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.