are taking. Most brokers have no idea whether their clients are taking too much or too little risk. As a general matter: * Conservative investors should have a standard deviation no higher than 8%;* Moderate investors should have a standard deviation no higher than 15%;* Very aggressive investors should have a standard deviation no higher than 20%;Defense Tip #4Nothing is more important than your asset allocation. You should know the percentage of your assets in stocks and in bonds. Most investors are overexposed to the stock market and do not have enough bonds. Defense Tip #5 Ask your broker whether she engages in stock picking or market timing. If she says "yes," ask her to send you copies of any peer reviewed financial article demonstrating that anyone can do this successfully over the long term. Don't count on receiving any. Defense Tip #6If you have actively managed mutual funds in your portfolio (and most of you do!), ask your broker how many of them equaled or exceeded their benchmark over the past 10 years. Less than 5% of all actively managed funds will pass this test. That's why you should invest in low cost index funds. Remember, it is critical that you get the answers to these questions in writing from your broker. Oral responses are worthless. If your broker tells you that his compliance department will not permit him to do so, run for the door and don't look back.

The Market Volatility Myth: Part 2

Sat, 15 Sep 2007 08:20:00 GMT

My column last week stirred up a firestorm of controversy. I stated that, over the long term, markets were about as predictable as the sun coming up in the morning: They go up.Many readers took issue with my views. Let's revisit the issues you raised and look at the data: 1. Do I concede that there is short term market volatility?Of course, but it is much hyped and of no consequence to Smart Investors who are properly allocated. These investors do not have sell their stocks in a down market and can wait for the recovery which 80 years of data tells us is likely to occur over a relatively short period of time. 2. But what about the admonition that "past performance is no guarantee of future results?" Neither short nor long term data is a guarantee of future results. In fact, you could make the argument that short term success as a fund manager is predictive...of poor performance the following year. One study examined the performance of 100 fund managers over an 11 year period. It found that only 14% of them were able to repeat their stellar performance the following year.Long term data is obviously more reliable than short term data, but it is still not predictive of future results. Nevertheless, long term market data is our most reliable source of risk and returns. It does not eliminate risk, but Smart Investors are guided by this data in making their investment decisions. And this data tells us that markets go up over the long term. With only one exception, the domestic stock market has not declined for three consecutive years in the past 50 years. That is a pretty impressive record. 3. What about inflation? Doesn't that distort this rosy picture? Not really, although that is a common misperception. In the past 50 years, investors in a globally diversified portfolio of two easily obtainable index funds would have earned an annualized return in excess of 11%. When you adjust for inflation, the return is still in excess of 7%.4. But what if you don't have 50 years to wait for these returns? Returns (before and after adjusting for inflation) for shorter periods of time were also impressive: For the past ten years, the returns for this portfolio were 8.5%/5.9%; for the past 5 years they were 10.0%/7.1%; for the past 3 years, they were 14.2%/10.8%. And keep in mind, these returns were yours for the taking. All these hypothetical investors did was buy the global stock market. No market timing. No stock picking. No studying. No research. 5. Should you invest today in such a portfolio? For the vast majority of investors, an all stock portfolio is too risky. For example, in 1973 and 1974, this portfolio lost about 40% of its nominal value and 51% of its purchasing power after inflation. But the historical data tells us that far more conservative portfolios still have yielded superior returns.Let's assume you had invested in a portfolio consisting of 60% stocks and 40% bonds. You followed the same, simple strategy for the stock portion of this portfolio that I described above for the all stock portfolio. For the bond portion of your portfolio, you simply replicated the Lehman Bros Aggregate Bond Index, using a low cost index fund. These would have been your approximate returns, before and after adjusting for inflation: 50 years: 10%/6%10 Years: 8%/5%5 years: 8%/5%3 years: 10%/7% So what's the bottom line?Investors with an appropriate asset allocation can wait out short term volatility, without incurring any losses. These investors were rewarded with superior, inflation busting returns. It is not risk free strategy, but that is the point. It is only by participating in the stock market -- and taking appropriate risks -- that you will be able to outpace the ravaging effects of inflation. If anyone has a better idea -- and the data to back it up -- I would like to hear it.

Breaking News: The Markets Aren't Volatile!

Sat, 15 Sep 2007 08:24:00 GMT

I broke some news on Fox & Friends last week. I said the markets are not volatile.This came as a shock to my genial hosts. But think about it this way: On September 17, 2001 (the first day the markets opened after 9/11), the DJIA fell 684 points and closed at 8920. Since that time, the perfect storm for stock market disaster has occurred...or so it would seem.

* We are engaged in an unpopular war in Iraq, which has sent our deficits soaring * Oil prices have zoomed above $70 a barrel and $100 a barrel is no longer considered to be a crazy prediction * The housing market is severely depressed * The much hyped hedge fund sector is faltering badly * "Sub prime loans" has become part of the daily lexicon and it is uttered with the same disdain as "Britney Spears," or other celebs behaving badly.

So what happened to the DJIA? It is presently above 13,000, having sharply retreated from 14,000. The markets really are not volatile. Over the long term, they always go up. We have 80 years of historical data -- through wars, recessions, a depression and calamities of all kinds -- to prove it. Even over the relatively short term, the markets still go up. In the past 50 years, we have only had one period of two consecutive years when the markets declined. All the incessant blathering about "buying opportunities" and "historic losses" completely misses the point.Investors should always be in the market. But not the way most individual investors currently invest. Smart Investors focus on their asset allocation. They don't care about short term volatility because the bond portion of their portfolios will help them weather the bumps in the stock market road. Since these investors do not have to liquidate their stock holdings in a down market, they do not incur losses during these times. Instead, they can hang on and reap the superior long term returns that equities will give them over the long haul. These investors use low cost index funds for the stock and bond portions of their portfolios to capture market returns (less low transactions costs) 100% of the time. Without much time, stress or effort, their returns place them in the top 5% of all professionally managed money.Often, they do so without using any broker or advisor. If they use an advisor, it is a passive advisor who assists them with asset allocation and helps them put together a portfolio of index or passively managed funds consistent with their investment objectives and tolerance for risk. The vast majority of individual investors are only getting a fraction of market returns on their investments. For these investors, it is useful to blame "market volatility" for their dismal performance record. That is a lot like blaming your television set for all of the investment pornography that masks as financial news on television. The cause of your losses is most likely your broker or advisor who invested your funds in a portfolio that is too risky for you.And you must also share the blame for not being wise to these machinations. There is no shortage of information that would put you on the right path. Short term stock market volatility does give you a "historic opportunity." You should use it to reassess how you invest and resolve to play by new rules which are in your best interest. If you wait for your returns-chasing broker or advisor to put you on this path, you can be confident that future market volatility will be the least of your financial woes.

Here's A Hot Tip: Buy Crappy Stocks!

Sat, 15 Sep 2007 08:25:00 GMT

"My broker is great a finding quality stocks." I hear this a lot from investors who believe their broker is adding value. However, the assumption that it is a good idea to load up your portfolio with quality stocks is not the no-brainer that it appears to be. The stocks of poorly managed companies, with bleak prospects, have historically outperformed investments in well-managed, financially healthy, companies over the long term. One study compared the investment returns of 29 growth stocks to 29 value stocks. The growth stocks were altogether impressive on paper: great returns on total capital, on equity and on sales. In stark contrast, the value companies were pathetic performers, with poor earnings and bleak financial prospects. So which category of stocks performed better? Not even close. Over the five year period studied, the "unhealthy" value stocks clobbered the "stellar" growth stocks with returns of 298 percent vs. 182 percent. It is true that these unhealthy companies are more volatile and the risk of investing in any of them individually may result in significant losses. It is also true that some distressed stocks may perform badly and some healthy companies may perform well. However, there is compelling historical data that, on balance, the quest for a broker who can find "quality stocks" is not a search likely to result in superior returns.Before you run out and load up on small and value-oriented funds for your portfolio, you should be aware that there have been significant periods of time when large growth stocks have significantly out-performed these sectors. Nevertheless, investors should consider, as a part of a globally diversified portfolio, tilting the stock portion of their portfolios towards domestic and international small-cap value, and large-cap value, low cost, index funds or Exchange Traded Funds, when comparable index funds are not available. Is it likely that your broker will give you this advice? No. And since we are on the subject of "No" -- that is still the answer I give when asked whether investors are well served by most brokers and investment advisors. When the securities industry puts the interests of its customers ahead of its lust for fees, and focuses on capturing market returns through the use of low-cost index funds and appropriate asset allocation, my views will change. Until then, I agree with Paul Samuelson, the first American to win the Nobel Prize in economics, who stated: "It is not easy to get rich in Las Vegas, at Churchill Downs, or at the local Merrill Lynch office."

Taking Candy From Babies

Sat, 15 Sep 2007 08:26:00 GMT

Get them while they are young. Every ad agency knows the value of a young demographic. They tend to be brand loyal for life. Now the securities industry is getting in on the act by offering mutual funds intended to "educate" young investors. "We want a fund that teaches financial literacy," stated the president of Monetta Financial Services, which runs the Monetta Young Investors Fund (MYIFX). This is a worthy goal. The stark reality is that parents of children are terrible investors, typically earning less than 50% of market returns that are easily achievable with index funds. Based on this dismal track record, most parents certainly cannot be entrusted with the important and oft-neglected task of educating their children about this important subject. Unfortunately, the idea of having active fund managers "educate" young children about investing is much like allowing the fox to "educate" the hens. Maybe we can turn the tables and educate the active managers of this particular fund about "financial literacy." Here are some questions I wish young children and their parents would ask them. I have some suggested answers for their consideration. Q. In your prospectus, it says that "Under normal market conditions, the Fund seeks to exceed the total return of the Index by investing the remaining assets in individual stocks that the portfolio manager believes to have above average growth potential." I am confused. If you have the ability to beat the markets, why aren't you trying to do so with all of the assets invested in the fund instead of with just 50% of them? A. Well, there is a limit on the amount of confidence we have in our ability to actually beat the markets. Q. If I want to be assured of always achieving the returns of the S & P 500, less transaction costs, why wouldn't I be better off investing in a low cost, S & P 500 index fund? A. Actually, you would. Q. I see that the total annual operating expenses of your fund are 1.44%, which are reduced to 1.01% until the end of 2008, but could go up after that date. How do these expenses compare to investing in an S & P 500 index fund? A. Very badly. You could buy the Vanguard 500 Index Fund (VFINX) and pay only 0.18% as the expense ratio. Q. Wow. That seems like a big difference. Your fund is costing me more than 500% more than the comparable Vanguard Index Fund. What am I getting for my money? A. In all likelihood, with us you are getting a fund that will underperform the Vanguard Index fund over the long term. In no small part, this is due to the fact that our costs are so much higher than the Vanguard fund. Q. How about the short term? How does your more expensive fund compare to the Vanguard Index Fund? A. Poorly. Year-to-date returns for our fund is 5.43%, compared to 6.88% for the Vanguard Index Fund. Q. How have similar funds performed? A. Very badly. The Columbia Young Investor fund was merged out of business in 2006. It had a dismal performance record. USAA First Start Growth is another expensive, underperforming fund.Q. Why should I invest in any actively managed fund, including yours? A. That's a really tough one. Over any long term period in the 80 years of available data, less than 5% of actively managed funds have been able to equal or exceed their benchmark. For example, the benchmark for my fund is the S & P 500 index. One study reviewed the performance of 1,446 large cap blend mutual funds, which are very similar to the Monetta Young Investors Fund. For the ten year period ending October, 2004, only 35 of them (2.4%!) outperformed the S & P 500 index. On a positive note, I applaud efforts to educate young people about investing. It isn't realistic to expect kids to digest the hundreds of academic studies by Nobel Prize winners. Or to heed the advice of Warren Buffet or Peter Lynch. Or to read books by John Bogle, Burton Malkiel, Bill Bernstein and Larry Swedroe. But surely we can do better than leaving the financial education of our children up to the same industry that has so terribly misled their parents.

Your 401(k) Plan: Is It A quot;Matchquot; Made In Heaven or Hell?

Sat, 15 Sep 2007 08:28:00 GMT

I really don't have anything against 401(k) Plans. The corporate match is a nice benefit and the automatic deductions from payroll checks insures that employees will have some savings towards their retirement. What does concern me, however, is how much hard working employees are being ripped off by a cozy system that they simply do not understand. The perpetrators of this mess are their employers and the bevy of pension consultants who "advise" these plans. Almost every major corporate employer utilizes the services of these consultants. There are almost 2000 of them. They are supposed to place the interests of the employees above their own. This means that the advice they give should be totally objective, transparent and free of conflicts. Unfortunately, for many pension consultants, this is simply not the case. Don't take my word for it. Check out a little publicized study by the Securities and Exchange Commission dated May 16, 2005, entitled Staff Report Concerning Examinations of Select Pension Consultants, available here.It really is enough to make you sick. Many pension advisors have consulting relationships with both employers and with the mutual funds they recommend for inclusion in the plan. So much for disinterested, objective advice. Some have affiliated broker-dealers, creating an incentive for the consultant to recommend that the 401(k) Plan trade actively, since the consultant benefits from brokerage commissions. Do you think this might be the reason why so few pension consultants recommended the inclusion of a broad range of index or passively managed funds in a 401(k) Plan? This terrible advice certainly is not based on any objective review of the overwhelming data indicating that these funds consistently outperform more expensive, actively managed funds over the long term. And then there are the really insidious arrangements that are never disclosed. Let me give you a few examples. Some pension consultants host conferences at lavish resorts for their corporate clients. The HR people and other corporate big wigs get their tab picked up by the consultants. Who else attends these conferences? You guessed it. The money managers who run the funds that somehow get recommended for inclusion in your 401(k) Plan. They get charged a fee. The fee covers the "free" attendance of the company reps. Get it now? Everyone's a winner. Except you. This one is my personal favorite. Some consultants "sell" software programs to the money managers whose funds are recommended for inclusion in your Plan. The fees for these programs can be as high as $70,000. The fact that these programs are commercially available for a fraction of these costs is not a mystery. Everyone knows how the game is played. Except you. The list goes on, but I am sure you get the drift. While these common abuses are reprehensible, they pale in comparison to the fact that so many 401(k) Plans include a dizzying array of actively managed funds in them. At least now you understand why this is the case. There is a model 401(k) plan in this country. It is huge. Guess who runs it? The U.S. Government! It is the 401(k) plan for all government employees, including all members of our military forces. It has no actively managed funds in it. The fees are extremely low. It has five, pre-allocated lifecycle funds that consist solely of index and passively managed funds. It rebalances automatically. You can check out the details here. This model plan is run by The Federal Retirement Thrift Investment Board, which is an independent Government agency. The five members of the Board and the Executive Director "are required by law to manage the TSP prudently and solely in the interest of the participants and their beneficiaries." And that is precisely what they do. To their great credit.You deserve a 401(k) that is as good as this one. If you are not getting it -- and few of you are -- make your voices heard. Start by complaining to your HR department. Show them this blog. Tell them you want a Plan that is free of conflicts. You want an advisor who will provide unbiased, totally objective, disinterested advice. You want funds in the plan that are solely low cost index or passively managed funds. Make your voice heard. There is no valid reason why your Plan should not be as good as the Plan for government employees. Demand it. You deserve it.

My 401(k) Plan: A Brutus Betrayal

Sat, 15 Sep 2007 08:31:00 GMT

Et tu my trusted corporate employer? I thought we were "family." You encouraged me to work hard for the company. I did. In exchange, you extolled the virtues of my 401(k) Plan. Our HR Department explained why enrollment in the Plan was such a great idea. After all, you matched 50 percent of my contribution. And here is what you told me about the fund choices in the Plan: There are thousands of them. All brand names. Some of them were supposed to have the best track records in the business. What a deal! How could I go wrong? I couldn't wait to sign up.Now I feel betrayed. Here is what you never told me: You don't pay anything for the cost of administering the Plan. Why? Because the fund family that "advises" the Plan gets to pick the funds that go into the Plan. And what funds do they pick? Mainly ones managed by their own company (surprise!) and others that pay it a "revenue sharing" fee. Come on. Even you can figure out that this process is geared to generate fees and not to pick the "best" funds for us to invest in. What do these funds have in common? High expense ratios, which means employees get stuck with really expensive funds. Why are there few, if any, low cost index funds in our Plan? Can I take a guess? You would have to actually pay a fee for the record keeping costs (which would be tax deductible). Bill Bernstein, the author of The Intelligent Asset Allocator and The Four Pillars of Investing said that "[T]he typical 401(k) Plan is an absurdly expensive vehicle with fees approaching 3 percent, ...Add commissions and other costs from frenetic trading at the funds. The typical fund company services participants in the same way that Baby Face Nelson serviced banks." This sad description aptly describes our 401(k) Plan. Just how difficult would it be for you to have a model 401(k) Plan? One that would really benefit employees like me (and you, I might add)? Not very. Just give us four pre-allocated portfolios to choose from. Low risk, medium low risk, medium high risk and high risk. All of the funds in these pre-allocated portfolios would be index funds from well known fund families like Vanguard, Fidelity or T. Rowe Price. You could also consider using Exchange Traded Funds. If you wanted to go all out and really set an example, you could use funds passively managed by Dimensional Fund Advisors. Historically, everyone but you seems to know that these portfolios will outperform the high expense ratio, actively managed, funds that populate our Plan. Again, listen to Bill Bernstein:

"For 1995-1998, the annualized returns of the 401(k) Plans at Morningstar, Prudential, and Hewitt Associates were 13.5 percent, 10.5 percent, and 11.8 percent, respectively, versus a 21.2 percent return for the global 70/30 mix. If employees at the nation's most sophisticated financial companies can't get it right, what chance do folks on the assembly line at Ford have?"

I can answer that question. No chance. I know. With your match, I am still probably better off than I would be if I didn't invest in the Plan. But think how much more money you and I would end up with if we had a decent Plan. One that had low fees. A few simple choices of portfolios. No conflicts of interest between you, us and the advisor to the Plan. After all, for most of us, the Plan is our only source of retirement savings. I read that you are supposed to have a "fiduciary duty" to employees like me. I looked that up. It means that you are expected to act solely in our best interests. Let's see. You get paid off by the advisor who gets the Plan business. The advisor gets paid off by the funds included in the Plan. The advisor engages in self-dealing. The funds in the Plan under-perform the markets. We get stuck with the tab. This does not make you look like you are much of a "fiduciary." Brutus would be proud.

It's So Easy, Your Broker Could Do It!

Sat, 15 Sep 2007 08:32:00 GMT

Last week, I described six deadly investing myths. It's easy to be negative, since most investors chase returns, following the advice of their brokers or advisors who tell them that they can "beat the market" by picking "good" stocks or "the best" mutual funds.So, if I have convinced you to refuse to be a lamb being led to slaughter, how exactly should you invest your hard earned money? When The New York Times reviewed The Smartest Investment Book You'll Ever Read, the headline was "A Stubborn Insistence On One Way To Invest." The reviewer went on to somewhat begrudgingly concede that "it is clear he is on to something." Actually, I am only partly guilty. I do not believe there is only one way to invest. I do believe there is only one way to invest intelligently. Here it is:

1. Determine your asset allocation. You can do this by taking a free risk capacity survey. There are many of them on the internet. I admit to a bias for the one at the web site for my book. And the one at the web site of Index Funds Advisors (with whom I am affiliated): 2. Buy three low cost index funds from Vanguard. * The Total Stock Market Index Fund (VTSMX). Put 70% of the amount allocated to equities in this fund. * The Total International Stock Index Fund (VGTSX). Put 30% of the amount allocated to equities in this fund. * The Total Bond Index Fund (VBMFX). Put 100% of the amount allocated to bonds in this fund. 3. Rebalance your portfolio once or twice a year to keep your asset allocation intact or to change it if your investment objectives or tolerance for risk have changed.

That's it. You are done. Depending on your asset allocation, the long term average annual returns of these portfolios have ranged from 9.06% to 10.86%. The portfolios with the highest allocation of equities have yielded the highest returns. Other fund families, like Fidelity and T. Rowe Price, offer similar funds. You would think that following this advice would be very simple. The basic principles are endorsed by hundreds of academic studies, the views of virtually every Nobel Prize winner in economics, Warren Buffet, Peter Lynch and $4 trillion of the smartest, most sophisticated pension, trust and endowment money invested in this country. So, what's the catch? The securities industry. They can't make any money giving you this advice, so they belittle it. They will tell you that it is fine for "novice investors." Or that it produces only "average returns". This is complete nonsense. What they mean is it produces below average fees.Trust me, if index funds were high commission products (like variable annuities -- but that is another story), every broker in this country would be extolling their virtues. If you follow my advice, you are guaranteed to make the market returns for your particular asset allocation, net of fees, because you are investing in the market. When your broker disparages this advice, ask him or her to take the Solin Challenge: Will you guarantee me in writing, that my returns will equal or exceed market returns, net of fees, for my particular asset allocation? I can assure you that you will never receive this letter -- and for good reason. Studies indicate that most investors, following the advice of their brokers or advisors, significantly underperform market returns. And that the mutual funds recommended by these brokers and advisors cost more and perform worse than funds selected by investors on their own.Other studies show that over 95% of mutual funds that have as their goal exceeding the returns of the S & P 500 index, fail to do so over a 10 year period. It follows that investors who followed the simple portfolios I recommend would have been in the top 5% of all professionally managed money. Does that seem like "average" performance to you? To be fair, there are reasons why some investors should not follow my advice. Here they are: You like to gamble. You confuse activity with progress. You like the thrill of the chase. You have an addictive personality. You believe that the overwhelming academic data does not apply to you and your broker. Notice that obtaining superior returns is not on this list. Following this advice is responsible and intelligent investing. It's so easy, a broker could do it. But she won't.

Six Deadly Investment Myths

Sat, 15 Sep 2007 08:34:00 GMT

Why are there so many myths about investing?Because it serves the economic interest of powerful interests to keep investors confused and misinformed. I find it particularly interesting that there is little distinction between wealthy investors and not-so-wealthy ones. Most people have no idea how to invest. And the results are stunningly bad. Just how bad? Studies by Dalbar, Inc., a leading research firm, demonstrated that, for a 16 year period ending in 2000, the average equity-fund investor realized an annualized return of only 5.32%, compared to 16.29% for the S&P 500 Index. How can this be? Investors hold steadfastly to a series of "sacred beliefs" that practically guarantee that they will underperform the markets. So let's take a look at six of the most deadly investment myths. Investment Myth #1: My Broker or Advisor Can Help Me Pick The Best Mutual Funds Wrong! The reverse is true. Your broker can help you pick mutual funds that will underperform the markets. A recent study by three well credentialed and highly respected authors showed that funds selected by brokers and financial advisors significantly underperformed those selected by investors on their own. The costs of these funds was higher and the risk-adjusted returns were lower.Investment Myth #2: My Broker or Advisor Can Help Me Pick The Best Stocks Sorry. There is not a shred of data to support the ability of anyone to pick outperforming stocks. Take a look at some notable bankruptcies: Enron, Worldcom, Delta Airlines, K-Mart, Conseco Inc., Polaroid, and the list goes on. Did your broker see those coming? Investment Myth #3: There Are Actively Managed Mutual Funds That Will Outperform the Markets Over the Long Term. Most investors believe that there are some great actively managed funds out there, if only they could find them! Certainly, there are many brokers who claim to have this skill. There are many studies that show that over a ten year period, only a tiny percentage of all actively managed funds will beat their benchmark index. The problem for investors is that there is little possibility of identifying the few funds that fall into this category and there is no evidence that this past performance will be repeated in the future.Investment Myth #4: Technology to the Rescue. Trading Programs Can Save The Day. What about those infomercials for trading programs? It looks so easy. You just buy when the green light flashes and sell when the light turns red. Here is what Burton Malkiel says about charting programs (which he likens to "alchemy") in his seminal book, A Random Walk Down Wall Street: "There has been a remarkable uniformity in the conclusions of studies done on all forms of technical analysis. Not one has consistently outperformed the placebo of a buy-and-hold strategy. Technical methods cannot be used to make useful investment strategies." By the way, in February, 2005, Citigroup fired its entire technical analysis group. Yet millions of dollars is spent by gullible investors on these useless programs. Investment Myth # 5: Study More and Get Better Returns This is a tough one. In most areas of life, more study pays rich dividends. So, the theory goes, if you study the fundamentals of companies, relying on books, articles and the financial media, your returns should reflect this effort. Actually, when it comes to investing, you would be better off studying less. The predictions of talking heads on television and the financial media are often wrong and misguided. Let me give you one of many examples: At the end of each year, many financial publications assemble "experts" to make predictions about the coming year. Business Week did this at the end of 2004. The "experts" consisted of representatives from some of the best known brokers and mutual funds. Each of these "experts" picked five stocks they recommended for 2005.Here is the bottom line: Some were right and some were wrong. However, as a group, the selected stocks significantly underperformed a number of broadly diversified market indexes. Now I am sure that these "experts" took the exposure they were getting in a well-respected business magazine seriously. No doubt significant resources were expended to get it right. If they can't do it, it is unlikely that you or your broker can do better. If you try and succeed, it is more luck than skill. No amount of studying, analyzing, listening and evaluating can overcome this irrefutable fact: The markets are random and efficient. They are not susceptible to any analysis that is likely to result in superior returns over the long term.Investment Myth # 6: If Only I Could Get Into A Hedge Fund. Those great returns! It is no wonder that the rich get richer. Right? Wrong. A recent survey of the performance of hedge funds from 1994-2005 concluded that the returns were about the same as the S&P 500 index. Hedge funds are beset with problems that include illiquidity, lack of regulation and high fees. It does not appear that their returns offer any incentive to assume these risks. So what's an investor to do? I will deal with this issue in my next column. However, be prepared. It is not exactly scintillating reading. Unless you find superior returns exciting!

The Only Thing They Have to Fear Is ... a Level Playing Field

Sat, 15 Sep 2007 08:36:00 GMT

Let's assume you recently bought a car and it turned out to be a lemon. The dealer won't return your calls, let alone make good on your complaints. You seek legal advice. Your lawyer tells you that the paperwork you signed when you bought the lemon required you to submit all disputes to arbitration."That's not so bad", you tell your lawyer. "I have heard that arbitration is quick, less expensive than litigation and just as fair." Not so fast. Your lawyer tells you that this is a special kind of arbitration. It is administered by the car dealers association. They make up all of the rules and have vast influence over the outcome. One of their rules requires that one member of the three arbitrators is required to be a car dealer.How do you now feel about your chances of getting a fair hearing? Welcome to the world of mandatory arbitration of securities disputes. If you have an account with a broker who is a member of the National Association of Securities Dealers (NASD) or the New York Stock Exchange (NYSE), you agreed that any disputes between you and your broker would be resolved by mandatory arbitration. And who runs this process? The NASD and the NYSE. It rules require that one of the three arbitrators be affiliated with the securities industry. How fair is this process? Well, as you already know, it certainly does not have the appearance of impartiality. But what about the reality? My colleague, Eddie O'Neal, who did this work when he was on the faculty at the Babcock Graduate School of Management, Wake Forest University, and I, spent two years looking at over 14,000 cases decided by NASD and NYSE arbitrators over a ten year period. We are releasing the results of this study today.Our study shows that investors have a very slim chance of recovering any meaningful damages from any of the major brokerage firms. When you crunch the numbers, an investor with a $500,000 claim against a large firm could expect to wind up with a paltry $26,000 after paying legal fees and expenses. In fact, the larger the case, the lower the amount awarded as a percentage of the claim. Indeed, across all categories and against all brokerage firms, the average amount an investor could expect to recover in these proceedings declined from a high of 38% in 1998 to a low of 22% in 2004. This period of declining recovery rates coincided with gross misconduct by many major brokerage firms who paid hundreds of millions of dollars and consented to findings that the reports of their analysts were conflicted and misleading. These troublesome statistics validate the concerns of Congress that there is something radically wrong with this process. Members of the Senate Judiciary Committee recently asked the Securities and Exchange Commission, which supervises this process, to make arbitration optional instead of mandatory. And Barney Frank, the Chairman of the House Subcommittee on Capital Markets, Insurance and Government Sponsored Entities has indicated an interest in holding hearings on this subject.Of course, the securities industry is adamant in its view that there is nothing wrong with this process. They may be right. If you are a broker or a brokerage firm, it is working really well for you.Dan Solin is both a securities arbitration attorney and a Registered Investment Advisor and Senior Vice President of Index Funds Advisors. He is the author of the best selling book, The Smartest Investment Book You'll Ever Read (Perigee Books 2006).

The Holy Grail Of Investing

Sun, 16 Sep 2007 11:21:00 GMT

Asset allocation and "holding period" are critical to all investors. They are far more important than stock picking and market-timing.Unfortunately, most investors still do not focus on either. Historically, large stocks have returned on average over 10% a year; small stocks over 12%. In contrast, long term government bonds have returned slightly more than 5%, which is pretty dismal given the historical inflation rate of 3%. Why not just load up on stocks, especially small stocks? Because of short term volatility. A small stock portfolio would have lost almost 50% of its value in 1973-1974. But what if you could minimize the volatility of a risky stock portfolio and make it almost equivalent to a conservative bond portfolio? The best of both worlds. Superior returns. Low volatility. The holy grail of investing. There is a way to do this. Most brokers and financial advisors will not tell you about it. Not because they have a sinister motive. They just don't understand the relationship between holding period and risk. Even a broadly diversified stock portfolio is extremely risky if your holding period is one year. The volatility of this portfolio, as measured by standard deviation ("SD"), is almost 20%. In contrast, a portfolio consisting of mostly bonds is almost risk free, with an SD of less than 2%. However, you can reduce the volatility of the all stock portfolio from an SD of 20% to less than 6%, if you know you can hold it for seven years. The risk is now almost equivalent to the one year risk of a very conservative portfolio. So what's the bottom line? Depending on your holding period, you may be able to achieve the higher returns of stocks over bonds, without significantly increasing your risk. The next time your broker or advisor blathers on above a great stock or a "hot" mutual fund, cut the conversation short. Tell him that you want to talk about your holding period.

Smart Advice for the HuffPost Investor

Tue, 23 Oct 2007 07:42:00 GMT

Are bonds really a necessary part of every investor''s portfolio?What is my prediction for the continuation of our aggressive foreign policy and how should investors adjust their portfolios to deal with it?'''' The markets are tanking, so what''s wrong with a savings account in these volatile times?I deal with these questions in this month''s column.If you would like your questions considered, please add a comment to this blog.Question from Cognate:'Dan,I don't understand the recommendation to include bonds in a long-term index fund portfolio (say 10 to 20 years before cashing anything in) and for someone who can tolerate occasional dramatic (say 30%) drops in one's net assets. The expectation is that even a 30% drop will recover over the life of the portfolio.Bonds prevent the possibility of a total loss (if the whole market crashes to zero) but they also prevent the high returns during the good years. You are correct that bonds should not be included as a part of every investor''s portfolio.' Investors who can confidently state that they will not need to access a significant portion of their assets for ten years or more could consider a globally diversified' portfolio consisting exclusively of low cost, stock index funds.However, there are relatively few investors who fall into this category.' And even some of those investors may not have the stomach to hold on when the market declines dramatically.' For example, in 1973-1974, an all stock portfolio would have lost over 40% of its value.' The markets did recover, but many investors panicked and incurred significant losses. Here is the bottom line:' Bonds reduce the long-term returns of an all equity portfolio, but holding them gives investors the staying power to wait out the inevitable downturns in the markets.Question From January:I read your advice with appreciation. Maybe that's because my modest mutual fund holdings are already diversified along the lines you suggest--with a bit more in international funds and a recent pull back into a somewhat higher percentage of bonds. All the talk about economic dislocation in the coming year spooks me. Isn't the goal to be able to sleep at night? My question is, Are we committed economically as well as politically to our pursuit of the warfare state? Hence the chances of cutbacks in military spending, no matter who runs the nation, are unlikely? Also, are our treasuries held by other countries always payable in dollars?I could not agree with you more:' the goal is to be able to sleep at night.However, the way to get there is not by trying to predict the unpredictable.' This strikes me as counter-productive.' When our predictions go wrong, our anxiety will be increased.There is a better way.' Determine your tolerance for risk.' You can do this by asking yourself these basic questions:

-''' Within how many years do you plan to withdraw at least 20% of your portfolio?-''' What is the worst twelve-month unrealized percentage loss you would tolerate?

The answers to these questions will permit you to structure an appropriate asset allocation that will permit you to '''sleep at night.'For example, risk adverse investors might consider a portfolio of low cost, passively managed mutual funds consisting of 65% bonds and 35% stocks.' Properly structured, this portfolio has a very low volatility.' Over the past 50 years, it has lost money only eight times, and its largest one year loss was 4%.' Its 50 year average annualized return was 8.72%.Similar portfolios can be structured for investors with a greater tolerance for risk.Question From humanoid: I have been investing in socially responsible funds for years now and am generally satisfied. However, after reading your advice, none of the funds I invest in were recommended by you. I checked their expense ratios and found them to be over 1%. Should I consider moving my money to other funds with lower expense ratios? The funds are no load and have low fees so I'm not sure if changing would be advantageous.Also, I have some cash right now sitting in a savings account that pays 5.05%. I'm 56 years old, married, with no children at home. I have a 30 years mortgage and no other debt. Where is the best place financially to put my extra cash?'Everything else being equal, you would be well served by focusing on the funds with the lowest expense ratios.' Lows fees correlate directly with higher returns.' However, with socially responsible funds, you will want to be sure that the screens used to define what is '''socially responsible' are the same for the funds you are considering.If you have '''extra cash', I am assuming that you mean you already have 6-12 months of living expenses in savings and are considering investing this cash.For my views on how investors should determine their asset allocation and select appropriate investments, please see my blog entitled:' It''s So Easy, Your Broker Could Do It!You are wise to consider investing your assets.' A savings account that pays 5.05% is fine for holding cash you may need short term.' However, when you consider the 3% historical rate of inflation, and the taxes (at ordinary income rates) on these earnings, you can see that you are barely breaking even, or possibly losing money in this account.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.

A Wake Up Call For Investors

Fri, 26 Oct 2007 05:33:00 GMT

Most investors use brokers or financial advisors.Most brokers and financial advisors justify their fees by claiming that they can ''beat the markets.'The most common way they try to ''beat the markets' is by picking actively managed mutual funds that will do so.This should not be very hard to do. After all, the fund manager of a simple index fund that has as its benchmark the S & P 500 index, has few options. He or she must hold all of the securities in the index. There is no discretion.The active fund manager can select those companies within the index that he believes will outperform others. He can also dump underperforming stocks like a hot rock.You would think the playing field is not level. The active managers should clobber the index funds.You would be wrong.The Morningstar data base lists 725 mutual funds that have a ''best fit index' with the S & P 500.The year-to-date (through September 30, 2007) return of the S & P 500 index was 9.13%.Of the 725 funds that should have equaled or exceeded these index returns, only 188 managed to do so. 74.07% of these funds underperformed a simple S & P 500 index.The average year-to-date return of all 725 funds was only 7.96%. In The Smartest Investment Book You'll Ever Read, I recommended four low cost index funds portfolios that I believe are appropriate for most investors. The one with the lowest risk has 80% of its portfolio in bonds and only 20% in stocks. The year to date return of this portfolio (through September 30, 2007) was 5.28%. It outperformed 96 of these actively managed funds (which have 100% exposure to the stock market), with far less risk.So what''s an investor to do?You could continue to rely on your broker or financial advisor to pick actively managed mutual funds that will ''beat the markets.' However, understand that you have only a 1 in 4 chance of being right. And the odds are much worse over the long term.Or you could dump your broker or advisor and ''buy the market' by purchasing low cost index funds representing an asset allocation appropriate for you. If you do this, you are 100% certain to capture market returns (after deduction of the low fees charged by these funds) because you are investing in the market.It seems like a no-brainer to me.Will this be a wake-up call to investors?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.

Smart Advice for the HuffPost Investor

Tue, 30 Oct 2007 09:45:00 GMT

Is my enthusiasm for Vanguard index funds influenced by undisclosed payments?Should an investor give up 28% returns for a boring index fund portfolio?Are Target Funds an intelligent option for Smart Investors?Why buy index funds without charge when you can pay a broker a hefty fee for the privilege?And (my personal favorite), should you buy individual stocks recommended by your broker based on his or her intuitive feelings that there is a ''bump coming'?You asked these excellent questions. I pulled no punches with my answers.Please keep your questions coming. Just add a comment to this blog.Question From Chris: Does Vanguard pay you to promote their funds? I think this is an important question since you are giving out financial advice and constantly mention Vanguard. Also most financial advisors disclose their holdings. So are you invested in any of the funds you name? All of this goes toward bias and is important for all people to know when reading your columns.This is a very fair question. Thanks for asking it.I receive no compensation from Vanguard, directly or indirectly. I recommend their index funds, as well as those of Fidelity, T. Rowe Price and Charles Schwab & Co, based solely on merit. Historically, Vanguard has been the lowest cost provider of index funds, although the competition is heating up. Since low costs are directly related to higher returns, I believe that this is an important factor for all Smart Investors to consider.I am not invested in any Vanguard funds. I am invested in portfolio #60 through Index Funds Advisors, with whom I am affiliated. All of the mutual funds in my portfolio are managed by Dimensional Fund Advisors (DFA). DFA passively manages all its funds. It does not engage in stock picking or market timing.DFA funds are only available through designated Registered Investment Advisors. Question From miguelpakalns:Mr. Solin -- I am a 26-yr-old 401(k) investor currently saving money to open a prospective online trading account, in which I had planned either to: A. Buy-and-hold equities of low-debt companies with strong earnings growth and positive cash flow, or B. Buy socially responsible Funds, or most likely C. Both. My 401(k) does not meet your standards. I currently hold about 60% emerging markets (FEMKX, reduced contributions from 50 to 33 a few months back but the % remains at ~60 due to NAV growth), 30% domestic (Fid Contrafund FCNTX and FDSCX) and roughly 10% junk bonds (FAGIX). As you can see, I am an investor willing to gamble, and so far it has payed off very handsomedly (FEMKX!! ; Began buying FAGIX when it was 8.60-8.70 two months ago, saw it was generic junk corporate debt with few direct ties to mortgages or subprime and I figured it was being panic-sold, now it's back toward NAV 9.00 plus the monthly dividend). Would your advice be for me to switch my 401(k) to Index Funds, and take my gambles with the online trading instead? To switch everything to Index Funds? I hate to admit it, but advice to dump my YTD-28% earning portfolio for 8-11% earners will not please me nor most investors my age, even if I/we know it is "the most sound" advice (with young colleagues we snicker about "index investors"). Should I jump out of Emerging Markets before the "inevitable" crash? (note again, I felt "bubble" in June/July and started cutting back contributions, but FEMKX keeps on chugging with only the occasional blip) Any special advice for online buy-and-hold investing? Or is the recommendation Index Funds uber alles? Trying to make sense of all this, much appreciated, Your questions raise some excellent issues.My views on intelligent investing, supported by reams of academic data, are set forth in my blog entitled: It''s So Easy, Your Broker Could Do It!There is no evidence that anyone has the ability, over the long term, to predict what segment of the market will outperform other segments. This applies to geographic areas as well. For example, as you note, emerging market funds (dominated this year by China funds) are having a great year. However, that does not necessarily mean that those funds will repeat their stellar performance next year. In 1999, Japan funds were all the rage, just like China funds are today. The Warburg Pincus Japan Small Company Fund was up 328.7% for the year.In 2000, these funds nosedived. The Warburg Pincus Japan Small Company Fund lost 71.6% of its value!One study of mutual funds over an 11 year period validated the lack of consistency of performance by mutual fund managers. The study concluded that only about 14% of the top 100 managers in one year repeated their top 100 performance in the second year. Over the long term, this percentage would decline drastically.The securities industry wants you to believe that market returns are ''average'. They do this so that you will use their services to try to ''beat the markets.' However, studies of the returns of mutual fund investors indicate that market returns are superior returns.Dalbar, a financial research firm, studied the returns of mutual fund investors from January, 1984 through December, 2000. During that time, the S&P 500 index returned an average of 16.3% per year.How did investors do? A pathetic 5.3% per year for the same period. Your 28% returns this year are impressive. But the data tells us that, if you continue to time the market and attempt to pick outperforming mutual funds, you are likely to underperform the markets.Therefore, my advice remains unchanged: Smart Investors should determine their asset allocation and invest in a globally diversified portfolio of low cost index funds.Question From SisterAnn: Dan, What do you think about target age funds? I am fascinated by them, but they own a lot of financial funds and bonds. The closer you get to your retirement date, the more they buy of the financial funds and bonds. Would it be better to buy them 20 years earlier than your actual retirement?Target funds can be an excellent option, but only if the underlying funds are low cost index funds (like the Target Retirement Funds offered by Vanguard) and not hyperactively managed funds. Reputable target funds are not overweighted in any particular sector or asset class. They should consist of a globally diversified portfolio that is rebalanced to become more conservative at the ''target date' gets closer.Question From Halsey: Dan...you cannot just tout the S & P...the performance "quilt"...clearly indicates that it is few years, indeed, that the S & P is the top performing..one year it will be emerging marking, the next, small cap grown, the next, managed futures, the next Large Cap Value. I too recommend index funds over mutual funds IF the investor has more than $25,000...as you cannot properly diversify with less...except to go the mutual fund route..and there ARE ways a broker can buy them at NAV..then just charge 85 bps a year..(we do have to make some money for our effort..but don't have to gouge!) I remain solid in my knowledge that at "good" broker" will properly diversity even the smaller investor...and NEVER put all the eggs in the s & P basket... By they way..did YOU buy Microsoft on Monday? I did..just "felt/knew"..it had a bump coming.I do not recommend that anyone hold a portfolio consisting only of the S & P 500 index. I agree that this would be far too volatile for investors. My views on asset allocation and the composition of an appropriate portfolio of globally diversified, low cost index funds for both stocks and bonds are set forth in my blog entitled: It''s So Easy Your Broker Could Do It!I don''t understand why anyone would pay a broker 0.85% per year to purchase index funds that they could buy directly from the major fund families (Vanguard, Fidelity, T. Rowe Price, and Charles Schwab & Co) and pay zero for the privilege. Finally, I did not buy Microsoft on Monday, or on any other day. I believe investors should make decisions based on hard data and not on emotion. Investing in Microsoft may, or may not, prove to be a wise decision over the long term. However, what few investors (and brokers) understand, is the risk inherent in buying individual stocks. When you hold individual stocks, you take on what is called ''uncompensated risk', which means that you could obtain the same expected returns with far less risk, by holding a more diversified portfolio. One study demonstrated that, from 1997 to 2003, an investor in a single S & P 500 stock had the same expected return as an investor who held an S & P 500 index fund. However, the single stock investor was exposed to nearly twice as much risk! Investors are, of course, free to use brokers who charge fees for putting them in index funds, or hyperactively managed mutual funds, and who recommend individual stocks, without regard to uncompensated risk. However, well informed investors would be well advised to take charge of their own finances and avoid these ''investment professionals.'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.

Fallen Stars

Tue, 30 Oct 2007 10:16:00 GMT

The Morningstar star system is often used by brokers and advisors to pitch hot mutual funds. A five star rating means huge inflows for mutual funds. A one or two star rating can mean significant outflows as investors flee these funds.Over the years, there has been considerable research demonstrating that high Morningstar ratings are not predictive of future performance. Some of these studies demonstrated little difference between the performance of five star and three star funds in the years after the rating was given.A new study by Professors Morey and Gottesman of Pace University concludes the opposite. The study looked at Morningstar rated, domestic equity funds for the three year period from July, 2002-June, 2005. They concluded that higher rated funds, for the most part, significantly outperform lower rated funds.So, should you run out and buy five star rated funds?Not if you are interested in superior returns.With minor exceptions, the study found that, in all star categories, index funds outperformed all of the rated mutual funds.This finding is not mentioned in the Conclusions to the study, which focuses on the predictive power of the higher rated funds, thereby missing the point. Why should investors care if five star funds outperform four star funds, when index funds outperform five star funds?Another study of mutual funds selected by Morningstar for its own 401(k) plan found that these funds significantly underperformed a broad U.S. market index for the period 1991-1999. The same study found that funds designated as top performing by Forbes, the New York Times, Worth magazine, Business Week and fifty-nine investment newsletters studied over a ten-year period all underperformed the same index.The next time your broker extols the virtues of a five star rated fund, tell her you want a six star index fund!

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.

Smart Advice for the HuffPost Investor

Wed, 07 Nov 2007 09:00:00 GMT

A reader believes he has found the magic bullet for huge returns. Is it luck or skill?How do you invest to beat inflation? Are there special considerations involved?Investing for retirement. Bond funds vs. a laddered bond portfolio. Which is best? Or is the answer neither?I tackle these questions in this weeks column.If you have a question, please ask it by submitting a comment at the end of this blog.Question From Bluesman48: Jeez, I guess now I'd better sell that five star fund that's up 44% annualized for the last three years and buy the index fund! You are really not asking a question, but your comment raises legitimate issues.Your premise is that your selection of this high performing fund is based on skill and not luck. You also believe that your use of the five star Morningstar rating was predictive of these outstanding returns.There is no data to support either assumption.There is no academic study indicating that anyone has the ability to consistently select high performing funds The majority of actively managed mutual funds do not equal, much less exceed, their benchmark in any single year.Do you have a skill that 97+% of mutual fund managers lack? They have been unable to match your achievement over a ten year period. Your skill has eluded at least six Nobel Prize Winners in Economics. It is also contradicted by the studies of Burton G. Malkiel, formerly a professor of economics at Princeton University and the author of A Random Walk Down Wall Street, Eugene F. Fama, a distinguished professor of finance at the University of Chicago, Roger Ibbotson, professor of finance at Yale University School of Management, and David F. Swensen, the Chief Investment Officer of Yale University and author of Unconventional Success, among many others who have spent their lives studying the capital markets and publishing their findings.Your reliance on the Morningstar five star rating flies in the face of numerous academic studies.One study found that there is a sharp drop off in performance after a fund receives its first 5-star Morningstar rating. The same study concluded that the risk levels of these funds increased significantly after it was rated five stars.Another exhaustive study concluded that high-rated funds (i.e., 5- and 4-star funds) do not generally perform better in the future than do 3-star funds.Your selection of an out-performing fund is most likely the product of luck and not skill. Five star Morningstar ratings are not predictive of future high performance.To answer your rhetorical inquiry, over the long term, you most likely would be better off with an index fund.Question From SRT34:Dan,How do you recommend guarding against inflation? TIPS? Commodities?The historical rate of inflation is 3%. If investors bought and held almost any investment, they would outpace inflation. For example, here are the historical returns of various investments for the past 80 years:Small stocks: 12.7%Large stocks: 10.4%Long term government bonds: 5.4%Treasury bills: 3.7%The problem is that investors, encouraged by their brokers and advisors, chase returns, to their detriment. One study measured the average return of investors over a 20 year period ending in 2004. Investors earned only 3.7% during a time when the S & P 500 earned 13.2% per year. After inflation and taxes, the average equity investor lost money!The best way to beat inflation is to have an appropriate asset allocation, to invest in low cost index funds and to hold on to your stock portfolio for as long as possible.For the past 36 years, the returns of a very conservative portfolio, consisting of 80% bonds and only 20% stocks, was 9.01%. The worst three calendar year performance of this portfolio was a gain of 8.17%.Smart, inflation busting, investing is really very simple. You just have to ignore much of the financial media and most brokers and advisors!Question From BarryT: What do you think about bond ladders vs. bond funds? Which involves the most risk for long term generation of investment income: a bond fund, or a carefully constructed bond ladder? Bond funds are highly diversified but appear to involve more speculation on interest rates. If the risk is higher for a ladder, is there a compensating increase in return? Finally, since (FDIC insured) CD rates seem to be close to those of bonds can CDs be included in a ladder to decrease risk?This is a complex area and there is no definitive answer to your excellent questions.My views are largely shaped by an article entitled A Synthetic Dividend. written by Eugene F. Fama, Vice President of Dimensional Fund Advisors, There is a significant body of research indicating that long term bonds add a significant amount of risk over short term bonds, without much added return. Long term bonds do not hedge against inflation. In fact, just the opposite. As inflation increases, the value of long term bonds decreases. Laddered bond portfolios typically have long term bonds that have these negative characteristics. In contrast, high quality, short term bonds offer better inflation protection, with less volatility than long term bonds. The negative is that the yields are lower.So whats the solution to this dilemma?Mr. Fama recommends that investors planning for retirement hold a portfolio consisting of an appropriate amount of stocks (represented by low cost, index or passively managed mutual funds) and short term bond funds, with maturities that vary according to changes in the yield curve.Income from this portfolio would be derived from redemption of the assets (both the stock and the bond portions). The benefit of this approach is that it focuses on total return, instead of just the yield from a laddered bond portfolio. There are tax benefits as well. Assets held for more that a year are taxed a capital gains rates, instead of higher ordinary income rates.For those investors who are not persuaded and want a portfolio consisting of just bonds, most investors would be better served by holding a low cost, index bond fund rather than a laddered bond portfolio. The benefits of the bond fund include greater diversification, professional management of cash flows and generally lower costs.Of course, there are exceptions to this rule. A laddered bond portfolio gives superior control to the investor. For some investors, this control may offset the benefits of a bond fund.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.