Look Who's Indexing - Investment Pros

On 4/14 and 4/15, 1,280 Bloomberg terminal users were asked "what do you think is most appropriate for someone who is mid-career and trying to save for retirement?"  Bloomberg terminal users are professional managers.  The choices scored as follows:

• 42% Passive index funds and etfs
• 18% Actively managed mutual funds
• 17% Individual stocks and funds
• 14% Real estate
• 3% Hedge funds

The study was reported by Charles Stein, Even Financial Pros Choose Indexing for Retirement Savings.

Getting to a Low-Cost Index Fund Strategy

Did you ever hear the old joke about the Maine farmer who was standing in his field when a car pulled up and asked if he knew how to get to a certain town.  He squinted, furrowed his brow, pursed his lip,s and then came out in his Maine accent with, "You know, I don't think you can get there from here."

That's how I feel sometimes when I meet with new clients.  We go over the principles underlying low-cost well-diversified index investing.  We cover the thinking behind different asset allocation models and the importance of sticking with an asset allocation strategy through the ups and downs of the market.

Then we look at their investments.  More times than not they include several bank accounts, multiple 401(k)s, IRAs and taxable accounts.  The taxable accounts include inherited stock, and they look at me quizzically when I ask about cost basis.

The Funds they hold include front load, back load, and everything in between.  Some hold private collective funds on which it is difficult to understand the management fees.

The bottom line is we need to go from a smorgasbord of investment vehicles to a well-structured basic asset allocation comprised of low-cost index funds.  Sometimes I feel like the Maine farmer.

But usually it is best to proceed slowly.  Take one account at a time.  Know exactly where you are headed and take baby steps if necessary.  Understand each investment.  If it's a taxable account, look at capital gains - are they long term or short term?  Look at the Funds - are they load Funds?  Does it make sense to hold for a while to lessen the deferred charge?

If moving accounts to a new broker, can the Funds be moved "in kind"?  If not, how will your overall asset allocation look over the transition period?

Sometimes it pays to have an advisor take over during this set-up period.  An advisor knows how to get from where you are to where you want to go on a tax-efficient basis.  In many instances, once the account is finally set up so that the asset allocation is clearly understood and assets are invested in low-cost index funds, the advisor can bow out and the client take over.

A Teaching Moment-Record Dow Jones

Teaching moments don't come along every day.  They have to be taken advantage of when they do arrive.

The Dow Jones Industrial Average hit an all-time high yesterday.  So, should we release the balloons and celebrate?  Actually, it depends.  If you are retired, go ahead and sip some champagne and let the balloons go.  Otherwise, take it in stride.  In particular, if you are building a nest egg, record highs are not what you want to see. You could very well be buying at prices that, in retrospect, will be high.  WHAT YOU CARE ABOUT IS WHERE THE MARKET IS WHEN YOU START DRAWING A PAYCHECK OFF OF YOUR NEST EGG!

It actually would be better for you, the dollar cost averager, if the market was down 20%!  Hopefully I didn't totally take away your warm, fuzzy feeling.

Looking Back

To gain some insight, let's take a step back 12 months and ask what we would have done if we knew some of the things that would happen over the ensuing 12 months.  Suppose we knew the government would continue its dysfunctionality, pushing to the fiscal cliff up until the last minute and actually going through with the sequester.  Assume we knew that the growth rate of the economy would remain anemic with only slight improvement on the job front.  Assume we knew the Italians would have a 3-ring circus of an election and bring the European malaise back to the forefront, not to mention the huge questions arising out of China.

Actually a lot of professionals saw these events unfolding and did what you would expect - they reduced stock exposure and took actions to take "risk off," as they like to say.  Consider, though, the following real world graph of the value of a portfolio positioned with 60% stocks and 40% bonds + cash, comprised of low-cost, exchange-traded funds managed on a "buy and hold" basis, carefully tracking the 60/40 agreed upon asset allocation.

Source: Schwab

 CLICK TO ENLARGE  The arrows show dysfunctional government events.  From left to right, you have the debt ceiling debacle, the fiscal cliff, and the sequester.  One after another, professionals and politicians on CNBC ranted and raved about the likely impact on the market.  In fact, the downturn initially (before the immunity built up?) was reason enough for market timers to exit the market.

What seems to have gone unappreciated by many has been the impact of Ben Bernanke on pushing investors into risky assets.  Simply, avoiding risk is very costly these days with short-term rates at zero and the 10-year Treasury note below 2%.  Investors figured out that taking risk byscarfing up dividend payers was the better choice.

Hopefully, your account has participated in the run up.  If it hasn't. you may want to ask questions.  It could be a teaching moment on how your retirement assets are managed.

Disclosure:  Past returns are not indicative of future performance.  This post is for educational purposes only.  Investors should do their own research or consult a professional before making investment decisions.

2 Great Weekend Reads

Below are 2 pieces from 2 of my favorite bloggers:  Andrew Hallam and the intriguingly named Mr. Money Mustache (aka Pete). Reading these 2 bloggers will change most people's lives - to some extent.

Understand that you don't have to buy into their respective life style or investment philosophies 100% to benefit from them.

For example, Andrew Hallam is a 100% indexer and thinks hard about lifestyle.  His mission is to lay out a clear path to creating wealth.  To that end, he has written Millionaire Teacher.

I get it that indexing turns off some investors.  I understand that some people just can't buy into the idea that indexing will outperform most investors who actively seek to beat the market.  I've met a lot of people who have no doubt that they can pick high-priced mutual funds that will be in the 10% that will outperform the market over the long term after all fees.

And I know for a fact that most people have never been challenged on the frugality front.

On the investment front, many investors like matching wits with Mr. Market, like the challenge of analyzing individual stocks to try and pick winners, and bask in the adrenaline rush of timing the market.

But you can both index and invest actively. You can invest in line with Hallam's philosophy with 70% or 80% of your money (I always recommend at least 80%!) and try to beat the market with the rest - if that's how you want to spend your time.  By doing this, you can have the best of both worlds:  having the bulk of your assets invested with the odds on your side à la Hallam's approach and meaningful assets seeking to capture what the industry calls "alpha."  One thing Hallam will teach you, unambiguously, is how to avoid the cost of investing in high-priced funds and using high-priced advisors!

The second blogger, Mr. Money Mustache, is frugality (frugal, not cheap - he will teach you the difference) to the extreme.  In his strong language, engaging style, he provides a path for young people to be able to retire early by thinking hard about life style.  Again, you don't have to buy in 100% by, say, seeking to live close enough to your job so that you can bike to work.  I believe, however, after reading Mustache you will question why you're buying that huge flat screen TV for your small apartment when you have unpaid credit bills.

In fact, it wouldn't surprise me if most of you who read the piece below join the rapidly growing army of Mustachions!

This interview of Andrew Hallam, "How I Made My First Million," lays out the key points of his book Millionaire Teacher.  Here is a piece that lists his "Nine Laws to Financial Freedom."

Here is a piece, "Get Rich With:  Good Old-Fashioned Hard Work," by Mr. Money Mustache.  It is representative of his engaging style and includes (warning if you've got sensitive ears) strong language and a valuable lesson for young and old alike.

Enjoy!

Market Predictions

This is the season of predictions and forecasts.  Pundits are getting a lot of air time and magazine space trotting out all kinds of charts and esoteric facts to support highly specific predictions on where markets are headed.

If you are like a lot of investors, you will be impressed.  In fact, crystal ball seers in the market are usually introduced by citing a time in the past when they made accurate predictions. 

What should you make of them?  Sometimes potential clients reel off well-known pundits' names and their forecasts.  They say so-and-so says the market is headed higher/lower or gold is going to $ _____/oz. etc.  They want to know what I think.

I patiently explain that I can get super smart, very articulate people to give well-reasoned, highly-believable arguments on both sides.  Jeremy Siegal (author of Stocks For the Long Run), for example, will argue forcefully that stocks are headed higher while Bob Shiller (author of Irrational Exuberance) will take the opposite side and say that now is not a good time to buy. 

What you don't see are all those in the gutter because their predictions turned out horribly wrong.  You won't see Miller, Paulson, Berkowitz, et al.  Sometimes this gets through; often times it doesn't.  After all, some people have their whole view of investing grounded in predicting which stocks and which sectors will do best.



If I thought forecasting was useful, I'd probably go with the most recent presenter given that they are so persuasive.  But I don't think it is useful.  In fact, it is harmful, IMHO, because many times investors use these forecasts as a  substitute for thinking; and when forecasts start to go awry, emotions come into play and the investor is set up for a stressful period that typically ends badly.


Larry Swedroe is the director of research of Buckingham Asset Management, LLC and a well-known proponent of index investing.  Here is his response when asked to make a forecast of macroeconomic events:
 
 From interview of  Larry Swedroe by "Seeking Alpha":


SA: Global Macro considerations dominated the headlines in 2011. Do you see 2012 unfolding differently? If so, how?
LS: Yes, it is always different, but my crystal ball is always cloudy. So I don’t make forecasts. Investors should learn what Warren Buffett knows: A market forecast tells you nothing about where the market is going but a lot about the person doing the forecast.
       There are good studies on the ability to forecast and the only thing that correlates with accuracy is fame, and the correlation is negative:  The more famous the forecaster, the less accurate the forecast.