Are you making your bank’s shareholders rich?
Most financial advisors will sell you actively managed mutual funds. But here’s the rub.
Academic studies on mutual funds all point to the same conclusions:
- There’s no evidence that people can consistently choose the top performing funds ahead of time. Nor is there evidence that an advisor can “trade” funds for you to improve what a low cost, buy and hold, diversified approach would provide.
- Actively managed funds are expensive—subsidizing the financial service industry nicely, at the expense of investors.
- Choosing the advice of ratings companies like Morningstar doesn’t help. Their four and five star funds don’t perform any better (going forward) than their 2 and 3 star funds.
But doesn’t all of that professional research help? Sadly, no.
In each of the below scenarios, a huge fund company (RBC financial) put their professional heads to work, buying and selling stocks and bonds for the RBC fund family. Watching the latest news, interest rates, and political sparring, the analysts at RBC did their dipping and diving to make money for their clients.
But you can beat RBC’s collective brains on your own.
How? By diversifying your account among different asset classes, and keeping costs low.
If you’d like a balanced portfolio of stocks (added risk, higher returns) and bonds (lower risks, lower returns) you could follow an allocation like Harry’s. It’s very well suited for someone in their 50s who will soon be drawing on that money for their retirement.
Roughly half of Harry’s portfolio is comprised of Canadian bond indexes, and the rest is divided between Canadian stock indexes, a U.S. stock index and an international stock index.
Harry doesn’t have to be a pro. He just needs a level head and to maintain his target allocation of stocks and bonds over time.
So, how would Harry have fared against the best and brightest at RBC?
He opened his account in August, 2008. And he used low cost index funds—which tend to be the pariahs of the financial service industry (when you buy them, advisors don’t make much money)
Thanks to www.globefund.com, we can see how each of RBC’s equity categories would have performed: the Canadian equity, U.S. equity, International Equity and their balanced fund–and we can plug in the dates from August 2008 to March 16, 2010 to see how they compared to Harry’s account.
Harry’s money hasn’t had to contend with management fees totaling about 2.5% per year. So it was easy for this non finance professional to come out thousands of dollars ahead of the RBC professionals.
His money (as of March 16, 2010) has only increased 3.6%, but RBCs Canadian equity, U.S. equity, International equity and its balanced fund would have fallen well short of Harry’s account.
Over this time period, the top performing fund was the balanced one—which is similar in asset allocation to Harry’s account, having both stocks and bonds.
But it’s safe to say that if Harry had invested in this fund from August 2008 to March 16, 2010, his account would be roughly $25,000 behind where it currently is: …read more
If Harry had the misfortune to deal with an advisor who put him more heavily into equities (fewer bonds, more stocks) Harry would have had a sadder tale to tell.
The dipping and diving of RBC’s U.S. equity fund managers would have created nothing but stress for Harry: … read more
Their Canadian equity fund would have hit Harry in the pocket: …read more
And their international fund—despite the nimble trading of the pros behind it—could have reduced a grown man to tears: …read more
As of March 16, 2010, Harry’s account is up 3.6% (from August, 2008). It’s nothing to write home about, but it beats the high-cost professionals who try racing Harry, while they carry backpacks full of rocks.
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11 comments
Natalie says:
March 18, 2010 at 5:54 pm (UTC 8 )
Go Harry. Don’t let them rob you.
The Rat says:
March 20, 2010 at 2:12 am (UTC 8 )
3.6% still isn’t that bad I suppose. It could easily have been worse given the financial collapse and the roller coaster its been for investors in general. Ensuring that one isn’t paying too much in fees is important; however, maybe Harry could consider restructuring his Asset Allocation and mixing things up a bit with different types of investments and only use the advisor for a % of his portfolio?
Nice post.
Jenn T says:
March 20, 2010 at 7:48 am (UTC 8 )
I’ve been following these Harry posts. Been with my advisor for ten years. Super nice guy, seems to care. But money just goes up and down. Checked my statements from the summer of 08. Not sure how to figure out returns, but my portfolio is lower now than it was then. And I’ve added money to it! Not sure if I have the courage to ditch my guy, but any good book suggestions that I could read on this indexed method?
Billy Bob says:
March 21, 2010 at 11:13 am (UTC 8 )
How are hedge funds doing right now and who is still investing in them?
Andrew Hallam says:
March 21, 2010 at 1:07 pm (UTC 8 )
Great question!
Performance related data on Hedge funds is always patchy because they don’t have the same reporting rules of integrity that regular mutual funds have. That said, according to Yale University’s David Swenson, finding a good Hedge Fund ahead of time has extremely high statistical odds of being a lousy proposition.
As cited in his book, Pioneering Portfolio management, Swenson discussed a Princeton based study suggesting that only 75% of Hedge funds that were around in 1996, where still around 8 years later.
And when looking at Hedge Fund aggregate performances, the data we do have doesn’t include “Backfill” and “Survivorship” bias. For example, Long Term Capital Management (the most famous Hedge fund bust of all) had its performance data calculated into tabulated averages until the very year it was completely crushed and disbanded. But that total loss it experienced, according to Swenson, was not put in the overall performance data for Hedge Funds that year. Funds that disappear after a devastating year don’t report that at year end. They have bigger issues to deal with, and the reporting for Hedge Funds (based on loose regulations) is still a process of “self-reporting”
Little tiny funds that work out also throw their historical return numbers into databases–which is referred to as backfill bias. For example, if it’s not worth reporting your fund because it’s too small ( a handfull of a million dollars, for example) most incubator funds won’t bother. But of those that start out, a few survive. As they grow larger, they then report their historical returns to databases. This is called backfill bias.
After considering backfill and survivorship bias, Hedge Fund returns lose badly to market indexes. But in the world of finance, hope springs eternal.
The Rat says:
March 23, 2010 at 4:04 am (UTC 8 )
After going back over Harry’s investments and comparing them to what could have been if he had gone with actively managed funds with higher management fees, we easily see that Harry would not have been a happy camper!
I think your article highlights what index investing can do for the investor who wants a non-volatile situation without all the risk while enjoy lower fees. And, as you mention, you’re likely to beat a lot of the ‘pro’s’ like RBC financial!
Nice post. I was originally fixated on the performance of Harry’s investment decisions (3.6%). But when you look at the turmoil in the markets that transpired from late 2008/early 2009 and shortly after Harry opened his account, the results aren’t bad at all!
Between the comments you left on my site and this post, I have a better appreciation for index funds and what they can offer to an investor’s portfolio in terms of diversification. Good stuff.
Ian McGugan says:
March 23, 2010 at 6:23 am (UTC 8 )
Good post, Andrew. It always amazes me well an investor can do with just three tactics–keeping costs low, diversifying widely, and rebalancing when you get too far away from your target weights. Unlike most things in life, the less you do, the better you wind up.
Mind you, people don’t get this. And I’m still searching for the right analogy to make the idea clear.
Case in point: I recently got into a debate with a friend whose wife is a stockbroker. I made the mistake of telling him that I thought most of the financial services industry are like rainmakers. They sing and they dance and tell you they’re going to make it rain, but, of course, none of their actions have any effect on the weather. They benefit from the coincidence that sometimes when they dance, it actually does rain and they get rewarded for an event they had no hand in causing. But the rainmakers never mention all the times they sing and dance and nothing happens. It’s far smarter, I wound up, to simply put a bucket out to catch rain when it does come along than to pay a fortune to a rainmaker.
My friend listened to all this in silence. I sat back, confident that my wonderful analogy had enlightened him.
Then he said, “Are you saying my wife is a bad dancer?”
Andrew Hallam says:
March 26, 2010 at 4:36 pm (UTC 8 )
@The Rat
Cheers Rat,
Thanks for the comment and the thorough read of the post. Like you, I think Harry has done very well.
Andrew Hallam says:
March 26, 2010 at 4:43 pm (UTC 8 )
@Ian McGugan
Thanks for the comment Ian, you made me laugh with your rainmaker analogy. John Bogle would like your “catch all the rain with your own bucket” analogy. It’s a bit like the family he described in his “Gotrocks family” story. But your idea goes one step further, driving the point further and making it funnier.
How’s this? It rains from time to time, so you can pay a financial advisor to run around with the bucket, trying to catch the rain. Sometimes, they wait inside, readying themselves for their prediction of rain. Or, more efficiently, someone could stick their bucket outside perpetually–and not pay anyone to run around outside with it. I wonder who would catch more rain. The ridiculousness of it hides the genius of your analogy.
Jimbo "hands off my cash investor boy" says:
March 30, 2010 at 5:02 pm (UTC 8 )
Well done Harry. Its hard to see progress when the horizon is so short. Only a few years (and tough years at that) will skew the general strategy here. Harry has the right perspective and may need a pat on the back and some kind words in order to stay the course. Ian’s advice to keep cost low, diversify, and rebalance when required will serve all of us “Harrys” well. The most important in my mind: keeping cost down while doing what you need to do. I recently sat down with a good freind of mine who related a similar story to Jenn’s above … after 15 years with their investor they were unclear how much money they had ‘made’ … when pressed, they were also unsure of how much money they had invested (but assured me that it was easy to figure out). I asked them if they had a projected withdrawal schedule for the future with detailed numbrs related to back end costs … to make a long story short, I called the company and after considerable wrangling managed to determine what the actual costs were for their programme.
We met again and I “excel-ed” a few scenarios. A bottle of cab-sav and some tears later, their “really nice investment guy” was the brunt of some of the harshest trucker language I have ever heard. I assured them that he was a nice man … who had used their money to make a living for himself with their permission. Lesson learned – 15 years too late.
So back to Harry, his returns look similar to mine over the same period as one would expect with a similar strategy. I would be somewhat concerned that Harry is expecting this to be his entire nest egg at the age of 50. Harry, Walmart greeters can work until age 75 … I’m just say’n.
Jimbo
Andrew Hallam says:
March 30, 2010 at 8:10 pm (UTC 8 )
Jimbo,
Thanks for the comment Jimbo. You’re a great friend to have opened your friends’ eyes to sound investment principles and low costs. But it’s tough. Sometimes, with friends, I don’t know whether it’s worth saying something or keeping quiet. Ignorance can be bliss sometimes, perhaps. Like Ian McGugan alluded to earlier, I too have opened my mouth and debated issues when it might have been easier to stay quiet.
As for Harry, his wife has a pension with Telus, so he’s OK. His plan is to sell off small pieces of his portfolio for “fun stuff”
On a final note, I could probably be a WalMart greeter if they gave me a 1 hour daily shift, and a comfortable chair to sit in.
Thanks again for the comment Jimbo.