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March 25, 2007

Three Card Monte'With A Mutual Fund Twist


Now you see it. Now you dont. That was the premise of a slick con game played regularly on the streets of New York City and other major cities. This scam involved tricking the victim into betting a sum of money that he can find the money card, which was one of three face down playing cards. In reality, through a number of clever maneuvers, the victim never had a chance and he or she lost every time.

Actively managed mutual funds (I call them hyperactive, because that is what they are) sold with much enthusiasm every day to unsuspecting investors, have a variant of this theme. To be fair, these funds do disclose some of their numerous categories of fees--although you have to read the fine print to find them, such as:

Of course, not all hyperactively managed funds charge all of these fees.

Here is the real shocker:

According to an academic study, nearly half of the real costs of owning hyeractively managed funds is hidden. How can this be?

Hyperactively managed funds have significantly greater trading costs than index funds. They are not required to disclose a large portion of these costs to investors.

It turns out that the total trading costs (disclosed and undisclosed) of hyperactively managed funds is seven times greater than the costs of comparable index funds.

For a summary of this study and additional references, go to:

http://www.carlsoncap.com/research/CCM-hidden-mutual-fund-fees.pdf

And what do investors get for paying these significantly higher (disclosed and undisclosed) costs? Funds that the overwhelming data tells us are likely to underperform comparable index funds over the long term.

The next time your hyperactive broker or advisor recommends an actively managed fund to you, bring this study to his or her attention. Tell him that you can capture market returns yourself, net of fees and costs, by following the recommendations in The Smartest Investment Book Youll Ever Read. If he responds by pushing hyperactive funds on you, watch out.

You may be playing three card montewith a mutual fund twist!

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March 17, 2007

An Award From The Library Journal

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.

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March 03, 2007

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

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.

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February 15, 2007

Long Term Data-Short Term Life

One of the most confusing subjects to investors is the use of long term data to illustrate returns.

The financial services industry adds to this confusion by touting short term returns, implying that these returns are predictive of future returns, while stating the opposite in the fine print (e.g. "past returns are not indicative of future performance.").

In my book, I use long term (28 year) data. Is this fair and relevant to today's investors? The answer is a resounding "yes."

I can''t say it any better than this quote from Mark Hebner's excellent web site, ifa.com:

"The first problem investors are faced with relative to history of stock market returns is the lack of quality long-term data. Secondly, they are not aware that long-term data has more value to them than does short-term data. When looking at 78 years of data many investors think it is irrelevant because they do not have 78 years to live. This point of view overlooks the importance of sample size and the concern for sample error. When gathering information to characterize the risk and return of capitalism, the more quality data you have, the more accurate your conclusions. Any subset of the data, such as five years worth of data, is bound to contain significant errors in its attempt to describe the risk and return of an index. For example, for the five-year period from 2000 to 2004, the S&P 500 had a total loss of 12%. Based on that negative total return, many investors would conclude that the S&P 500 was not a good investment. But when considering 78 years from 1927 to 2004, we see that the annualized return over that period is about 10% per year, and it would be within normal limits for it to fluctuate that much over five year periods. Therefore, it is still an important component of diversified index portfolios. That is a very different conclusion and is far more accurate than the conclusion many investors make based on the last five years."

Keep in mind that the data in my book takes a 28 year period and provides the average annual (geometric) return for each of the portfolios over that lengthy time period. Clearly, this is more reliable data than providing similar numbers over a shorter time period.

Some readers have noted that long term data ''allows for anomalous data in the rare years where the data shows phenomenal results.' But this is also true for short term data. To illustrate this point, I ran the numbers on each of the four portfolios in my book for the ten year period ending December, 2005. However, I excluded the two best performing years (1985 and 1986) and the two worst performing years (2001 and 2002). Here are the results:

20/80 40/60 60/40 80/20

8.76% 10.05% 11.35% 12.64%

These results are reasonably close to the long term data in my book.

Here is the bottom line:

No data can reliably predict the future. However, if you have a choice, there is no doubt that long term data is far superior to short term data.
























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January 28, 2007

Some Common Sense--From Maine

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:

http://www.bangordailynews.com/news/t/viewpoints.aspx?articleid=144762&zoneid=34

So far, this has not been my experience. I have been gratified by the hundreds of grateful e-mails I have received from U.S. and Canadian 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. The reception from Canadian investors has been particularly enthusiastic. The Smartest Investment Book You'll Ever Read has been at the top of the business best sellers in Canada since its publication.

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 Morningstar''s online fund screener to determine the performance of 1,446 U.S based 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: http://www.ifa.com/Media/Images/PDF%20files/BeatingIndexesarehardtodo10-12-04.pdf.

Based upon my research of Canadian actively manged mutual funds, the results in Canada are similar.

Another common observation is that the four portfolios in the U.S. edition of 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 don''t 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 investor in the U.S. 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=2003071601

Compare the returns of these hapless investors to the 35 year returns of investors who achieved market returns.

While I have seen no similar studies for Canadian investors, I have no reason to believe that the results would be any different.

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!

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January 17, 2007

The Income Trust Debacle

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.

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January 13, 2007

Canadian Investors Are Becoming Smart Investors!

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.

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