MarketRiders - A Resource

As most of you know, I believe that most investors are best served by investing in low-cost, low-turnover, highly diversified, index mutual funds or exchange traded funds.  Many market stalwarts support this approach including Warren Buffett, John Bogle, William Bernstein, Charles Ellis, and Burton Malkiel.  This indexing approach rests on considerable evidence showing that active managers, after fees, fail to outperform the market.  This is because their fees and hidden costs are significant; and markets are basically efficient, meaning that prices rapidly incorporate publicly available information.

My service is unique in that I offer to teach investors how to manage their assets with this approach.  I either give them direction or initially manage their assets and then, when they are comfortable, turn over management to them.

MarketRiders is an online site that follows the indexed approach and offers software (approximately $100/year subscription services) or low-cost management services (flat fee of $495/year/account).  Some DIY investors will find this to be exactly what they are looking for.

Their website is extremely well done, and they lead the investor  through the process and underlying philosophy quite well.  I recommend that all investors considering this approach to the market at least spend some time on their site.  Again, it could be the exact fit you are seeking.  Please note that I am not affiliated with them and, if anything, could lose potential clients to them.

From my perspective, I have the question of whether this process can be commoditized to the extent implied by the MarketRiders approach.  They do have counseling available, and maybe this overcomes my objection; but in many cases, the key in the overall investment approach is fitting in goals and extraneous items that are client specific. For example, some clients own real estate or have the likelihood of receiving a sizeable inheritance in the next few years.  Some want to leave an inheritance, and others are fearful of running out of money.  Some need considerable guidance on simplifying by combining accounts and locating investments appropriately.  All of these figure prominently in the overall investment program.

In summary, check out this resource.  If interested, try the free trial.  It very well could fit your needs.

Do You Have a Good 401(k) ?

Many times a couple has to decide the best place to make their retirement fund contributions - in the husband's or wife's 401k or an IRA? And the answer depends on the quality of the plans, company matches, etc. To help answer this question, BrightScope provides an online 401k rating service as described in this Yahoo! article: "How Good Is Your Company's 401(k ) Plan?" by Carla Fried. BrightScope examines fund costs, investment choices, company generosity as well as other key features relative to a peer group. For each peer group, it shows a comparison relative to the best, worst, and average plans.

Generally, a couple will first want to make contributions to take advantage of the company match. After that, they may consider, if feasible, contributing to IRAs and taking advantage of low-cost index funds. Finally, they can max out on the better 401k plan, etc.

It should be stressed that it is easy to get a plan rated. Plan administrators just need to get readily available documents to BrightScope. Carla Fried lists the steps a plan can take to improve their plan and what participants can do in the meantime.

Opt in/Opt out ?

Not long ago I was in a meeting of community college professors and a concerned professor raised her hand and asked, "What do professors do if a student sleeps during class?".

I responded that I thank the student and let them know that if they, or any of their friends, are willing to spend $300 to put their heads down on a desk and sleep for an hour and 20 minutes to let me know and we can get a classroom anytime. This, of course, got some laughs and, somewhat surprising to me, a number of professors agreed with me. Of course some were appalled.

I think I am beginning to feel pretty much the same way about the whole opt in/opt out issue as it pertains to 401k participation. For those not familiar with the issue, behavioral economists have found that the simple change of requiring people to check a box if they don't want to participate in the 401k increases participation. In other words, if you have to take action to participate in the plan, some people won't participate. Sort of like having to get up off the couch to change the channel when we can't find the remote. We all know that there are some people who will watch the same channel for hours.

OK. So opt in is great? I disagree. I think plan sponsors/human resources need to work harder to explain to employees the benefits of the plan and educate participants on responsible steps to take to have a secure retirement. Participants need to understand that they will be 65 years old some day. They need to understand compounding. They need to think about where they will get an income when they are no longer in the work force. After that, it is the responsibility of the participant to take action.


Yahoo Finance has a good article today on "How Good Is Your Company 401(k) Plan ?". It references BrightScope which rates plans and compares them to their peers. It is a useful tool in getting action on reducing fund costs, improving investment options, etc.

Index Funds-Mediocre Performance?

Many investors go the active management route because they believe indexing produces mediocre results. After all, in any period it is obvious that there are active funds, sectors, market timers, etc., that beat the market and beat the market by a lot. That will be true as well for 2010.

It follows, then, that the reward is huge for those who are able to beat the market or pick those who will beat the market - in the short run. If the investment strategy outperforms by 9%, it doesn't matter if fees and hidden costs are huge.

In my former life, I was an institutional investment manager. ,I managed funds for some of the largest pension funds in the country. Performance results were a big deal. Rankings with other managers who were competing for business were compiled, scrutinized and were a primary factor in gaining or losing business. The objective was to get performance in the upper quartile - the top 25%.

Quartile rankings were done for various periods: 1-year, 3-year, 5-year, 10-year, etc. As time went by, I noticed something interesting. We went through a period where we were consistently in the 2nd quartile - respectable, but not hitting the ball in the upper deck. What I noticed was that consistent 2nd quartile performance in the short run pushed us into the upper quartile over the long run.

Being in the second quartile meant you never went into a meeting and said we were number 18 out of a 100 managers for the last quarter or last year. Instead, you were more like number 38 or 42, etc. But for the longer term, the 5-year or 10-year results, you were able to say, in fact, we were number 18 or 15 out of 100.

How could this be? Studying the rankings over the long term, I found that many managers in the top quartile over the short term took risks or used a style that went out of favor in subsequent periods. They took positions and structured their portfolio radically different from the indices they were seeking to outperform. In some periods, they were very aggressive in timing the market. They went out of favor to such an extent that they performed in the bottom quartile - they went from hero to goat. Over the longer term, many ended up in the 3rd quartile.

For individuals, as well as for pension funds, the most important performance is over the longer term. Most individuals will be investing 35 - 40 years. By investing in low cost index funds, diversifying appropriately, and rebalancing according to a well-thought-out asset allocation, results will be in the second quartile ranking over most short-term periods. Over the longer term, this will have the best chance of reaching the top quartile where they want to be.

Total Return Equity Swaps/WMDs

How many times can a man turn his head And pretend that he just doesn't see
The answer, my friend, is blowing in the wind The answer is blowing in the wind - Dylan

Suppose you wanted to get a loan, but your balance sheet is looking a bit shaky. You come to me and we make an agreement. I buy your 100 shares of Johnson & Johnson stock, you get the dividends, and each quarter we settle up on the gain or loss in the stock. This removes the stock from your balance sheet and you have increased your liquidity. There has been no change - you've moved the stock, in effect, off balance sheet but you still participate fully in the movement of the stock. You've engaged in a "Total Return Equity Swap".

These swaps are what Buffett was referring to when he called derivatives weapons of mass destruction.

It would seem that anyone with at least a 3rd-grade education could see that this type of swap increases leverage, is designed to manipulate balance sheets, and is dangerous. Unfortunately, our former Chairman of the Federal Reserve didn't grasp the danger of these types of derivatives. His view was that derivatives spread risk to those that can handle it.

This it does. But there are typically at least two sides to an economic action. They do spread risk in a beneficial manner; but they also increase speculation, potentially to dangerous levels. This, of course, is being kept simple - you can imagine the potential abuses in the bond area. If I have too much debt, I can't get a rating on the borrowing I need to do. No problem - let's do a swap and lower my debt/equity ratio.

The big problem, in my opinion, is that there are people who see the dangers of these kinds of instruments (I'm talking broadly now - not just about swaps and derivatives) but they "pretend he just doesn't see" because of short-term economic gains.

To realize our potential as we move into a new decade, we need at some point to stop looking the other way and pretending we don't see.

The Yield Hunter - A Resource

As we move into 2011, the biggest challenge facing DIY investors continues to be yields. Yields are historically low, and DIYers are on the lookout for yield enhancement opportunities. It can't be stressed enough, however, that risk has to be carefully managed. A lot of money has been lost by investors seeking higher yields.

I have read with interest the post by MoneyCone on royalty trusts. This is an area that yield seeking investors should know about. Yields in excess of 6.5% are not unusual in this area. Again, however, risks need to be managed. It is possible to get stuck in a long-term security in a rising rate environment or have the underlying resource price collapse, etc. Be sure to understand what you are investing in. MoneyCone provides an excellent introduction.

A big help also along these lines is available at The Yield Hunter. This site lists a number of areas where high yields are available, as well as commentary on the various sectors, types of issues, etc. Click on a sector such as "U.S. Royalty Trusts" and scroll down. You'll come across an informative table, listing several securities, that provides comparative information at a security specific level. Again, note the commentary. This is where you will learn what a grantor trust is, what happens when the resource is depleted, etc.

Also, be sure to click on the model portfolios on the upper right hand side. These are excellent guides, for those who might need them, on a basic setup to track income paying investments that, with a little facility with Excel, can be easily set up.

2010 Performance - BlackRock Diversified Portfolio

In past posts, we've looked at the BlackRock chart that covers performance over a 20-year period. The performance shown is for 7 asset classes and ranks performance from top to bottom for each of the 20 years.

It also shows returns for a diversified portfolio, which is something I really like about BlackRock's table. Although the diversified portfolio never is among the top 2 performers, it has excellent performance over the long term. In my opinion, this type of chart is extremely useful in pinning down risk tolerance.

The table below shows a quick estimate of of the diversified portfolio's return for the various sectors represented. For the weights assumed in the table, the return was +13.25% for the year. It is worth noting that this portfolio could be set up in 20 minutes on Monday morning, requires very little maintenance and monitoring, and historically has outperformed much higher cost professional managers over the long term.

Performance numbers obtained from Morningstar.

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