I'm starting to warm up to Index Funds

[youbet]

Depends on which active funds............

Of course!

youbet, keep in mind I have access to programs and other resources the average investor does not, so perhaps I have that as a small advantage in some ways.......

I'm not sure what you're saying. Do you mean you have software and information that will allow you to be able to pick active funds that will outperform indexes at all times and without exception?

 

[justin]

youbet, keep in mind I have access to programs and other resources the average investor does not, so perhaps I have that as a small advantage in some ways.......

spidey sense?

If by "other resources" you mean a crystal ball, then give us some inside tips.

Being serious for a minute, if one were to want to invest in actively managed funds, do you have any recommendations for good funds/fund families? In other words, what are you putting your clients in these days? I'm curious because I may be forced to recommend some actively managed funds for certain purposes and I'd rather get the good actively managed funds instead of the crappy ones.

Any opinion on vanguard actively managed funds (the quant funds or other actively managed funds)?

 

[FinanceDude]

Of course!
I'm not sure what you're saying. Do you mean you have software and information that will allow you to be able to pick active funds that will outperform indexes at all times and without exception?

If I did that have info, why would I share it on here?? No matter what I or anyone else says, most folks on here are going to put total trust in index funds anyways.........

BTW, I don't NEED actively managed funds to BEAT indexes at ALL TIMES, I have beat them over the past 10 years using my own analysis, so that is good enough for me. And I also know that people are beating my up for using SPY and QQQ to do my indexing, but that is my choice, and so far, so good.............

 

[Gone4Good]

All I can offer is: You can get to ER< either way, MORE of it depends on delaying gratification (LBYM) than anything else.

Sure you can get to ER in a lot of ways, but staying there is just, if not more, important.

A portfolio made up of 60% Vanguard Total Stock Market Index Admiral Shares and 40% Total Bond Market Index AS has an expense ratio of about 0.1%.

According to FIRECalc a 4% withdrawal rate at 60/40 split and a 10bp expense ratio has a 96.2% success rate over 30 years.

If you leave everything else the same and increase the expense ratio to your 62bp, the success rate drops to 90.6%. At 1% the success rate falls to 82.1% and at 1.25% plummets to 76.4%. Clearly expenses matter . . . a lot!

Further, the above example does not take into account the higher tax drag of managed funds or the higher transaction costs incurred by the trading within the portfolio. All those commissions paid to churn the portfolio don't show up in the published expenses but are real costs that eat into returns.

On top of all that, you better hope your manager does not underperform the market or your chances of staying ER'd drops further.

youbet, keep in mind I have access to programs and other resources the average investor does not, so perhaps I have that as a small advantage in some ways.......

You'll excuse my skepticism that any "research" can determine which mutual funds will outperform the market on a going forward basis.

What, pray tell, do you do in year 3, or so, when you learn that your star fund manager just quit? Sell the fund and pay the gains taxes so you can buy the next "winner"?

 

[FinanceDude]

Sure you can get to ER in a lot of ways, but staying there is just, if not more, important.

A portfolio made up of 60% Vanguard Total Stock Market Index Admiral Shares and 40% Total Bond Market Index AS has an expense ratio of about 0.1%.

According to FIRECalc a 4% withdrawal rate at 60/40 split and a 10bp expense ratio has a 96.2% success rate over 30 years.

If you leave everything else the same and increase the expense ratio to your 62bp, the success rate drops to 90.6%. At 1% the success rate falls to 82.1% and at 1.25% plummets to 76.4%. Clearly expenses matter . . . a lot!

Further, the above example does not take into account the higher tax drag of managed funds or the higher transaction costs incurred by the trading within the portfolio. All those commissions paid to churn the portfolio don't show up in the published expenses but are real costs that eat into returns.

On top of all that, you better hope your manager does not underperform the market or your chances of staying ER'd drops further.




You'll excuse my skepticism that any "research" can determine which mutual funds will outperform the market on a going forward basis.

What, pray tell, do you do in year 3, or so, when you learn that your star fund manager just quit? Sell the fund and pay the gains taxes so you can buy the next "winner"?

Hey, do what you want..........

How am I going to have a big tax drag? Do you have empirical data of this by someone else other than a Bogle??

The funds I carry have a weighted average turnover of 22% a year, so I don't know where you are getting your ideas. My fund's average manager tenure is 18 years, and so on.

You are not going to get me to carry 100% index funds in a portfolio no matter what. If I have been able to beat a portfolio of index funds by managing my active funds, why do you care??

 

[mathjak107]

there have been years my portfolio hasnt beaten the indexes but if i pull out any 8-10 year time frames i have beaten the market in everyone of them. there isnt one major downturn that i have fallen in 20 years with my active funds that hasnt been way less than the markets.

as i get closer to retirement im not as concerned about growing richer as i am about not getting poorer.

my portfolio is geared to have about the same growth potential as the indexes but with only 75-80% of the risk.

so far so good,

 

[Gone4Good]

Make sure you compare apples to apples. My portfolio of index funds has handily beat the S&P 500 too.

 

[heyyou]

A fraction of all investors are truly going to beat the markets. Some of you are in that group. Good for you. Your methods have worked. Many, many others have tried and failed. That is one of the shortcomings of using averages as a hard data point, average is just the middle speck in a cloud of data points. There are many outliers.
Is the out-performance repeatable in the future? No one knows, but that doesn't matter to those who have the gold now. You don't have to keep performing like a fund manager does. I have no doubt about your success with active funds, I doubt the repeatibilty for most investors in the future.
One side has been successful and thinks it is all due to ability, and is coy about what was done. The other side thinks that market average is a hard ceiling on performance, so you can go that high but no higher, but they are happy to tell how to get to average. Plenty of talk, but little communication between the two.
Another group is the BeardstownLadies/Rich Dad authors who think they are successful investors, but are self-deluding. Few those here.

 

[Gone4Good]

How am I going to have a big tax drag? Do you have empirical data of this by someone else other than a Bogle??

Seek and yee shall find:

We estimate trading costs for a sample of equity mutual funds and find that these costs average 0.78% of fund assets per year . . . Summing brokerage commissions, spread costs, and tax costs, funds’ trading activities cost an average of 1.14% of fund assets annually.

BTW the average commission, spread, and tax cost of 1.14% is in addition to the fund's stated expense ratio.

Moreover, the authors find a very high negative correlation between fund performance and trading costs and go on to say:

the activities generating fund costs have no beneficial effect on fund returns. In fact, a plausible inference from these results is that every dollar spent on trading costs results in a dollar less in returns.

Good luck!

 

[FinanceDude]

I've seen that report before...............

So you are telling me that actively managed Vanguard Funds DON'T face this same problem? Interesting...........

The report SAYS that trading costs are MORE of an issue to a fund than EXPENSE ratio..........

So I guess a low turnover mutual fund should be ok, or is that too logical to surmise?

Again, you seem dumbfounded folks other than you are not 100% in index funds.........I believe there are 12000 funds out there, so there are choices outside of Vanguard...........

 

[FinanceDude]

My holdings change from year to year, but I currently hold the following:

American Funds Small Cap World
American FUnds Income Fund of America
American Funds Capital World Growth and Income
Lord Abbett Small Cap Value
ING Russia Fund
Marsico 21st Century
Neuberger Berman RE Trust

I am able to buy these funds at NAV, because I am an advisor...........

 

[Gone4Good]

I've seen that report before...............

So you are telling me that actively managed Vanguard Funds DON'T face this same problem? Interesting...........

The report SAYS that trading costs are MORE of an issue to a fund than EXPENSE ratio..........

So I guess a low turnover mutual fund should be ok, or is that too logical to surmise?

Again, you seem dumbfounded folks other than you are not 100% in index funds.........I believe there are 12000 funds out there, so there are choices outside of Vanguard...........

You misunderstand me.

1) Vanguard actively managed funds fall into the category of "actively managed funds" and will suffer from the same shortcomings as other actively managed funds. Did I imply otherwise?

2) I could care less if you, or anyone else, invests in actively managed funds. In fact, I encourage you to. It is all of those research dollars being wasted spent in search of excess returns that drives market efficiency - and, incidentally, gives index investors a free ride. So once again, thanks for your contribution.


As far as the study goes, the authors did not look at expense ratios specifically. They do, however, refer to other studies claiming that fund returns are negatively correlated with expense ratios (the higher the expenses the lower the returns). The authors found that trading costs were at least as high as expense ratios and were more negatively correlated with returns then the expense ratio. So yes, while both were deemed detrimental to returns, trading costs were found to be more so. Interestingly, the authors found that expenses and trading costs were not correlated with one another, meaning that they were independent drivers of poor performance . . . i.e. high expenses combined with high trading costs are really, really, really bad for your financial health.

The authors also found that turnover, while contributing to trading costs only accounted for something like 60% (exact % subject to fact check). They found that trading costs were often times driven higher by trading stocks with high bid-offer spreads or brokerage costs. So while high turnover may indicate high trading costs, it isn't the whole story.

You missed the punch line of the study, though. They concluded that trading costs were nearly a dollar for dollar detriment to returns. Not only does all that activity fail to earn a positive return, it fails to offset any of its direct costs. So why do it?

 

[Gone4Good]

My holdings change from year to year, but I currently hold the following:

American Funds Small Cap World
American FUnds Income Fund of America
American Funds Capital World Growth and Income
Lord Abbett Small Cap Value
ING Russia Fund
Marsico 21st Century
Neuberger Berman RE Trust

I am able to buy these funds at NAV, because I am an advisor...........

Yeah, but what about your clients. . . . . . .


5.75% sales charges and 1% expense ratios . . . yikes.

Good luck to you and your clients.

 

[FinanceDude]

Yeah, but what about your clients. . . . . . .


5.75% sales charges and 1% expense ratios . . . yikes.

Good luck to you and your clients.

You're pretty critical for a guy that manages no other portfolios than his own, and has NO idea how life works outside of index funds.

Must be nice to live in a box of your own creation.......... : :

BTW, who said my clients are in these funds, anyway?? Perhaps you should know more about how advisors manage money before you think you know everything...........

 

[FinanceDude]

You misunderstand me.

1) Vanguard actively managed funds fall into the category of "actively managed funds" and will suffer from the same shortcomings as other actively managed funds. Did I imply otherwise?

2) I could care less if you, or anyone else, invests in actively managed funds. In fact, I encourage you to. It is all of those research dollars being wasted spent in search of excess returns that drives market efficiency - and, incidentally, gives index investors a free ride. So once again, thanks for your contribution.


As far as the study goes, the authors did not look at expense ratios specifically. They do, however, refer to other studies claiming that fund returns are negatively correlated with expense ratios (the higher the expenses the lower the returns). The authors found that trading costs were at least as high as expense ratios and were more negatively correlated with returns then the expense ratio. So yes, while both were deemed detrimental to returns, trading costs were found to be more so. Interestingly, the authors found that expenses and trading costs were not correlated with one another, meaning that they were independent drivers of poor performance . . . i.e. high expenses combined with high trading costs are really, really, really bad for your financial health.

The authors also found that turnover, while contributing to trading costs only accounted for something like 60% (exact % subject to fact check). They found that trading costs were often times driven higher by trading stocks with high bid-offer spreads or brokerage costs. So while high turnover may indicate high trading costs, it isn't the whole story.

You missed the punch line of the study, though. They concluded that trading costs were nearly a dollar for dollar detriment to returns. Not only does all that activity fail to earn a positive return, it fails to offset any of its direct costs. So why do it?

It's easy to talk smart since it's 2006, and index funds have been up the past 3 years...........I would love to rewind time and see how happy you were with your beloved index funds from 2000-2003.

In a bull market, everyone makes money........in a bear market

 

[FinanceDude]

You misunderstand me.

1) Vanguard actively managed funds fall into the category of "actively managed funds" and will suffer from the same shortcomings as other actively managed funds. Did I imply otherwise?

2) I could care less if you, or anyone else, invests in actively managed funds. In fact, I encourage you to. It is all of those research dollars being wasted spent in search of excess returns that drives market efficiency - and, incidentally, gives index investors a free ride. So once again, thanks for your contribution.


As far as the study goes, the authors did not look at expense ratios specifically. They do, however, refer to other studies claiming that fund returns are negatively correlated with expense ratios (the higher the expenses the lower the returns). The authors found that trading costs were at least as high as expense ratios and were more negatively correlated with returns then the expense ratio. So yes, while both were deemed detrimental to returns, trading costs were found to be more so. Interestingly, the authors found that expenses and trading costs were not correlated with one another, meaning that they were independent drivers of poor performance . . . i.e. high expenses combined with high trading costs are really, really, really bad for your financial health.

The authors also found that turnover, while contributing to trading costs only accounted for something like 60% (exact % subject to fact check). They found that trading costs were often times driven higher by trading stocks with high bid-offer spreads or brokerage costs. So while high turnover may indicate high trading costs, it isn't the whole story.

You missed the punch line of the study, though. They concluded that trading costs were nearly a dollar for dollar detriment to returns. Not only does all that activity fail to earn a positive return, it fails to offset any of its direct costs. So why do it?

Well, trading costs are probably pretty detrimental to high turnover funds, since my portoflio as a whole is under 30% turnover a year, not such a big deal. And 95% of this money is qualified. Plus, you take the report at face value. Remember all those guys "making it" as day traders? Ever wonder what happened to them? Ever hear the term "whipsawed by institutional traders"??

 

[Gone4Good]

You're pretty critical for a guy that manages no other portfolios than his own, and has NO idea how life works outside of index funds.

Must be nice to live in a box of your own creation.......... : :

You have no idea who you are speaking to.

 

[astromeria]

You have no idea who you are speaking to.

Say, isn't Bill Gates planning to retire in 3 years? :

 

[samclem]

You missed the punch line of the study, though. They concluded that trading costs were nearly a dollar for dollar detriment to returns. Not only does all that activity fail to earn a positive return, it fails to offset any of its direct costs. So why do it?

No, see, that study lumped all the funds together to produce average numbers. But, the managers of SOME active funds are well above average--they are endowed with super stock picking ability. As an investor, you just have to be able to pick the super stock pickers in advance. These guys are super stock pickers! Overcoming a 1% ER disadvantage and a 5% load is no problem for these guys.

It's a huge industry. Like Vegas, but with lower odds, a veneer of respectability, and no free drinks. But the House makes a killing.

 

[FinanceDude]

You have no idea who you are speaking to.

Are you John Bogle??

 

[FinanceDude]

No, see, that study lumped all the funds together to produce average numbers. But, the managers of SOME active funds are well above average--they are endowed with super stock picking ability. As an investor, you just have to be able to pick the super stock pickers in advance. These guys are super stock pickers! Overcoming a 1% ER disadvantage and a 5% load is no problem for these guys.

It's a huge industry. Like Vegas, but with lower odds, a veneer of respectability, and no free drinks. But the House makes a killing.

Something tells me these types of conversations would have been much more interesting before Google and Investopedia.com..............

 

[justin]

Something tells me these types of conversations would have been much more interesting before Google and Investopedia.com..............

Access to information among the common folk doesn't change the fundamentals of the investing business.

 

[samclem]

Access to information among the common folk doesn't change the fundamentals of the investing business.

I wonder. Bogle et al have been beating the drum for a long time, and they are definitely having an impact. Education s working, but it is a slow process. Unfortunately, many of the sheep now being shorn really can't afford to lose the money that will be taken from them in fees, etc. It is a shame, but as we have talked about here frequently, it is very difficult to give people investment advice. Might as well talk about religion.

 

[Nords]

Access to information among the common folk doesn't change the fundamentals of the investing business.

Maybe not, but it sure changes the competition.

When everyone can raise their level of awareness, including competitors as well as customers, then you can't charge a fee for blissful ignorance and it's harder to find people willing to volunteer to pay one.

 

[FinanceDude]

I wonder. Bogle et al have been beating the drum for a long time, and they are definitely having an impact. Education s working, but it is a slow process. Unfortunately, many of the sheep now being shorn really can't afford to lose the money that will be taken from them in fees, etc. It is a shame, but as we have talked about here frequently, it is very difficult to give people investment advice. Might as well talk about religion.

You are right on point with that comment. There's still no curriculum in high school, college, or tech colleges on a consistent basis.

I suppose the big problem is we as advisors are paid fees or commissions to work with clients. For instance, I charge a fixed fee on each account, but I do charge more on smaller accounts. I have found the smaller accounts take up twice as much time or more as my large clients.

I personally would like to see some big reform in financial services anyways. For one thing, most mutual fund companies and brokerage houses are not required to foward cost basis to the new firm if the advisor makes a change. With the techbology we have today, this is not hard at all. So, brokerage firms get a lousy name with investors because they have been fighting reform for years.

FWIW, I have seen more utter scalpings of innocent investors from the "friend of the family" insurance guy or the newbie broker or the Primerica rep than any experienced advisor. And as I have found out on here, most folks here have a bad experience that happened to them or a close friend that doesn't help............

BTW, I personally know 3 fee-only CFP's that have given up their practices because they are having a hard time finding clients. All of these folks have 10-15 years as a CFP under their belts. So the environment is not friendly to them either.