Andrew Hallam

… but what exactly are they and how do they differ from what most investors are sold?
 
“The best way to own common stocks is through an index fund”
–Warren Buffett, Berkshire Hathaway shareholder letter, 1996
 
“The most efficient way to diversify a stock portfolio is with a low fee index fund”
–Paul Samuelson, the first American to win a Nobel Prize in Economics 
 
Stock market index funds are similar to actively managed stock market mutual funds because they both hold baskets of stocks.  But an index is different to an actively managed mutual fund because an index is meant to hold a group of (or nearly all) stocks in a given market, while an actively managed mutual fund is meant to trade a group of stocks.  As such, there’s a cost difference that can’t often be overcome.  The fees for the average U.S. mutual fund are 600% higher than the fees for a low cost index fund, when accounting for the expense ratio, 12B1 advertising fees, transaction costs, opportunity costs and sales costs.  It’s a financial albatross that’s virtually impossible to overcome—no matter how great your advisor claims to be.
 
Here are the main differences between index funds and actively managed mutual funds.  For simplicity, I’ll be using Vanguard’s total stock market index, which provides all the exposure to the U.S. market you’ll ever need.  In essence, owning it is like owning slivers of shares in every public company in the U.S.

Actively Managed Mutual Funds	Total Stock Market Index Fund
1.  A fund manager buys and sells (trades)  dozens  or hundreds of stocks.  The average fund has very few of the same stocks at the end of the year that it holds at the beginning of the year.	1. A fund manager buys a large group of stocks—more than a thousand.  More than 96% of the stocks are the same from one year to the next.  No “trading” occurs.  A new business that enters the stock exchange will, however, be added to the index and any businesses that go bankrupt will no longer be part of the index.
2. The fund manager and his/her team do loads of research.  Their high salaries compensate them for this, adding to the cost of the fund.  This added cost is paid by investors.	2. No research is done on individual stocks.  A total market index fund can literally be run by a computer.  Its goal is to virtually own everything on the stock market so there are no “trading” decisions to make.  This means that there are no research costs, and no high salaried fund managers to pay.
3. Stock trading (the buying and selling of stocks) within the fund generates commission expenses, which are taken out of the value of the mutual fund.  The investors pay for these.	3.  Because there’s no “trading” involved, commissions for buying and/or selling are extremely low.  The savings are passed down to investors.
4.  Trading triggers tax consequences that are passed down to the investor when the fund is held in a taxable account.  The IRS sends you this bill.	4. The lack of trading means that, even in a taxable account, capital gains can grow with minimal annual taxation.  You keep the IRS at bay.
5. They focus on certain stock sizes and sectors.  For example, a small cap fund would own small companies only; a large cap fund would own large companies only; a value fund would own cheap companies only; a growth fund would own growth companies only; a medical sector fund would own medical companies only etc.	5. A total stock market index would own every category listed on the left—all wrapped up into one fund, because it owns “the entire stock market.”
6. Actively managed mutual funds (other than TIAA CREF) have owners who profit from the fund’s fees.  The more fees that are raked from investors, the higher the profits for the fund company’s owners.  You didn’t think banks and fund companies were charitable organizations did you?	6. A fund company like Vanguard is a “non profit” company.  Nobody owns the company.  Any “profits” made from the miniscule fee expenses go into operating the fund, and paying employee salaries.  But there are no “owners”.  If any “profits” are made by the fee costs exceeding salaries, the proceeds go towards lowering the fees.
7. Because mutual fund companies have “owners” who seek profits for their fund company, there are aggressive sales campaigns and incentives paid to salespeople (advisors) to recommend their funds for clients.  The proceeds come from the fund’s assets, so investors pay for those.	7.  A company like Vanguard doesn’t have owners seeking profits, so advertising is minimal.
8.       Actively managed fund companies pay  annual “trailer fees” to advisors, rewarding  them for buying their funds.  This money comes from the fund’s assets.  In other words, investors pay for them.	8.  A company like Vanguard doesn’t pay commissions or trailer fees to advisors.
9.  Most American fund companies charge sales or redemption fees—which go directly to the broker/advisor who sold you the fund.  The investor pays for these.	9. Vanguard doesn’t charge sales fees or redemption fees.
10.  Actively managed mutual fund companies are extremely well liked by advisors and brokers	10. Vanguard puts money in your pockets—not in your advisor’s.  And you still wonder why most investors don’t use index funds?

)f you owned a mutual fund company, and you realized that investors were catching on to the advantages of index funds, what would you do?
 
First, you’d train your sales staff to come up with the greatest stories they could to debunk what the greatest minds in finance have concluded about index funds.  Your staff would have to come across as convincing—and come across as smarter than Economic Nobel Prize winners, and smarter than Warren Buffett, the world’s greatest investor.
 
But, as an owner of an actively managed mutual fund company, if your sales team fails you, you’ll need a back-up plan:  you’ll need to offer your own “in house” index funds.  But as an investor, you’ll want to be careful.  Find out what the index funds cost, and don’t ever buy an index fund with a sales load.  You should never pay an expense ratio of more than 0.3% for a U.S. stock index, or 0.4% for an International stock index either.
 
Vanguard’s total stock market index costs just 0.15% and their International stock index costs just 0.27%. Over time, they have been lowering their fees, while most fund companies have been raising theirs.  Again, there is no fee to get in or out of either of these products—and your investment advisor isn’t likely to recommend them: 
  
“When brokers realize that they won’t be compensated for putting our funds in a plan, they typically hang up on us.”
Vanguard, director of institutional sales.

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:

1.  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.
2. Actively managed funds are expensive—subsidizing the financial service industry nicely, at the expense of investors.
3. 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.

Taking advantage of low cost exchange traded index funds and developing a responsible portfolio allocation, our friend Harry sets a nice precedent for others to follow.

 In August, 2008, he started his account.  The Canadian stock market is roughly 10% lower today (March 14, 2010) than it was in August, 2008.  Likewise, the U.S. and international markets are still down more than 20% since August 2008, when measured in Canadian dollars.

With the rising Canadian dollar, investments in the U.S. market and the International markets were albatrosses to many Canadian investment accounts between August 2008 and mid March, 2010. 

But Harry, as a smart investor, didn’t try to second-guess where currencies were going to go. He knows that very few people are ever successful trying to do that.

Instead, he maintained a diversified account with both the EAFE international index (ticker XIN-to) and the American S&P 500 index (XIC-to).
 
Yet, despite the drumming that the U.S. and International markets have taken (in Canadian dollars) Harry’s account is up $7,914.60 Canadian since August, 2008.

As mentioned in previous posts, Harry rebalanced his account back to his desired allocation when the markets kept falling in January, 2009.  This allowed him to sell some of his bonds to buy cheaper equities.

 From Harry’s Qtrade account (www.qtrade.ca) you can see his recent performance below.

PORTFOLIO PERFORMANCE VIEW

Monthly Market Value   Net Invested   ROR   March 2009 $234,942.90 $278,651.99 3.27% April 2009 $238,269.25 $268,651.99 5.67% May 2009 $246,995.75 $268,651.99 3.66% June 2009 $249,865.32 $268,651.99 1.16% July 2009 $258,109.76 $268,651.99 3.30% August 2009 $262,043.11 $268,651.99 1.52% September 2009 $266,777.46 $268,651.99 1.81% October 2009 $263,621.34 $268,651.99 -1.18% November 2009 $270,497.49 $268,651.99 2.61% December 2009 $271,793.49 $268,651.99 0.48% January 2010 $269,304.39 $268,651.99 -0.92% February 2010 $272,982.39 $268,651.99 1.37%

Quarterly Market Value   Net Invested   ROR   1st Quarter ’09 $234,942.90 $278,651.99 -4.17% 2nd Quarter ’09 $249,865.32 $268,651.99 10.82% 3rd Quarter ’09 $266,777.46 $268,651.99 6.77% 4th Quarter ’09 $271,793.49 $268,651.99 1.88%

Yearly  Market Value   Net Invested   ROR   2008 $255,528.62 $288,651.99 -11.5% 2009 $271,793.49 $268,651.99 15.52% 2010 (YTD) $272,982.39 $268,651.99 0.44%

Considering that the world’s stock markets are still much lower than they were in August, 2008, Harry has done very well to record nearly an $8000 profit.

 But was he just lucky? I don’t think so.  He followed the tenets of sound investing:

1. He kept his costs low with exchange traded indexes instead of actively managed mutual funds.
2. He kept a balanced allocation of bonds and stocks, allowing his account to hold steadier during the 2008/2009 market collapse.
3. He was then able to rebalance as the stock markets fell, selling some of his bonds to buy cheap equities.

 When selling some of his bonds to buy stocks, Harry wasn’t able to “time the bottom”.  He didn’t even try.  But he knew that he needed to rebalance, so that’s what he did.

 To see Harry’s account holdings, look below:

Description	Symbol	Quantity	Currency	Current Price	Market Value	%
Cash			CAD		$209.89	0.1%
ISHARES CDN D/J SLCT DIV IDX	XDV	1,660	CAD	$19.60	$32,536.00	11.8%
ISHARES CDN MSCI EAFE IDX FD	XIN	1,735	CAD	$18.32	$31,785.20	11.5%
ISHARES CDN S&P 500 HEG CAD FD	XSP	2,500	CAD	$13.31	$33,275.00	12.0%
ISHARES CDN S&P/TSX CP CMP IDX	XIC	1,130	CAD	$18.94	$21,402.20	7.7%
ISHARES CDN UNIV BD IDX FD	XBB	1,520	CAD	$29.59	$44,976.80	16.3%
ISHARES SHORT BD IDX FD	XSB	3,850	CAD	$29.19	$112,381.50	40.6%
Totals					$276,566.59	100%

 

…continue to track the progress of Harry’s Account from the right menu

 

Roughly 95% of investors are either financially uneducated, or they believe they can find needles in haystacks. 

The financially uneducated ones give their money to financial advisors who typically invest their hard-earned money in actively managed mutual funds.  The investors may be rocket scientists, doctors, lawyers or ingenious academics, but most of those handing their hard-earned money over to a financial advisor tend to be financially naive.

The odds of paying somebody to choose funds that will beat a broad market index over time are miniscule, especially when accounting for the poorer tax efficiency that actively managed funds have over indexes.  Oh, and despite what their advisors tell them, they are paying those advisors—via load fees in, load fees out, trailer fees, soft dollar fees, or all of the above. 

But is it possible to find actively managed funds on your own that will beat the stock market indexes over the long term?  Maybe!

The average investor (buying actively managed funds) will trail a stock market index fund over the long term by roughly 2% to 3% a year, eventually earning a fraction of what they deserve.

Warren Buffett suggests that most individual investors (as well as most institutional investors) should stick to broad stock market index funds to maximize their success.

So is Buffett suggesting that investors can’t beat the stock market?  You might presume so.  But that’s not the case.  In his famous 1984 essay, “The Superinvestors of Graham and Doddsville”  he demonstrates that the market isn’t efficient, short term.  And well-trained, disciplined investors (with the right temperament) can beat the market.  Temperament, he suggests, is the key.  You can be the smartest person in the world, but if you aren’t “wired” to invest money, then no amount of academic learning is really going to help.  If you can control fear and greed, and you understand the fundamentals, then it’s possible:  you might be able to out-invest the market indexes.

It’s understandable then, that if you can’t beat the market yourself, you might want to find someone else who can invest on your behalf.  This is where market-beating mutual funds come in.  Buffett recommends indexes because of the high fees that most fund companies charge—not to mention their poor, after tax performance.  But does that mean that index-beating actively managed funds are impossible to find?  After all, there have to be mutual fund managers from the same genetic/academic vein as the “Superinvestors of Graham and Doddsville”, right?

If you twisted my arm and made me buy a slew of actively managed mutual funds, I know what I’d buy.  And for the most part, they’re fund companies that you haven’t heard of.  The top fund companies aren’t household names.  You generally don’t see them advertising themselves the way a well-known company like Fidelity advertises.  And they tend to pay financial advisors very little, if anything at all, so you won’t find them in most financial advisor-led accounts.

 Can you see the conflict of interest here?  Most advisors want to fill your investment account with funds that compensate themselves first, you second.

Great fund companies don’t tend to pay advisors generously (if at all), and they have some other things in common:

1.  They often shut their funds to new investors when they become too big.  Large fund assets make it hard to beat the market, so great fund companies shut their doors to new investors when their large funds balloon.  Companies like Fidelity and American Funds don’t bother doing this.  Assets under management mean money for the mother-ship, after all.  So if a particular fund attracts plenty of investors, it becomes a cash cow for the company, so why close their doors?

2.  They tend to charge low fees, and they have low taxable turnover.  In many cases, you must buy great mutual funds directly from the fund company, not through an advisor.  They keep fees low by keeping out the middleman, and they don’t “trade” a lot.  High trading volume means lower taxable efficiency.  For an actively managed fund to perform as well as an index fund after taxes, most have to beat the index by about 1% a year, just to break even.  And that’s really tough to do.

3.  They also tend to mandate that their managers invest large portions of their own net worth in their funds.  This also ensures that the managers are eating their own cooking.  They’ll want their money to do well, and they’ll want to do well after taxes.

4.  They are honest with their reporting.  On their websites, it’s always very easy to see what their fees are and what their returns have been relative to the stock market index.  They don’t just give you pieces of the truth; they give you the whole truth.  For every time period comparison (ie. How have they done over 1 year, 3 years, 5 years, 10 years, 15 years etc) they compare their funds’ results directly with the S&P 500 index—if it’s a large cap U.S. fund.  If it’s a small cap fund, they compare their performance to a small cap index.  It’s very admirable reporting.  Here’s an example: 

5.  Their funds have been around a long time.

So….which do I think the top mutual fund companies in the U.S. are?

In no particular order, here are a handful of companies deserving applause.  And they have all beaten the stock market indexes over the long term.  Funny though.  You may not have heard of them:

1.  Tweedy Browne

2.  Longleaf Partners

3.  Dodge and Cox

4.  Sequoia funds

5.  Royce Funds

There might be brilliant fund managers out there who can beat the market.  And this list of five fund companies may have a few of them in their midst. 

And if you’re going to venture off onto the road rarely taken (with these fund companies that are rarely, if ever, pushed by advisors) invest in them for the long run.  Most investors (and most advisors) jump around.  When their fund hasn’t done well lately, they switch to a fund that has.  I’m sorry if you think your advisor can do this and stay ahead of the curve—he or she can’t.

Stick with a great fund for the long haul and you’ll do far better.  And if anything, do the opposite of what most financial advisors would do:  buy mutual fund shares (in the above companies) after they have had a terrible year, relative to their peers.  Because they’ll likely come roaring back if they follow disciplined investment approaches.  And I believe that the above funds do.

If you want to know if your investment advisor is truly a fool, listen for these words:

“We’re going to get you out of this fund because it hasn’t done well lately.  And we’ll get you into this other one because it has.”

It doesn’t matter what those funds are.  A poor recent performance alone is a terrible reason to leave a mutual fund.  If your advisor lacks the sophistication to say something so silly—run from that advisor, and don’t look back.

Then buy and hold broad market indexes–or funds like the companies listed above.  Studies have shown that investors who trade more often (whether they’re mutual funds or individual stocks) perform far worse than investors who buy and hold.

Human instincts tempt most people to sell low and then buy high.  Buying yesterday’s recent winners is always a bad idea because they often turn into tomorrow’s losers.  And jumping around, instead of buying and holding, can have significant tax consequences as well.

But another word of caution:

Do you remember what I said about how an actively managed mutual fund (in a taxable account) will have to beat its counterpart index by roughly 1% a year, just to break even with the performance of the index?

One of the above companies, Tweedy Browne, actually shows its pre-tax and post-tax performance comparison with the S&P 500 index.

Since 1993, its value fund has amazingly beaten the S&P 500 before taxes.  As you can see below, it has produced an annual return of 8.53% before taxes, versus 7.59% for the S&P 500 index.  But that’s before taxes.  Tweedy Browne is fabulous enough (I love honest companies) to show its annual return after taxes and distributions.  Compared to the index (which is more tax efficient than an actively managed fund) the comparison doesn’t look as stellar for this fund now, as you can see below.

Annual Total Returns For Periods Ending 12/31/09 (%)
	Tweedy, Browne Value Fund
Average Annual Total Returns	Return Before Taxes	Return After Taxes on Distributions	Return After Taxes on Distributions & Sale of Fund Shares	S&P 5002		Morningstar Average Domestic Stock4
1 Year	27.60	27.39	18.23	26.47		30.90
3 Years	-0.98	-2.20	-0.94	-5.61	-	-4.20
5 Years	2.08	0.82	1.71	0.42	-	1.27
10 Years	3.82	2.83	3.12	-0.95	-	1.88
15 Years	9.24	8.26	8.03	8.03	-	7.77
Since Inception (12/08/93)1	8.53	7.60	7.39	7.59	-	6.92

 But Tweedy Browne is still a fabulous actively managed fund company.  And if you twisted my arm and made me buy some actively managed funds, this would definitely be one of them.

That said, tread lightly into this good night.  Finding outperforming actively managed funds ahead of time can be a tough thing to do—as the past isn’t always a prologue to the future.  You’ll be relying on long odds, and if you want to beat a comparable index after taxes, your funds will have to beat the market by more than 1% a year.

Impossible?  Nope.  You might be able to do it.  It’s just not a wager I’d be willing to bet.

In August of 2008, our friend Harry kissed good-bye to the expensive financial products that his advisor sold him.

With annual expense ratio fees of 2.6% for his Canadian mutual funds, adding with an estimated hidden fund cost of a further 0.75% per year for the fund’s expenses related to buying and selling stocks within the fund, Harry’s investments were costing him more than 3.5% annually.

For Canadian mutual funds, these costs would be about average. But Harry didn’t want to be average. He wanted to follow a simple principle designated statistically superior by virtually every academic study that has ever been done on mutual funds. Harry wanted to buy products called Index Funds. They are cheap, diversified, and nobody but Harry stands to benefit from them when Harry makes his purchase.

But, did not having an “investment professional” at the helm hurt Harry’s account during the market downturn? After all, the market drop of 2008/2009 was the biggest market decline since 1973/1974. It was much bigger than the overall drop in 1987.

Should Harry have had his money managed by a professional? Would they have been able to save his account? The answer to those questions, are “Nope” and “Nope”.

Harry has done very well on his own. You see, Harry was pretty smart. He knew that, because he was retired, he’d want a portfolio that had only half of it exposed to the stock market. The other half, he wanted exposed to the bond market—but safe, government bond indexes only.

And when the stock market started to get cheap, Harry sold some of his bonds to rebalance his account. With the proceeds, he bought some cheaper stock indexes.

Harry took some money out when the markets were low also, when he needed some cash for an airplane he was working on. But Harry was smart. The stock markets were cheap then, so Harry took that money from his bond indexes—which hadn’t dropped in value.

Harry hasn’t made a fortune since August, 2008, but he has made a profit of $3,578.06, which you can see below.

But are there Canadian balanced mutual funds that would have performed as well, if not better? If the answer is, “yes”, I haven’t been able to find them. Over that time period, they would have needed to make about 4%-5% more than Harry, before fees, just to keep pace with Harry’s account. A quick look at www.globefund.com reveals that if they do exist, they’re scarce. I sure wasn’t able to find them.

Simply, if Harry had bought some professionally managed balanced funds, he wouldn’t have done as well. I’ve picked on the big Canadian bank mutual funds with my other postings, so I’ll broaden my horizons here to compare Harry’s account with some of the alternative fund companies.

Acuity Canadian Balanced

as of Dec 3, 2009

He would have been about $20,000 worse off with the acuity balanced fund:

 

 

AIM Canadian Balanced

as of Dec 3, 2009

He would have been about $21,000 behind if he bought the AIM Balanced Fund:

 

BonaVista Canadian Equity

as of Dec 3, 2009

 He would have been about $25,000 behind with the Bona Vista Canadian balanced fund:

 

 

 

Davis-Rea Balanced Pooled

as of Dec 3, 2009

He would have been about $27,000 behind with the Davis-Rea Balanced Fund:

 

 

Invesco Trimark Core Cdn Bal Cl

as of Dec 3, 2009

 He would have been about $25,000 behind with the Invesco Trimark Balanced Fund:

 

TD FundSmart Mgd Balanced Grt-P

as of Dec 3, 2009

And he would have been roughly $16,000 behind if he bought the TD Fundsmart Managed Balanced Fund:

 

 

Brigata Canadian Balanced-A

as of Dec 3, 2009

He’d be about $16,000 behind with  Brigata Canadian Balanced-A too:

 

 

Clarica SF Portfolio Series Bal

as of Dec 3, 2009

 And he’d be about $30,000 behind with the Clarica Balanced Series:

 

 

In case you’re wondering why I picked balanced funds to compare with Harry’s account—there are a couple of reasons:

• Reason 1

A balanced fund is the single fund that most closely resembles Harry’s portfolio. And other than straight bond funds (that avoided the stock market completely) they had the best performance since August, 2008.

• Reason 2

If I compared with a 100% stock fund, regardless of which one I chose, the comparative results would have been disastrous. Harry would have looked like a genius.

And Harry is no genius. What he did with his own account, you could have done with yours. And you could do it now, if you want to.

Avoid high cost mutual funds if you can. Buy low cost index funds instead.

And do me a favour. If you can, find me a Canadian balanced mutual fund that has outperformed Harry’s indexed account from August 15, 2008, until December 4, 2009. After all fees, Harry made 1.3% during this time frame.

But if you can find me some better balanced funds, I’ll then show Harry.

 After all, Harry might be getting a very big head over all this.

…continue to track the progress of Harry’s Account  from the right menu

I’ve devoted all sorts of time on this site to explaining why buying actively managed mutual funds is a fool’s errand.

After all expenses (most of which are hidden) and after taxes and survivorship bias, the odds of matching the returns of a low cost index fund are far lower than the odds of walking into Las Vegas with $10,000, gambling for a full week, and coming home with more than $10,000.  If you think those odds are even decent, think about why casinos are in business.  Trust me, you’d make more money owning the casino than by gambling in it.

So where do I put my personal money? 

Despite also writing about my investment club, and how we have beaten the market index (S&P 500) for a decade, I still have roughly 70% of my own personal money in indexes.

I own short term Canadian and International government bond indexes (symbols  XSB.TO and IGOV). 

And I own a Vanguard first world international index (symbol VEA).  For reasons describing why I don’t own emerging market stocks or indexes, please check out my post, “Why I don’t invest in India or China”.

With my individual stock picks (which constitute roughly 30% of my invested assets) I own a variety of U.S. stocks.  For ten years, I have beaten the S&P 500 quite handily.

 So why, then, do I not have all of my stock market money in individual stocks instead of indexes? 

The answer is simple:  the odds of me beating the market indexes going forward are slim.  I don’t believe, 100%, that I can beat the markets going forward.  And this is why 70% of my money is indexed.

It’s not that the market road ahead is going to make it harder in the future to replicate my past performance.  I’ve been very lucky in the past, and I’ve avoided doing silly things.  I’ve kept my investment costs extraordinarily low—because I don’t trade stocks, I buy them and hold them.  I also don’t have to pay mutual fund fees, which has helped me as well.

And as much as I’d like to think that I’m a market wizard, the reality of history brings me back to earth.  There have been fund managers who have built God-like reputations for themselves (like Bill Miller, who beat the market for 15 straight years) but ultimately, the market’s odds slap these guys back to reality.

I’m not smarter than Bill Miller.  And I can tell you that despite his extraordinary 15 year streak, an investment in a simple S&P 500 index would have beaten him after all taxes and expenses.   It’s very humbling.

I’ve never bought a lottery ticket in my life, and I haven’t wasted so much as a dime at a casino, yet I have immensely enjoyed giving the indexes a beating over the past decade.  That said, I keep track of every dollar I have invested.  And if the market indexes catch me, I’m going to sell the stocks that I own, and run with an investment portfolio that is 100% indexes.

I may not be a genius, but I’m smart enough to understand odds.

I have an apology to make to my friend Harry … 

I have been tracking his balanced investment account—made up entirely of stock and bond index funds– and I have showcased his results on this website. 

But Harry isn’t happy…

During my last post, I indicated that Harry ‘s account had dropped 0.7% between September 30, 2008 and September 30^th, 2009.  Then I compared that 0.7% drop to the results of various balanced mutual funds from Canada’s biggest financial institutions, during that one year time period. 

And Harry beat all of the Canadian balanced funds that I could find.

But I didn’t do Harry’s account justice.

His account didn’t actually drop 0.7% from September 30, 2008 to September 30, 2009, as I had indicated.  It had dropped 0.7% from August 15^th, 2008 to September 30, 2009.  And there’s a huge difference—because the markets fell considerably from August 15^th, 2008 to September 30, 2008.  So I didn’t track his starting point fairly.  I didn’t track his account from the same day that I tracked the balanced mutual fund accounts’ performances.

So the reality is that Harry gave the mutual funds a bigger drumming than I thought.  Sorry Harry. 

Below, you can see his performances, compared to various indexes (reporting in both Canadian and U.S. dollars)

		Year-to-date	Last 12 Months	Since Inception(Jul/2008)
Harry’s Portfolio		13.39%	13.26%	0%
Dow Jones Index – CAD		-3.14%	-10.02%	-6.01%
Dow Jones Index – USD		10.66%	-10.49%	-11.72%
Russell 2000 – USD		20.99%	-11.08%	-10.03%
Russell 2000 = CAD		5.90%	-10.61%	-4.21%
S&P 500 – CAD		2.43%	-8.76%	-8.64%
S&P 500 – USD		17.03%	-9.24%	-14.19%
TSX – CAD		26.78%	-3.05%	-17.38%
TSX – USD		44.85%	-3.55%	-22.40%
TSX 60 – CAD		25.64%	-3.76%	-17.30%
TSX 60 – USD		43.54%	-4.27%	-22.33%
USD – CAD		-12.47%	0.52%	4.46%

Harry’s returns are pretty impressive.  According to Harry’s Q-Trade account tracker (a very nifty feature available for anyone using this Canadian brokerage, www.qtrade.ca)  Harry’s account has made the following gains:

Over the past 12 months:  +13.26% (in Canadian dollars)

Since January 1, 2009:  +13.39% (in Canadian dollars)

***Figures as of October 15, 2009

In U.S. dollar terms, that would be more than +17% over the past 12 months and nearly +18% since January 1^st, 2009—thanks to the 4.46% gain that, according to Q-Trade, the Canadian dollar has gained on the U.S. dollar during that time.

Harry’s recent move: 

And last night, Harry’s account was adjusted slightly.  Roughly $18,000 worth of his International Index fund (XIN.TO) was sold and traded for more of the short term Canadian government bond index (XSB.TO).  Harry’s account needed to be rebalanced, since the recent rise in stocks over-weighted his account in stocks.  You might recall that Harry did the opposite when stocks had fallen.  Earlier this year, he sold some bonds (which hadn’t dropped) to buy some cheap stock indexes (which had dropped).

Harry doesn’t attest to being a genius—he’s just a guy following responsible portfolio allocation who keeps his fees low, while remaining fearful while others are greedy, and greedy when others are fearful (to borrow Warren Buffett’s term).

Harry’s Challenge:

If your personal retirement portfolio has gained more than 17% in U.S. dollar terms (or more than 13% in Canadian dollar terms) over the past 12 months, then Harry and I want to hear about it.  We know that it’s possible.

Please post your response.

Harry’s portfolio was as follows, before his most recent trade:

Description	Symbol	Quantity	Currency	Current Price	Market Value	% Holdings
Cash			CAD		$99.23	0.0%
ISHARES CDN D/J SLCT DIV IDX	XDV	1,660	CAD	$18.45	$30,627.00	11.4%
ISHARES CDN DEX	XSB	3,250	CAD	$29.02	$94,315.00	35.2%
ISHARES CDN MSCI EAFE IDX FD	XIN	2,555	CAD	$18.15	$46,373.25	17.3%
ISHARES CDN S&P 500 HEG CAD FD	XSP	2,500	CAD	$12.66	$31,650.00	11.8%
ISHARES CDN S&P/TSX CP CMP IDX	XIC	1,130	CAD	$18.14	$20,498.20	7.6%
ISHARES CDN UNIV BD IDX FD	XBB	1,520	CAD	$29.23	$44,429.60	16.6%
Totals					$267,992.28	100%