Model Indexed Account – How Are We Doing?

If you’ve been following your investments over the past five years, you might feel like a white collar boxer who suddenly found himself in the ring with a bruising welterweight champ.

But there’s a reason to be optimistic.  The welterweight’s best round was 08 and 09 and you’re still standing.

Of course, I’m referring to the beating that the stock market took in 2008/2009 and if you kept your head, and didn’t sell during the panic, you’d still be firmly on your feet today.

In September, 2006 I gave a seminar on indexed investing at Singapore American School.  I suggested that even a fifth grader could beat the vast majority of investment professionals by doing the following:

  1. Creating a low cost, diversified portfolio of index funds
  2. Rebalancing the account once a year

Perhaps more importantly, I suggested that they would never have to follow economic news.

All they would need to do is spend 10 minutes a year rebalancing their portfolio.

Back in 2006, I created a model portfolio for my attendees.  It was comprised of a total U.S. stock market index, a total international stock market index and a total bond market index.

Plenty of financial advice looks silly, in retrospect, years after it’s given.  But I wouldn’t have to worry about that.  Regardless of where the markets were going to go, I knew that a low cost account such as this, would beat the vast majority of professional investors over time.

First… A Peak At The Landscape Covered

The past five years have been tough. 

The five year total return of the Vanguard U.S. total stock market index was just 5.92% and the total return of Vanguard’s total international stock market index was just 2.9%.  You can see their charted progress here.  Yeah, the markets recovered from the slaughter they experienced in 2008/2009, but after the more recent drop that we experienced over the past two months, the markets have their heads barely above water.

The world’s stock markets have been bouncing like an unconscious tourist on a bungee.  But rebalancing between stocks and bonds can generate generous profits.

Actively managed balanced mutual funds can take advantage of this kind of volatility.  They keep a portion of their fund in stocks and a portion in bonds.  When stock markets bounce upwards, they can sell some of their stocks and buy bonds.  When stock markets drop, they can sell some of their bonds to buy stocks.  The people running these funds research economic news, stocks, interest rates and political news…supposedly basing their investment decisions on their findings.

So let’s have a look to see how some of America’s biggest balanced funds would have performed during the last five years, to September 20th, 2011.

+11.3% Fidelity Balanced Fund

If you haven’t heard of Fidelity, you’ve probably been squatting in a remote tent for the past 30 years.  There’s nothing wrong with that.  You could live on a beach, access the internet once a year, and beat the backsides off most of the professional investors working at Fidelity. 

An investment, five years ago, in Fidelity’s flagship balanced fund would have increased by 11.3% during the past five years.

Do you want to know how the Johnson Family (owners of Fidelity) got so darn rich?  They didn’t invest in their own funds.  They own the fund company that reaps annual fees every year from investors.  Abigail Johnson and Edward Johnson are each independently wealthier than Steve Jobs, and they make Donald Trump look like a pauper.  Check out the Forbes 400 list of richest Americans to see for yourself.

And if you invest with Fidelity, you make the Johnsons richer.

+5.75% American Funds Balanced Fund

I have a brilliant, occasionally hot blooded friend I work with who has a MBA from Harvard.  He realizes that the fund company, known as “American Funds”, pays its sales force a 5.75% fee of what its clients’ invests. 

He’s a bit hard-core, but he suggests that salespeople taking a 5.75% cut on deposited invested money deserve to be in jail. 

Yeah…that’s a hard-core judgement, but it does make me laugh every time he says it.  Over the past five years, the American Funds Balanced Fund actually made 11.5%. 

But that doesn’t include the 5.75% sales fee that the salesperson reaps. 

Deduct that from the return, and the investor who invested money five years ago, would have made a paltry 5.75% over the past five years.

+11.8% T. Rowe Price Balanced Fund

Another one of America’s most renowned actively managed fund companies is T. Rowe Price.  Author, Louis Lowenstein, allocates much of his energy towards hammering T. Rowe Price, in his book The Investor’s Dilemma:

Investors hurt themselves by bringing to their portfolio decisions an attitude of childlike trust, even of naiveté.  Indeed, when one considers the fierce attention that consumers devote to the cost, and to the quality, of their weekly groceries or, say, to the purchase of a new washer and dryer, their nonchalance when it comes to mutual fund cost and quality is remarkable.  Perhaps, and this might be a third factor, the investors assume that TROW [T. Rowe Price] being a financial intermediary, will rise above the minimal standards of honesty that one expects from ordinary commercial enterprises (pg. 73).

Invest in T. Rowe Price if you want to make its shareholders rich.

If you invested in T. Rowe Price shares in 1990, and your friend bought shares in Apple, who do you think would be richer today? 

See the surprising chart below.  The green line represents Apple, and the blue line represents R. Rowe Price.

Splits: Jan 2, 1990 [2:1], Dec 1, 1993 [2:1], May 1, 1996 [2:1], May 1, 1998 [2:1], Jun 26, 2006 [2:1]

+11.7% Franklin Balanced Fund

A look at the Franklin Balanced Fund reveals a startling trend.  Over the past five years, the balanced funds listed above all have ranges of return between 11.3% and 11.8% (if you don’t count the gouging that the American Funds salesperson would take from their clients).

 Why are the returns so consistent?

This comes down to something called “closet indexing”.  In crude terms, these fund managers are lacking a dangling part of the male anatomy.  They are essentially shadowing the holdings within their respective indexes, and charging fees to do so.

This will prevent them from earning returns that deviate too far from their competitive peer group.

Fund managers, after all, who grossly underperform their peers, typically get fired.  But closely following their professional peers prevents these fund managers from actively seeking opportunities, and it also prevents them from acting responsibly with their respective funds. 

For instance, when the stock markets fell in 2008/2009, did these fund managers have the guts to rebalance their funds, selling off some bonds to buy discounted stocks?  As balanced funds, they should have… that’s what a balanced fund is supposed to do.  But as you’ll see when reading further, the answer to that question is almost certainly, no.

+10.9% Goldman Sachs Balanced Fund

There’s nothing golden about Goldman Sach’s 5 year total return.  Again, it’s within a very tight range of the other funds above…revealing the reluctance of these fund managers to branch out on their own and think independently.

The Singapore American School Fund

OK, this isn’t really a fund that represents my school.  But the portfolio I’ll show you below is exactly the same as the one I outlined (and promised to track) in September 2006, using www.SmartMoney.com.

I suggested then, and I’ll reinforce it again, that this portfolio will (over a lengthy period of time) beat the vast majority of actively managed money.

Unlike the American Funds Balanced Fund, there are no atrocious fees charged to investors who buy Vanguard’s funds.  And the expense ratios are a fraction of what they would be if investors had chosen actively managed products instead.

Five years ago, I suggested that investors should rebalance their portfolio annually… spending just 10 minutes on their investments.

I’ll admit that I was pretty lazy about rebalancing this portfolio.  I rebalanced it today, and I rebalanced it at the beginning of 2009.  In total, I have spent no more than 10 minutes (total!) on this portfolio in the past five years.

Yet if this portfolio was a boxer, it would have knocked out the balanced funds from Fidelity, American Funds, T. Rowe Price, Franklin and Goldman Sachs… blindfolded!

Five Year Overall Portfolio Gain:  +19.08%

Initial Investment in September 2006:  $200,000 (including cash)

Current Account Value, September 20, 2011:  $238,166.48

Fund

% Currently Allocated in each

Initial investment

Current Value

Vanguard Total Bond Market Fund

34%

$66,000

$80,983

Vanguard Total U.S. Stock Market Fund

32.56%

$66,000

$77,554.11

Vanguard Total International Stock Market Fund

33.25%

$66,000

$79,188.79

 No money was added to this account, and it was rebalanced on two occasions.  Rebalancing can be a very powerful tool during volatile stock markets.

If you think that I got lucky, think again.

If I had spent just ten minutes a year rebalancing this portfolio (instead of 10 minutes over 5 years) it probably would have done a lot better.

Want proof? Check this out:

The company, Assetbuilder, creates portfolios of indexes for investors who don’t want to manage their own money.

They charge a small annual fee, and they aren’t afraid to rebalance without emotion.  They don’t have peers that they’re trying to keep pace with.  The folks at Assetbuilder just build diversified portfolios of indexes, at a very low cost, and they rebalance those indexes.

If you’re an American (even an American living overseas) you can use their services.

Based on investors’ ages and risk tolerances, they offer 14 model portfolios.

On their website, they track the performance of those portfolios.  And here are the portfolios that combine stock and bond indexes, with varying degrees of risk.

Every single one of them beat the overall return of the Singapore American School Portfolio.  Looking below, you can see that their Model Portfolio 14 has a five year compounding return of 4.42% (the lowest of the bunch below).

But compounded, that’s a five year total return of 24.14%.

In contrast, their portfolio model 7 returned 5.53% for a five year total return of 30.88%.

As of August 2011

 

3 Mth Period

1 Yr Annual

3 Yrs Annual

5 Yrs Annual

YTD Period

Since 09/2006

Annualized

STD Dev

               

Model Portfolio 06

-2.89

6.67

5.61

5.30

0.33

5.30

7.79

Model Portfolio 07

-3.95

8.00

5.83

5.53

-0.29

5.53

10.02

Model Portfolio 08

-5.15

9.19

5.71

5.46

-1.12

5.46

12.26

Model Portfolio 09

-6.40

10.54

5.32

5.24

-1.94

5.24

14.72

Model Portfolio 10

-7.30

11.91

5.04

5.34

-2.46

5.34

17.15

Model Portfolio 11

-7.76

12.41

4.90

5.23

-2.71

5.23

18.30

Model Portfolio 12

-8.66

13.67

4.12

5.00

-3.22

5.00

20.80

Model Portfolio 13

-9.11

14.11

3.71

4.73

-3.46

4.73

21.97

Model Portfolio 14

-9.68

14.54

3.15

4.42

-3.86

4.42

23.52

 Will the Assetbuilder portfolios continue to beat the Singapore American School portfolio that I created?

Maybe.  Maybe not.

But there’s one certainty.

As an aggregate, indexed portfolios pull further and further ahead of the vast majority of actively managed portfolios over an investment lifetime.

Academic evidence supports that notion.

So if your money is mired in actively managed funds, what’s keeping you there? If you’re an American, give Vanguard or Assetbuilder a ring.  You’ll be glad you did.

For more information, please order my book, Millionaire Teacher: The Nine Rules of Wealth You Should Have Learned in School.

 





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 (2nd Ed. Wiley 2017) and The Global Expatriate’s Guide To Investing: From Millionaire Teacher to Millionaire Expat (Wiley 2015). 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. However, please read the Terms of Use, Privacy Policy and the Comments Policy.

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33 Responses

  1. NewbieNC says:

    Hi Andrew, nice post. I wonder if there is any company like Vanguard or Assetbuilder in Singapore?

  2. RobberBaron says:

    Just for fun, I've created a new "lazy" investing index tracker based on two of my current lesser holdings.

    I call it the "Lazy Two-step." 50% in each of two ETFs. Sort of like country-western dancing from the sofa. Not a lot of intellect involved. But the results from this will help shape my future monthly investments.

    Lazy Two-step Holdings:

    _TIP – iShares Barclays TIPS Bond Fund (US Treasury Inflation-Protected Securities)

    _VOOV – Vanguard S&P 500 Value ETF

    (As I buy through Sharebuilder, I need not be loyal only to one funds family, and the Vanguard comparable to iShares TIP was not available when I started investing. The difference appears to be negligible anyways)

    This is not the broader market coverage Andrew espouses – no "growth" stocks, only large-caps, and very limited bonds coverage. This would be a very conservative approach. Yet with a much lower dividend payout than I usually target (usually >3%). These are, however, very inexpensive funds, and while the first isn't quite a true "index" it is priced like one.

    I chose July 1 2011 as my start date, and started with $3,300 in play money for each (no commissions calculated).

    Here's the 85 day valuation performance:

    July 1 2011 Sept 22 2011 NET

    TIP 3,300 $3,477.90 $177.90 Up 5.39%

    VOOV 3,300 $2,679.60 $620.40 Down 18.80%

    More details, if you want that.

    Purchase price and (fictional) share holdings on July 1 2011:

    TIP $110 x 30 = $3,300

    VOOV $60 x 55 = $3,300

    Subscribing to Andrew's maxims, guess what I'll be buying next week? (real money, in my regular monthly activity

    The next few months should be interesting.

    • RobberBaron says:

      Here's the 85 day valuation performance:

      ……………July 1 2011 . . .Sept 22 2011 . . . NET

      TIP…………… 3,300 . . . . . $3,477.90 . . . . . $177.90 . . . Up 5.39%

      VOOV……….3,300 . . . . . $2,679.60 . . . . . $620.40 . . . Down 18.80%

      More details, if you want that.

      Purchase price and (fictional) share holdings on July 1 2011:

      TIP…………… $110 x 30 = $3,300

      VOOV……….$60 x 55 = $3,300

    • Hey RobberBaron,

      It sounds like you have a great strategy in place. And thanks again for all the detail. This is the kind of thing I love seeing on my site because so many people can learn from or be inspired by it. Thanks!!!!

  3. Hey Newbie NC:

    I really wish there were a company like Assetbuilder or Vanguard here in Singapore. But there isn't!

    Having said that, you can build a portfolio of exchange traded index funds (ETFs) which would do the same thing for you, at an extremely low cost. You would just have to be responsible for the monthly transactions on your own. If you go to my section titled, Expat Investing, you will find some models (when scrolling down) for Singaporeans, and expats based in Singapore. Let me know if you have questions!

    Cheers Newbie!

  4. Matt Sheflin says:

    Andrew,

    I have a Vanguard Account with the following balance-

    Vanguard Total Bond Market 40%

    Vanguard Total US Stock 30%

    Vanguard Total Intl Stock 30%

    I am having a hard time figuring out when to rebalance. I don’t mind spending up to an hour a week on this portfolio, so time isn’t a consideration. I want to figure out when I should rebalance and when I shouldn’t-especially when its so easy to transfer electronically. At one point, my portfolio increased by 11.5% in in just two weeks (stocks up, bonds down), but I didn’t rebalance to my percentages above because it happened so quick and I wasn’t sure if frequent rebalancing in an up-an-down market is detrimental or now. I’m not even sure what frequent is…

    Do you have a rule about rebalancing if time commitment is not important? If portfolio goes 5% off target balances? 8%? Does it matter whether bonds or stocks are up? Does it matter how quickly they have changed?

    Thanks for any advice,

    Matt

    • Hi Matt,

      I have rebalanced about four times in the past 12 years. That's once every three years. At most, I think you should rebalance once a year.

      Simply buy the underperforming index each month, with your fresh money. And if, on January 1st each year, your portfolio is off by 5-10% or more, then do a bit of rebalancing. But don't do it more than that. It will drive you crazy.

      If the markets get hammered (dropping 20% or so) you could rebalance at that level, regardless of the time of year, but don't get sucked into "doing something" just for the sake of it. Rebalancing sometimes improves improves, and sometimes it doesn't. So I don't think you should consider doing it more than once a year.

  5. NightSky says:

    My question is, if you're in a boat like me being a late blooming college student (I'm 27), and you don't have a lot of money to invest in a US Index stock and bond combo, what are the chances I will make any kind of decent return on my money? I'm talking like 1k. And since I can't provide a decent monthly contribution, that cuts in even more to the equation. I just finished your book Andrew, and I'm just a little confused about which US Indexes and bonds to invest in and what the likelihood is of someone who is ranked below the middle-class that I could make a decent return on my investments.

    • Hi Nightsky,

      Whatever you do, don't reach for higher risk. Start slowly and responsibly. Save some more money, and when you have at least $2K, then buy a Singapore stock market index (ETF) through Standard Chartered or DBS Vickers' brokerage. Save a further $2000 after that (even if it takes you a year) and then invest in a Singapore bond index. When you have a few more thousand saved, buy a world stock market index (VT). You're young, so your concern should be a very long term one. Don't get wrapped up in what returns you think you'll get today. Overall, this strategy will give you (statistically speaking) the best long term chance of success. And you won't need this money for a very long time (because you're young) so you can let patience and discipline allow you to slowly amass wealth.

      How does that sound? It takes patience and discipline, but I think you can do it!

      • NightSky says:

        Thank you for your response Andrew. I'm definitely planning on keeping the money in there for a long time. I don't plan on touching the money. I appreciate the advice on which stocks/bonds to invest in. I'm already trying to save an additional 1k now. Looking forward to having a great financial future!

  6. Patrick V. says:

    Hi Andrew- are purchasing index funds and bonds via Schwab competitive with Vanguard? I currenlty have most my funds with them and it would be very convenient.

  7. matador2004 says:

    Hi Andrew,

    I've read your book and it's opened my eyes in the world of indexed investing. I'm living in the Philippines and there's only two funds that offer an indexed approach. The fund that offers a much lower initial investment and lower annual fees is PSIF. Here's the link to the Oct 2011 performance- . Even if the annual management fee is 1.5%, would you still recommend I get this fund?

    Thank you for your advice.

    • Matador,

      The most important indicator of future performce for any portfolio will always be the expense ratio of the funds you hold. Your fund (at 1.5%) is far too expensive.

      But your options are limited unless you're able to open a brokerage account with access to the New York Stock Exchange. Many people in your part of the world actually set up accounts in Singapore, with companies like DBS Vickers. Build a portfolio of low cost ETFs, and you could get your average expense ratio down to 0.2 percent or lower. But if you can't open an account in the Philippines, you may need to visit Singapore, open an account there, then wire the money to Singapore when you want to add to your investments.

      Remember, past results are poor indicators of future performance. The cost of the portfolio, over time, is the only thing that will count over the long haul. The lower, the better, as long as you're nicely diversified.

  8. Patrick V. says:

    Hi Andrew- are purchasing index funds and bonds via Schwab competitive with Vanguard? I currenlty have most my funds with them and it would be very convenient

    • Hi Patrick,

      If you don't know what your expense ratios are with Schwab, then you may be paying far too much.

      As a brokerage, Schwab can sell you everything including the kitchen sink. This can be a good and a bad thing. Look up the expense ratios on the funds you own. They shouldn't be hgher than 0.17% for a U.S. fund or 0.2% for an international fund. If they are higher, you can still use Schwab to find lower cost funds (actually, ETFs might be your lowest cost option through Schwab)

  9. matador2004 says:

    Thank you so much for your detailed reply. I will look into opening an account in Singapore.

    Wishing for more success of your book in this new year!

  10. Patrick Voyles says:

    Thanks Andrew….the Schwab total market index fund(SWTSX) has a net expense ratio of .09%. The Schwab international index fund(SWISX) has a net expense ratio of .19%. The Schwab total bond market index fund(SWLBX) has a net expense ratio of .29%. Based on that data and following your book my thought would be to move my current Schwab actively managed funds into the above noted idex funds with the proper balance you outlined. Would really appreciate your thoughts prior to pulling the trigger. Thanks in advance!

  11. NightSky says:

    Hi Andrew. So after a short period of time, I was able to have enough money to invest 2k in a Singapore Index, Singapore bond, and a world stock index (total is 6k). The question I'm wondering is why Singapore? I looked at the total stock fluctuations since its inception and it doesn't seem to be growing. It seems to rise and then fall in approximately equal proportions so as to never go anywhere. The US economy, however, is on its way up again as the recession finally dies down. I know that you teach buying at clearance prices, but I see the US economy rising even higher. I don't see this happening for Singapore. I'm wondering what your rational behind me investing my life savings into a market that doesn't seem to grow over time is.

    On another note, I can't seem to find out how to sign up for Standard Chartered on their website. Am I missing something? I can't find a sign up link. I cannot us Vickers because they require a passport, and as of now, I don't have one.

    • Hello Nightsky,

      I recommend (no matter what the economic climate) that people put their eggs in multiple baskets (International stocks, domestic stocks, domestic bonds) and rebalance. You must ignore what index is "doing well" and what index isn't. In fact, your instinct is actually very human, but this isn't a good investing trait. To be good, as investors, we shouldn't chase rising prices, we should dispassionately keep a balance, and actually be a bit fearful when others are greedy and greedy when others are fearful. The rebalancing process (or buying the lagging index in our portfolios) automatically ensures that we do this.

      • NightSky says:

        I understand. Buy low, sell high! I'm just wondering why you picked Singapore. I've researched a little and know that it's a big hub port for goods. Beyond that, however, I know little about its economy and the economy's stability. I have a lot of questions, and I'm really eager to learn. I don't want to take up a lot of your time asking all these questions, but it should be a good sign when I'm asking a lot. It shows that I care where my money's going, and I don't have blind faith like the people you mentioned in money market accounts.

        As for signing up for Standard Chartered, am I supposed to open a Singapore account? I can't find a way on the website to open a US account.

        Thanks for all your help and answering my questions thus far! I've never invested before and I don't know anyone that has. I want to do it the smart way.

  12. Andrew says:

    Hi Andrew,

    I am an Australian, living overseas (currently Vietnam) so I am a non-resident for tax purposes. I have contacted Vanguard Australia regarding getting the ball rolling. This is what they have told me:

    Vanguard Investments Australia Ltd and its Funds are registered in Australia and are operated to comply with Australian laws.

    We regret to inform you that unfortunately Vanguard Australia can no longer accept applications from non-Australian residents which includes Australian citizens currently residing overseas.

    This policy is as a result of the US Foreign Account Tax Compliance Act (FATCA) and similar expected legislative changes in Canada, Europe and elsewhere which increases our compliance burden from accepting non-residents.

    What do you suggest I do in this situation? Should I look into other options in Australia?

    Thanks

    • It sounds like a national tax issue, rather than a Vanguard issue. Your best option would be opening an account in Singapore, with DBS Vickers. They will allow you to do it, as long as you end up speaking to someone on the phone who knows of the option. If they say no, it means you have someone on the line who just doesn't know. Call them back. This is what many of my readers have done…from Vietnam, Thailand, Malaysia etc.

      Cheers,

      Andrew

      • Andrew says:

        Hi Andrew,

        Thanks for the reply and the advice. I'll look into DBS.

        I've been reading about the Singapore 'issues' in the comments on your other posts. I have no investment experience, nor do I have any sort of university degree in anything related to finance. Does that mean that I will have to pass the test that other people mention, or is that for something else?

        Thanks

        Andrew

        • You may have to take the test, but it's just a multiple choice test and they would give you the study material. And it would take a few hours to study for it. In some cases, those living outside Singapore have not had to take it. I have friends who took it without any experience in money. In fact, the test itself is so irrelevant, I wouldn't pass it either, without studying the silly questions first.

      • VeronicaB says:

        Hi Andrew, just came across your site. With regard to your suggestion for an Australian expat to open an account with DBS Vickers on account of Australian tax laws preventing Vanguard from offering services to Australian non-residents (conversation thread from April earlier this year), would you know whether it is possible to set up such an account for an Australian expat based in PNG? Many thanks

  13. Lance Shubert says:

    Hi Andrew;

    I plan to buy your book but wanted to ask before hand if someone in their 60s should bother with index funds rather than actual stocks since it appears you need time with unmanaged index funds?

    I'm Canadian living in Thailand and have a brokerage account at Citibank Singapore but not happy with them because the interface is hard to use. I also have a Schwab account in Hong Kong for my US stocks and an Interactive Brokers account for my Canadian stocks.

    I will eventually retire to Canada so my question is as I'm a senior citizen do you recommend buying unmanaged index funds at my age.

    Thanks

    Lance

  14. VeronicaB says:

    Hi Andrew, sorry, PNG stands for Papua New Guinea. We are Australian expats based there and are exploring investment options (on the share market) that are available to us (and align with Australian tax law rulings for non-residents). I found the commentary very useful – just querying the applicability of advice to people based further afield from Singapore. Thanks

  15. Ivo says:

    Hi Andrew

    I am a Bulgarian expat in Singapore.
    I recently read your book and thanks to it i decided to stop my Zurich application!…

    But now my partner and i are a bit stuck – what to invest in from Singapore, which can be also portable as in a couple of years we might be in Australia, Nz or back in Europe…

    Your advice is very welcome! 🙂

    Cheers, Ivo

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