Financial Wisdom 101 (draft FAQ)

[donheff]

Quote:

Originally Posted by Nords The point of the FAQs is to link the best examples of those individual posts into one location in a coherent summary for the new posters to browse. Then guys like me won't have to keep searching for all our pearls of wisdom every time the question comes up. It's a nice benefit for the new posters but it's an even better benefit for us grumpy old posters who still want to pontificate help out.

+1. I largely agree with the OP's conclusions but I would not agree that they should be posted as "answers" in an FAQ. On any given topic (indexes, allocations, etc) there are lots of interesting and well thought out views expressed on this board. The best we can do with a fundamental FAQ (like finances 101) is link to the best threads on a variety of component topics.

[jIMOh]

If a person takes on less risk, they may have better risk adusted returns than the market.

In addition, low cost index funds are not a sure way to retire, retire early or make money. The indexes are quite volatile, and in many cases index funds are more volatile than managed funds with similar holdings.

Cost is a great predictor of poor performance, but at very high end (top 50%, top 25%) of funds, cost is less a predictor of good performance.

It should be stated that most of the time if two funds are invested in the same holdings, the lower cost fund should have better performance.

Then I read an article this weekend where two ETFs have the same holdings, but one has a 3% performance over the other. The reason was the better returns came from a weighting towards the dividend stocks, where as the other ETF was cap weighted.

I proudly invest in low cost managed funds, and most of what was posted above seems like financial pornography and financial spam to me.

[unclemick]

Wellll - if one were foolish enough to ask a person who has been investing since 1966(41 yrs or so) with a downloaded Curmudgeon certificate from this very forum to employ hindsight:

1. Successful investing is a matter of faith:
'God Looks After Drunkards, Fools and The United States of America.'
2. Unless the investing business is your day job - don't read books, follow the market, or any of that clap trap. Skip Maria - watch football - including some college ball if you are hardcore.
3. Dollar cost average as early and often and as long as possible in the lowest expense, lowest turnover, most tax efficient fund(like TSM - total stock market). When your bellybutton agrees with your brain that it's time to retire - then rock up and retire. Before that - keep your day job.

heh heh heh - then again if you are a smart ass - read books, try to beat the market, dink around with Harry Browne type multi asset schemes(before slice and dice), resource stocks, gold and silver coins, timberland, rental RE, etc.

You may(slim odds) get your butt bailed out by 500index 401k dollar cost averaged over a lot of years - blind squirrels and acorns being what they are.

Can you miss the fun of Pssst Wellesley at parties? Or nod nod wink wink - mentioning Fama and French 3 factor model to attractive members of the opposite sex!

Seroius investing only takes one fund(like TSM or a lifecycle if you wish modern fancy smancy) auto funded via dollar cost averaging and totally ignored for a long period. Go out front and watch your grass grow - do some gardening!

[kcowan]

Because the subject is so diverse, my thinking is that each topic might be presented like:
What is it?
What is good about it?
What is bad about it?

e.g. Exchange-traded fund - Wikipedia, the free encyclopedia
ETF = Exchange traded fund, usually aiming to represent some segment of the market with relatively low overhead costs.
+ Removes emotion from the investing decision while enabling specific segment plays
- Will unlikely even meet the average performance in the segment being represented (Index growth less MER)

I know this is abbreviated but it has to be to deliver any value.

[FinanceDude]

Quote:

Originally Posted by twaddle RR, I enjoy your contributions to the forum. Keep 'em coming, and feel free to throw a few punches at Nords, too. He can take them. So far, nobody has been able to knock him off his high horse. Here's a random bit of wisdom. Watch out for the classic signs of poor investor behavior: The greatest Wall Street danger of all: you. - By Henry Blodget - Slate Magazine

Blodget is one of the BIGEST FRAUDS I know on Wall Street. He makes Abby Joseph Cohen look like Warren Buffett or George Soros............

[FinanceDude]

Quote:

Originally Posted by jIMOh In addition, low cost index funds are not a sure way to retire, retire early or make money. The indexes are quite volatile, and in many cases index funds are more volatile than managed funds with similar holdings.

Couldn't agree more..........in a bad market, a managed fund can do damage control on behalf of the investor..........

Quote:

Cost is a great predictor of poor performance, but at very high end (top 50%, top 25%) of funds, cost is less a predictor of good performance.

yes and no..........

[RetireeRobert]

Quote:

Originally Posted by twaddle RR, I enjoy your contributions to the forum. Keep 'em coming, and feel free to throw a few punches at Nords, too.

Thanks.

Another for the financial wisdom 101 FAQs, since no one here mentioned this one yet----Live Below Your Means (LBYM). Here is the requisite link:
Hello, Dollar! - Living Below Your Means

[pedorrero]

I just finished browsing Burt Malakiel's (sp?) "must read" book A Random Walk Down Wall Street. I'll recommend this book as one of the best "pro-indexing" or "can't beat the market" books. Yet, I found interesting that in this exhaustive book, Burt covers several of the various stategies to beat the market, and he seems to say that some of them have merit (e.g. value investing, low p/e ratios.) He cites some of the historical bubbles (Dutch Tulip Bulbs, East India Co., up to the Internet Bubble) which certainly no one would claim were examples of a rationally priced market. So sure, the markets can go haywire sometimes.

[pedorrero]

FinancialDude, have to disagree with your "damage control" of managed funds. Do some reading (if you're not the Curmudgeon mentioned earlier.)

Per Malakiel (and probably other authors):

Mutual funds, as a group, have a history of being "wrong", at least per their cash holdings (at a peak when the market is at a trough; at a minimum when the market is near a major top.) Mutual funds have many, many sins. Style drift? How about complete lapses from stated investment policy. Read all about it in the Edelman book.

My wise ass has this to say: The only thing a "managed" fund will "manage" to do for you is to take an extra 1.5% (average) or more of your potential returns.

[FinanceDude]

Quote:

Originally Posted by pedorrero FinancialDude, have to disagree with your "damage control" of managed funds. Do some reading (if you're not the Curmudgeon mentioned earlier.) Per Malakiel (and probably other authors): Mutual funds, as a group, have a history of being "wrong", at least per their cash holdings (at a peak when the market is at a trough; at a minimum when the market is near a major top.) Mutual funds have many, many sins. Style drift? How about complete lapses from stated investment policy. Read all about it in the Edelman book. My wise ass has this to say: The only thing a "managed" fund will "manage" to do for you is to take an extra 1.5% (average) or more of your potential returns.

Sounds like you're buying the wrong funds. The managed funds I own are trouncing index funds as we speak........and I don't pay loads.........

I have all Ric Edelman's books...he's not right about everything...........

Differences of opinion are healthy and should be encouraged..........

[jIMOh]

Quote:

Originally Posted by FinanceDude Sounds like you're buying the wrong funds. The managed funds I own are trouncing index funds as we speak........and I don't pay loads......... I have all Ric Edelman's books...he's not right about everything........... Differences of opinion are healthy and should be encouraged..........

Most financial porn suggests all managed funds are in same category-
as in managed are high expense and unmanaged are indexed and low expense. This is so far from reality it will take pages to discuss.

The managed funds I own follow their prospectus, their philosphy- and I don't pay loads or high expenses either. I trust the company which runs the funds (T Rowe Price) and the expenses I pay are around .7% on most funds, and this is slightly higher than expenses for VFINX (.3% last I checked). That .4% difference is worth the price of a manager, to me.

It's OK to be average, and it's OK to invest in index funds. I don't plan on being average... and in many cases with managed funds a person can reduce their risk while staying invested in nearly the same holdings as the index itself.

But preaching that indexing will win out 30 years from now is quite naive. You might pay less expenses than me- that I could pretty much guarantee. But you and I both know we can't predict the market performance tommorrow or next week-month-year-decade. Having a fund manager which can react to a changing condition (like sell a company like Enron, or not buy them in the first place) is important to me.

[flipstress]

Quote:

Originally Posted by kcowan Because the subject is so diverse, my thinking is that each topic might be presented like: What is it? What is good about it? What is bad about it? e.g. Exchange-traded fund - Wikipedia, the free encyclopedia ETF = Exchange traded fund, usually aiming to represent some segment of the market with relatively low overhead costs. + Removes emotion from the investing decision while enabling specific segment plays - Will unlikely even meet the average performance in the segment being represented (Index growth less MER) I know this is abbreviated but it has to be to deliver any value.

I like this suggestion--short and sweet summaries. It leaves people free to investigate the different investment options.

We The volunteer (hi, pedorrero!) can then add links to threads here that discuss the pros and cons of the different investment vehicles/options/topics.

[RetireeRobert]

Quote:

Originally Posted by Nords Thanks, and if you don't have anything nice to say further to contribute then we'll fumble along without you somehow.

With that most gracious invitation, and not wanting to leave you Nords fumbling along, here is another Financial Wisdom 101 bit:

The magic power of compounding. Link---
The Power of Compounding Interest

[bongo2]

Quote:

Originally Posted by RetireeRobert Assets allocation accounts for 94% of investment return. Stock selection and timing a account for less than 6% of return.

This is an almost universal misconception. The accurate result from Brinson's study is that 94% of the variability of a portfolio's return over time is due to asset allocation. Not 94% of it's return.

See here for a detailed explanation: http://www.ifa.com/Media/Images/PDF%...erformance.pdf

Quote:

Originally Posted by Nords Buffett got to where he is, however, by starting just like the rest of us.

This is true if you started out managing millions of dollars for an insurance company. Buffett is a fine stock picker, but that's not where he makes his dough.

Quote:

Originally Posted by FinanceDude The managed funds I own are trouncing index funds as we speak

Isn't that always the retort. We should have some fun with this. Perhaps managed fund champions should pick their 10 favorites in another thread and we can see who beats the indexes 7 out of 10 (roughly 83rd percentile) or 8 out of 10 (roughly 95th percentile) for the next month.

[FinanceDude]

Quote:

Originally Posted by bongo2 Isn't that always the retort.

Yeah, it is for us who are not indexers........

Quote:

We should have some fun with this. Perhaps managed fund champions should pick their 10 favorites in another thread and we can see who beats the indexes 7 out of 10 (roughly 83rd percentile) or 8 out of 10 (roughly 95th percentile) for the next month.

Interesting.........and indexer than wants to measure ONE-MONTH returns?? Isn't indexing about "beating the managed funds over time"??

[RetireeRobert]

Quote:

Originally Posted by bongo2 This is an almost universal misconception. The accurate result from Brinson's study is that 94% of the variability of a portfolio's return over time is due to asset allocation. Not 94% of it's return. See here for a detailed explanation: http://www.ifa.com/Media/Images/PDF%...erformance.pdf

You are quite right. My bad for the imprecise wording. Thanks for the clarification and link to additional info on asset allocation.

[bongo2]

Quote:

Originally Posted by FinanceDude an indexer wants to measure ONE-MONTH returns?? Isn't indexing about "beating the managed funds over time"??

I said this was for fun! The contest that measures the thirty-year results would get pretty dull. We could even do one week or one day.

[FinanceDude]

Quote:

Originally Posted by bongo2 I said this was for fun! The contest that measures the thirty-year results would get pretty dull. We could even do one week or one day.

Month is ok.........quarter would be ok too........

[jIMOh]

Quote:

Quote: Originally Posted by RetireeRobert Assets allocation accounts for 94% of investment return. Stock selection and timing a account for less than 6% of return. This is an almost universal misconception. The accurate result from Brinson's study is that 94% of the variability of a portfolio's return over time is due to asset allocation. Not 94% of it's return.

This is what I understood as well (94% of movements based on asset allocation), but I also understood that this movement is also correlated to investment return.

Meaning most of return in any portfolio will be related to the percentages of assets in holds in a given security. Other return factors include expense and timing, but these two aspects contrubute much less than the actual security held.

If I found a way to buy bonds when they were cheapest at a next to nothing cost, that portfolio would probably not beat equities in most time periods of significance. Because the return of the security (equities) is expected to be higher.

[jIMOh]

Quote:

Originally Posted by FinanceDude Month is ok.........quarter would be ok too........

I am in a contest like this on another board.

Here's my suggestion (how we do it on another board).

We create a yahoo account (like ER-2008xyz), and each contestant gets a $10,000 or $100,000 porfolio of play money.

Using yahoo transactions, securities are bought and sold. Each person must identify their brokerage and follow cost structure of that broker (so if Ameritrade is chosen and they charge $20 for buying, then that cost must be reflected when making transaction). If Vanguard is used, and someone trades within 60 days, the cost Vanguard assesses to timers must also be assessed.