This week’s edition of Jason Zweig’s Wall Street Journal article addresses the issue of management fees. These are the fees that investment advisers charge investors to manage their portfolios. Mr. Zweig discusses several online services that provide the same management services either for free or at a significant discount to the fees charged by full service brokerage firms. The reason these online services can operate at such significant discounts is that most portfolio management is done by computers that selects a number of index ETFs. The business model of the full service brokerage firms is to beat the market by picking individual securities or whizzing in and out of the market. With a little luck some of these advisors do occasionally beat the market. But, most of the hyperactivity reduces the client’s returns instead of raising them. Bottom line, you pay a lot, but, often only get a little.
Saturday, March 8, 2014
Friday, March 7, 2014
An investment approach of buying one or two index funds and passively holding on to them is a proven solid long run approach. But, it is definitely not for the faint of heart. Academics define risk not as the loss of all your money, but as volatility in the value of your portfolio. This means that, in the short run, the value of your portfolio fluctuates up and down, but in the long run it reaches a favorable outcome. However, not every investor lives in the long run. An approach designed to reduce volatility incorporates a portfolio of differ types of financial assets rather than concentrating solely on the stock market. For example, the stock market and the bond market often move in opposite directions. Low interest rates are very favorable to the stock market and high interest rates are more favorable to the bond market. There are indexes of other asset classes that lend themselves to an index fund approach. Morgan Stanley has a number of indexes that track segments of the bond market. Case-Shiller has an index for commercial and residential real estate. Using index funds you can build a portfolio which will reduce the volatility and allow the faint of heart to get a good night’s sleep.
Wednesday, March 5, 2014
There are currently $1.7 trillion in exchange traded products in the United States. Of that total, 99.2% are in passive index products. A recent article in the Wall Street Journal however, reported that several of the big fund companies are preparing to launching a variety of new actively managed ETF’s The WSJ reported that the fundamental challenge facing actively managed ETF is the same one confronting actively managed stock mutual funds: The odds are stacked against active management. While some active managers may beat their benchmarks, others will trail the benchmarks. On average the funds can expect to get market returns, but the return to investors will be reduced by the higher expenses of active fund management. Which translates into; these new funds are designed to line the pockets of the manager, not increase investment returns for the shareholders.
Tuesday, March 4, 2014
For years, I have been preaching and teaching that the markets are efficient and include an emotional component. I have also been preaching and teaching the Wall Street either ignores efficient markets and behavioral finance or believes that they are incorrect. In today’s Wall Street Journal there is an interesting story on mixing and matching index funds with actively managed funds in which the author acknowledges the existence of emotion and efficient markets. The article states that mixing and matching of index funds with actively managed funds is okay for individual investors if the combination is used to satisfy an emotional need, ie. the reduction of volatility. The author goes on and recognizes the difficulty of active management to beat the broad market over long periods. He further states that there are less efficient market areas where the turnover rate is low and the market is slow to respond to new information. At least some financial professionals recognize the existence of efficient markets and emotional behavior.
Monday, March 3, 2014
A homework assignment that I would give everyone who reads this blog is to go to the Berkshire Hathaway website, click on Warren Buffett’s “Letter to Shareholders and read pages 16 through 18. What he has to say is nothing I haven’t been saying for the past three years, the difference is he is Warren Buffett and I am no. In these few pages he explains how non-professionals can beat the professionals simply by being disciplined. Non-professionals need to block out the noise of the market and “Focus on the playing field, not on the scoreboard.” His recommendation is short and to the point; buy an S&P 500 index fund and focus on long-term. In a move which I think is a bit unusual for him, he recommends a specific fund, the Vanguard S&P 500.
Saturday, March 1, 2014
The first time I met Warren Buffett was in 1992 at a talk he gave in downtown Omaha. I don’t remember who sponsored the event, but there were only about thirty people in the room. During the Q&A that followed his remarks, all the questions revolved around getting him to provide the questioner with a hot stock tip. In true Buffett fashion he dodged the question by suggesting that the questioner invest in Berkshire Hathaway. It was about that time that the media began to refer to him as the “Oracle of Omaha.” The Berkshire Hathaway annual report and Buffett’s “Letter to Shareholders” was released this morning and I was asked by the local newspaper to provide my thoughts on it. As I began to read it my, initial response was this is just a boring business report. But, towards the end there is a section titled “Some thoughts on investing” and I was really taken aback. In a very few, extremely well-chosen words, he was able to describe why the average investor can outperform the professionals by using an index fund. That motivated me to look up the word oracle. Webster says an oracle is a human being through whom the gods can speak. A sage on the other hand is someone who has become wise through experience and reflection. His description the proper attitude and approach to investing by the non-professional is truly the work of the sage.
Friday, February 28, 2014
Market timing is the way that the conventional wisdom thinks that successful investing is achieved. On a macro scale, market timing it involves getting out of the market when you think the market is going to go down and then getting back in when you think it’s going to go up. Another approach is doing the same buying and selling activity for individual stocks. The problem is human beings are very poor at predicting the short-term movement of the market. The way this works for individuals is that they sell after the market has gone down and they get back in when the market has gone high enough so they feel that it will not go back down again. At the professional level there are hundreds of studies, none of whom were able to find that financial professionals were able to time the market on a consistent basis. The objective of market timing is to outperform the market, but the end result is a net under performance. By definition the performance of index funds equal to that of the market. This result can be achieved with little effort and a small amount of training. Take your pick.