Indexing Seminar Funk

Today I hosted an investment discussion at work about index funds. I’ve probably done it a dozen times. In the past, I’ve always felt empowered by showing people how to save money in fees, and how to construct simple portfolios that will beat 90% of the pros.

But despite having a superb, active group of attendees, I felt defeated when I finished.

Around the room, I distributed 25 different investment books. I put tabs on certain pages and before I started the session, I asked attendees to read the highlighted section of each respective book and write down the gist of what it said.

There was nothing earth shattering there; just the usual academically irrefutable logic:

1. Nobody has a proven method of picking winning mutual funds ahead of time

2. Investment advisors don’t generally recommend the products that provide the highest statistical chance of success—index funds.

3. In taxable accounts, actively managed funds add roughly a 1.8% drag, on average, compared to the post tax index fund drag of 0.5%. So an actively managed fund in a taxable account has to beat an index by 1.3% annually, just to keep pace.

4. After taxes, fees and survivorship bias, more than 90% of actively managed funds lose to their indexed counterparts.

5. Of the pension funds that don’t invest in indexes, more than 90% of them lose to an indexed portfolio of 60% stocks and 40% bonds.

6. More than half of all American pension funds index their money—but only 5% of individuals do.

7. A 40 year old (just starting to invest) who lives to 80 is going to have money in the markets for 40 years. With actively managed funds, they have the highest statistical odds of having half the money they deserve when they retire—compared to an indexed alternative. Fees are destructive.

8. There are loads of advisors who charge wrap fees, fleecing people a further 1% to 2% per year, on top of expensive mutual fund fees. Many of my colleagues pay these wrap fees when they invest with Raymond James Financial.

What depressed me, perhaps, was the fact that these eight points represented “news” to a bunch of very astute, educated colleagues.

Or maybe it was the thought that if my seminar friends asked a financial advisor/salesperson about what I showed them, they’d get talked out of an indexed strategy.

Then there’s another thought: maybe I let them down. Maybe I unsettled them. Maybe it’s best not to show people how to invest if they don’t know what they’re missing.

But it could have been something else. One attendee found it tough to believe that so many advisors who watch the markets so closely, would lose to a market tracking index over time.

I explained that if advisors worked for free, if mutual fund managers didn’t get paid, if taxable agencies turned a blind eye to mutual fund turnover, and if trading commissions for stocks (within funds) were non- existent, then slightly more than 50% of actively managed funds would beat a total stock market index over a long period of time. The reason so few would do it—even if they didn’t have associated expenses? Most of the money in the stock market is comprised of pension funds, mutual funds and index funds. They earn the market’s return because they represent the market. So when the market makes 8% annually over a period of time, roughly half of the actively managed funds would have beaten “the market” (ie. a total stock market index) and half of them would have lost to the market. But that’s the fantasy scenario. In the real world, there are fees. And after fees (and taxes in taxable accounts) the odds swing heavily in the favour of indexes.

The man questioning how so many professionals could lose to the market was logically sceptical.

Maybe the answer I gave depressed me.

Maybe the system is broken. Or maybe it’s Darwinian. Those who care to learn, excel, and those who blindly trust get “taken”.

I’m going to bed tonight thinking, “It’s only money. It doesn’t matter. It’s only money”

I’m hoping to feel a lot better in the morning.

Andrew Hallam

I’m a financial columnist for Canada’s national paper, The Globe and Mail, as well as for AssetBuilder, a financial service firm based in Texas. I’m also the author of Millionaire Teacher: The Nine Rules of Wealth You Should Have Learned in School and Millionaire Expat: How To Build Wealth Living Overseas. My mission is to educate, motivate and inspire people on basic retirement planning and best practices for investing, using evidence-based strategies. I'm happy to comment on your questions.

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21 Responses

  1. The incentives of easy money has damaged trust in the financial system, and deservedly so. First, they take your money in fees. Then, they take your money through inflation. Third, they make bad bets and collapse the financial system. Finally, they screw you by collecting bailouts.

    I believe it all stems due to the lack of sound money. Funny money is "easier" than sound money, but it leads to bad results…

  2. And by sound money I mean a set of competing currencies that is not manipulated or "quantitatively eased" by the government.

    Good luck on that, though. 😉

  3. BadCaleb says:

    I recently talked to my nephew about the power of index investing at a young age. He just finished school and started his first career job. I am hoping he will ask me more about it so he doesn't just buy the high fee mutual funds his banker advises. He seemed interested but kids just starting their careers suddenly have more money to spend on their dates and outings with friends don't always want to to read about investing for their future. I am a late bloomer myself so I can't blame him.

  4. @BadCaleb
    Hey Bad Caleb,

    At least you're bringing him to the water. I guess it's his choice or not, whether he drinks it. When you're young, saving/investing isn't much of a sacrifice, relative to what the long term payback is. How old were you when you started investing? Did someone urge you–or was there another catalyst?


  5. @Kevin@InvestItWisely

    Hey Kevin,

    I don't have the answer to this, but I wonder if the general public ever had trust in the financial system–going back decades, or a century.

  6. The majority of mutual funds simply can't overcome the handicap of their management fees, trading fees and capital gains taxes. It's like that Kurt Vonnegut story, Harrison Bergeron, where the Handicapper General has placed weighted chains on the managed mutual funds while the index is free to dance without those burdens.

  7. Kevin@InvestItWisely says:

    @Andrew Hallam

    I think they did; at least, people seemed like they had more trust than they do today. Back in the 50s and 60s people still had a lot of faith in government and in the system, and people talked about a "great society". Perhaps in a sense government did work better back in those days, and outsourcing, moral hazard, etc… weren't the issues that they are today.

  8. @The Biz of Life

    Hey Biz,

    I'm going to have to read that story. It might make a great analogy for my next session. Thanks for the great tip!


  9. @Kevin@InvestItWisely

    Hey Kevin, I think you're right about the government, but I'm not so sure about Wall Street. Perhaps I'm thinking of stocks in general, but I think most people in the 50s felt that stocks weren't much better than going to Vegas. Memories and stories of 1929 kept most people out of the stock market. Nobody had written "stocks for the long run" at that point, and advisors weren't peddling long term growth charts. So I think the majority of people could have been far more fearful of stocks then, than they are now. They were, possibly, corrupt sirens in the eyes of the masses.

    But of course, I don't really know. What do you think?

  10. Kevin@InvestItWisely says:

    @Andrew Hallam

    Actually, I think you're quite right about stocks. I remember reading how many large funds focused significantly more on cash and bonds in those days.

    The 80s and 90s may have been what turned many people on to the equity markets. Funny how it's so easy to see these things in hindsight though. At each point we always extrapolate current trends, but trends can change at any point.

  11. Kevin@InvestItWisely says:


    And of course to add to the previous point, by the mid and late 90s, every man and his dog went into equities. We all know where that went.

  12. @Kevin@InvestItWisely

    Here's a big question Kevin, but do you think our educational system for kids needs an overhaul? When really smart people blindly sign up and lose 1.75% to a wrap fee (not including mutual fund expense fees) do you think some kind of intelligent investment consumer course needs to be taught in schools—perhaps every year?

    Would that change the way investment advisory services do business? What would some key concepts be, that you would teach, if given the opportunity?

  13. I'm actually in awe of people like Robert, at DIY investor who can tirelessly explain all of this stuff to people far better than I can. He has been managing money for more than 30 years, and if you haven't checked out the wisdom on his site, I highly recommend it.

  14. Kevin@InvestItWisely says:

    @Andrew Hallam

    Andrew, I believe that monopolies are bad, and the government sponsored and legislated monopolies tend to be the worst of all. I get that we don't want poor kids to be illiterate, but I think the reality of public education is that when it comes to real world literacy, everyone is illiterate in the sense that they won't gain many skills in dealing with the real world. Public schools are good at teaching you how to behave and maintain order, and they can be good in building teamwork and team spirit through sports and such, but they are not so good at fostering independent learning and thought.

    The upper middle class and rich can send their kids to private school, but private schools can be regulated to a degree where they are basically exclusive and expensive versions of public schools.

    My view is that there is a lot of good material out there, but it is not to be found in an institutional setting. It is instead found in the great universe of information on the Internet, including

    I'm not kidding; this site has helped ME out a lot, and I think that the most significant educational achievement of the last decade has been the stellar growth of information on the Internet.

    Sure, the Internet is not regulated like the public schools are, and there is some bad information out there, (who is to say there is no bad information in the public schools?) but I believe that the variety of viewpoints, the spontaneous nature of the net, and the ability for two way dialogue greatly increase the learning opportunities available to all. The net works based on merit, not authoritarianism.

    To answer your question, yes, the educational system needs a huge overhaul. It needs to be more competitive, for sure, with cirriculum decided solely by the consumer and not by any political considerations, and an elimination of monopolies that prevent schools from hiring outside of the politically-controlled public unions. These are two crucial steps needed to shift the balance of power back toward the consumer.

    As for learning material, People are not taught about opportunity costs, they are not taught proper economics (subjective value, comparative advantage, etc…), and they are taught *nothing* about finance whatsoever, which I really don't understand. Yeah, compound interest might have been covered in Math, but it is covered with zero context. Back when I was in elementary and high school this was a commonly acknowledged point, but has anything changed? It doesn't look like it.

    At the very least, I think that they should start including some basic material written by you and distribute it to every student. I am sure you could find a great way to get the lesson across, Andrew. 🙂

  15. Kevin@InvestItWisely says:

    Yep, Robert has a great site at DIY Investor. I've learned a lot from him as well.

  16. Dave says:

    @ Andrew

    You shouldn't be feeling down. You should be proud that you are lifting the scales from these people's eyes., You have to realise, you've been at this for years and yet, In a short time you have destroyed quite a few perceptions, possibly the most important and fundamental — trust. I believe people inherently trust and want to trust the people they deal with. Think of doctors. People want to trust them when they're ill and many, many doctors are ethical and work with ill people to the best of their knowledge and ability. But also realise some doctors are stuck in mainstream allopathic medicine and won't consider there are any other alternatives such as eastern or ayurvedic – for some doctors chiropractic or acupuncture and even podiatry is quackery. On the other hand there is greed. Using the example of medicine again, we see the greed of some doctors who overprescribe drugs, but we also see examples of drug companies that do cost benefit analysis and decide it's more profitable to keep a dangerous drug in the market and pay people out for death and damages. What you revealed yesterday to people is the fact that many of their financial advisors, people that they trust and who have the long term health of their wealth in the hands are totally unnecessary, and in fact are not fully informing them of their options and in reality are actually ripping people off when many do put their own money in index funds. And that may be the key – as in medicine these days require doctors to fully inform people about the procedure they are going to receive, personal Finance demands regulation where the Adviser MUST give people all the information including the fees they will receive and the performance of their funds.

  17. @Kevin@InvestItWisely

    Thanks for the encouragement Kevin,

    I really did need it. It's strange when you know that the earth is round, but loads of people are paid to convince people that it's flat. And most of those people paid to convince others that it's flat haven't learned anything about the solar system—just a ticket to sell the "sail too far and you go off the edge unless you pay me" service.

  18. @Dave

    I think you're right Dave. But we also need to teach people a couple of things:

    1. Most of the fees are hidden in extra operating costs beyond the expense ratios

    2. The cost of losing out on 2% to 3% annually means a nest egg reduction of 50% or more.

    Costs talked about as 2% or 3% seem like small numbers. If an advisor said his services would cost 1% on top of 1.5% mutual fund fees, that looks like peanuts. But it isn't. I noticed what happened last night, during the session, when we played with an online compound interest calculator. people gasped when I calculated the difference between 7% and 9% over 40 years. A 2% fee wipes out half the money over the long term.

    Kevin suggested that he was taught compounding interest in school, but not in any kind of context. Last night we contextualized it with real dollars and cents. People were genuinely surprised at what a 2% cost meant over 40 years. It surprised me that they were surprised by that. And I want to go back to Kevin's point again, about the failure of our education system. We teach far too much that doesn't matter, and we ignore the real-life lessons that can prevent us from getting exploited. The word "exploited" in this case, comes from David Swensen, Yale University's endowment fund manager. He uses it wehn referring to the retail investors choices in the actively managed mutual fund zoo. And when everyone who has ever won a nobel prize in Economics is saying the same thing (Miller, Sharpe etc) and when Buffett is saying the same thing, and when Charles Schwab (the owner of the world's biggest mutual fund supermarket) is saying the same thing, you'd think some of it would filter down to schools. But it doesn't. It's very frustrating for me. My friends are really good people. And they're smart. But their own educational systems let them down, and it breaks my heart to think of the monetary price most of them are paying for that.

  19. Dave says:

    @ Andrew

    Spot on Andrew — Fully Informed Consent would mean every percentage point they are 'earning'.

    & to be honest, I was one who was staggered when I realised that each 2% reduction (starting with 100K @ 9% & over 40 years) equates to reduction of 50%.

    Kevin is right, compounding needs to be taught in context, as Einstein said.. “The most powerful force in the universe is compound interest”. Maybe we can get the math teachers to have their lessons based around real life scenarios.

    And it is about exploiting people in their ignorance. And while I think there needs to be regulation, I also believe that education is fundamental. Again, using medicine as an example, doctors are taught to be doctors, but not taught how to run a business. (And that applies to nearly all health professionals.)

    Ultimately, the education system has a duty to include classes on educating people on Personal Finance, because ultimately, at the end of the day, if people aren't in a position to support themselves, it falls back onto the taxation/welfare system.

  20. @Dave

    I also think the education system falls short when teaching nutrition. The surgeon who cut the bone cancer out of my spine and back has no concept of nutrition. I know. I tested him! The guy cut out the cancer and told me to eat a balanced diet. What the bleep is that about??????

    When I started talking about proven foods that combat cancer, he had no idea.

    So if he doesn't know about basic nutrition, how is a typical kid in highschool to know? I'm not talking about the basic food groups here. I'm talking far beyond that. Again, we do learn a lot of useless things. Where are the classes relating to human psychology? I'm not referring to the silly stuff I took at college. I'm thinking of the real nuts and bolts of practical psychology: how do we get along with people, why should we never argue or disagree with someone in public, why should we always allow people to save face, how should we deal with confrontations in a relationship? These things are far more important than money. But again, they get ignored.

    Why? I really don't know why.

  21. Kevin@InvestItWisely says:

    @Andrew Hallam

    It's turtles all the way down… didn't you know? 😉

    Andrew, I see you as a captain facing the mother of all storms. It's not easy to sail into a massive wave of ignorance, but it isn't your fault. Don't ever stop fighting the good fight.

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