Federal Reserve Chairman Ben Bernanke recently held a town forum with local citizens in Kansas City, Mo. The event was moderated by PBS NewsHour anchor Jim Lehrer. While I have not seen the entire interview, I have read excerpts of the program in The Wall Street Journal.
When asked about investment advice, Bernanke recommended that the questioner practice diversification and avoid trying to time the stock market. Bernanke is arguably the most powerful person in the global economy. He is highly educated and well trained. His comments should serve to reassure investors that the basic principles of investment management have not gone out of style.
What are the keys to successful investing?
• Allocate across a broad range of asset classes
• Diversify within asset classes
• Use passive investment vehicles such as no load mutual funds and ETFs
• Keep your investment costs low
• Do not attempt to time the market
• Do not attempt to buy the next hot investment
• Rebalance no more often than annually
• Do not actively manage your portfolio
• Manage your emotions
We call this “Intelligent Investing.” Wall Street would prefer that you ignore these principles and instead spend your money chasing investment returns. Ignore Wall Street and listen to Chairman Bernanke.
Thursday, July 30, 2009
Monday, July 27, 2009
Index Funds in 401(k) Plans
I recently reviewed a client’s 401(k) account. He works for local technology company. The 401(k) plan is administered by a major insurance company. It offers proprietary funds from the insurance company and a number of actively managed funds. There are no passive funds available to participants.
I encouraged my client to contact the human resources department and express an interest in adding index funds to the menu of options. I explained that passively managed index funds capture the returns of the market (minus internal expenses). Actively managed funds are more expensive and routinely fail to beat their comparable index.
The Wall Street Journal ran an article recently indicating that employers are increasingly offering index funds inside their company 401(k) plans. Currently 90% of the $1.5 trillion in 401(k) and other defined contribution assets in mutual funds are invested in actively managed offerings. The article noted that fund companies prefer actively managed funds because they produce fees that are higher than index funds.
The 401(k) industry is in need of reform. Documents provided to plan participants fail to properly disclose expenses. These expenses drag down the performance realized by plan participants. The federal government is currently considering revising the laws surrounding 401(k) plans. Let’s hope our lawmakers have the fortitude to resist pressure from the major financial institutions to preserve the status quo.
I encouraged my client to contact the human resources department and express an interest in adding index funds to the menu of options. I explained that passively managed index funds capture the returns of the market (minus internal expenses). Actively managed funds are more expensive and routinely fail to beat their comparable index.
The Wall Street Journal ran an article recently indicating that employers are increasingly offering index funds inside their company 401(k) plans. Currently 90% of the $1.5 trillion in 401(k) and other defined contribution assets in mutual funds are invested in actively managed offerings. The article noted that fund companies prefer actively managed funds because they produce fees that are higher than index funds.
The 401(k) industry is in need of reform. Documents provided to plan participants fail to properly disclose expenses. These expenses drag down the performance realized by plan participants. The federal government is currently considering revising the laws surrounding 401(k) plans. Let’s hope our lawmakers have the fortitude to resist pressure from the major financial institutions to preserve the status quo.
Sunday, July 12, 2009
Active Managers: Skill or Luck?
Ever felt lucky? Perhaps you won a game of bingo at your church one Saturday evening. Maybe you won the drawing at the local Rotary meeting. Did you ever come back from a trip to Las Vegas with more in your wallet than you when you left?
Whenever you have felt lucky, did it occur to you that the outcome was totally beyond your control? Unless you were able to rig the results, you won because of the laws of chance. These laws suggest that results of such situations are distributed in a random manner.
Those on Wall Street would have us believe that certain money managers are able through the application of knowledge, skills and experience to achieve investment performance that is better than average. They point to notable figures like Peter Lynch who ran the Magellan Fund at Fidelity from 1977 to 1990 and who reportedly beat the Standard & Poor’s 500 index benchmark in 11 of those 13 years. Bill Miller, Portfolio Manager for the Legg Mason Value Trust mutual fund, beat the same benchmark for 15 consecutive years from 1991 through 2005.
I am not particularly persuaded by the suggestion that Peter Lynch or Bill Miller or any other money manager is somehow better than all the other mangers in the investment community. I am more inclined to believe that some managers were able to outperform the market, because the laws of chance tell us that in the universe of thousands of managers a few will.
Some will disagree and believe that some fund managers are more gifted than others. They are faced with another problem. How do you identify these managers before they put together their streaks of outperformance? I liken this to entering The Rose Garden in Portland. You walk to center court. Every seat in the facility (19,980 to be precise) is filled with a money manager. We can expect that the average performance of these managers will be that of the stock market, because this population is large enough to represent the market itself. However, we know that that some of the managers sitting in the stands will turn in performance that is better than the average. The question is who? If you are an investor you have to place your money with the managers you believe will beat the market before they actually do so.
I agree with Russell Wermers, Finance Professor at the University of Maryland who said, “[It is] exceedingly probable that any fund that has beaten the market by an average of more than one percentage point per year over the last decade achieved that return almost entirely due to luck alone … By definition, therefore, such a fund could not have been identified in advance.”
Given that most fund managers do not beat the market, why would anyone gamble their financial future by investing with managers who they hope will beat the market in the future?
Whenever you have felt lucky, did it occur to you that the outcome was totally beyond your control? Unless you were able to rig the results, you won because of the laws of chance. These laws suggest that results of such situations are distributed in a random manner.
Those on Wall Street would have us believe that certain money managers are able through the application of knowledge, skills and experience to achieve investment performance that is better than average. They point to notable figures like Peter Lynch who ran the Magellan Fund at Fidelity from 1977 to 1990 and who reportedly beat the Standard & Poor’s 500 index benchmark in 11 of those 13 years. Bill Miller, Portfolio Manager for the Legg Mason Value Trust mutual fund, beat the same benchmark for 15 consecutive years from 1991 through 2005.
I am not particularly persuaded by the suggestion that Peter Lynch or Bill Miller or any other money manager is somehow better than all the other mangers in the investment community. I am more inclined to believe that some managers were able to outperform the market, because the laws of chance tell us that in the universe of thousands of managers a few will.
Some will disagree and believe that some fund managers are more gifted than others. They are faced with another problem. How do you identify these managers before they put together their streaks of outperformance? I liken this to entering The Rose Garden in Portland. You walk to center court. Every seat in the facility (19,980 to be precise) is filled with a money manager. We can expect that the average performance of these managers will be that of the stock market, because this population is large enough to represent the market itself. However, we know that that some of the managers sitting in the stands will turn in performance that is better than the average. The question is who? If you are an investor you have to place your money with the managers you believe will beat the market before they actually do so.
I agree with Russell Wermers, Finance Professor at the University of Maryland who said, “[It is] exceedingly probable that any fund that has beaten the market by an average of more than one percentage point per year over the last decade achieved that return almost entirely due to luck alone … By definition, therefore, such a fund could not have been identified in advance.”
Given that most fund managers do not beat the market, why would anyone gamble their financial future by investing with managers who they hope will beat the market in the future?
Subscribe to:
Posts (Atom)
