Step 1: Active Investors

Recognize an active investor

Step 1: Active Investor

Backtested Disclosures

1.2

Active investing is a strategy that investors use when trying to beat a market or appropriate benchmark. Active investors commonly engage in picking stocks, times, managers, or styles. As later steps demonstrate, active investors who claim to outperform a market also claim the power to predict the future. When accurately measured, this is simply not possible. Surprisingly, the analytical techniques that active investors use can best be described as qualitative or speculative. They include predictions of future sales and earnings growth, and are often based on gut feelings and intuition. On the other hand, the passive index investing approach is best described as quantitative or scientific. Indexing techniques include statistical analysis of risk and return data of 20 years or more, in addition to extensive measurements of numerous performance criteria. Many indexes are now based on more than 83 years of risk, return, and correlation data.

1.2.2

What Is Index Funds Investing?

As opposed to active managers, investment managers of index funds are far less active in the buying and selling of stocks, because they do not pick stocks or managers, time markets, pick styles, or make attempts to forecast the future. As previously mentioned, the analytical techniques that index funds managers use are best described as quantitative or scientific.

Approximately 15% of all individual assets and 44% of all institutional assets are currently invested in different index funds. Many institutional funds are one hundred percent indexed. Even Charles Schwab and Company recommends that investors put 80% of their large cap assets into index funds. Mr. Schwab himself has 75% of his mutual funds in index funds. Other indexing proponents include Barclay's Global Investors, Dimensional Fund Advisors, The Vanguard Group, Warren Buffet, Peter Lynch, numerous academic institutions, Economic Nobel Laureates, and Index Funds Advisors (IFA). Insurance companies use a similar approach to indexing when setting premiums for the risks taken by insuring against thousands of different random events. Most of those premiums are also invested in index funds while held in reserves for the inevitable claim payment.

Most investors believe that index funds investing means investing in familiar market indexes, such as the Standard and Poor's 500. S&P 500 funds are structured with the aim to provide the same investment performance as the S&P. By holding all the stocks in the same proportionate amounts as the S&P index, the fund index represents about 86% of the market value of all U.S. companies, mostly large blue chip stocks. The problem is that market indexes, such as the S&P 500, were not originally designed as investment vehicles.

Since the late 1980’s, index funds have expanded and are based on more discrete customized indexes. Originally designed for very large pension funds, institutional-style index funds are meant to capture various financial risk factors or dimensions of the market. Exposure to a risk factor such as company size or value constitutes a risk dimension of the market. Investors have been compensated with higher returns for risk exposure to these risk factors since 1929. These dimensions of the market can also be referred to as indexes. Indexes are groups of stocks that have common risk and return characteristics and comply to specific and clearly defined sets of rules of ownership. These groups of stocks include companies from the United States, foreign companies, and even emerging markets. There are additional indexes within these markets, such as value, large value, small growth, large growth, real estate securities, and many fixed-income investments, such as short-term and long-term treasury bonds, municipal bonds, and corporate bonds. Companies are purchased and held within the index when they meet the index parameters. Stocks are sold when they move outside of these parameters and no longer meet the index rules.

An example of an index fund is Dimensional Fund Advisors' (DFA) Micro-Cap index fund, which invests in securities of U.S. companies whose size (market capitalization) falls within the smallest 4% of the total market universe. This includes all stocks traded on the New York Stock Exchange and the American Stock Exchange, as well as those listed in the National Association of Securities Dealers Automated Quotation Over-the-counter (NASDAQ OTC) market. Another example would be DFA’s Small Cap Value Fund, which invests in companies ranked in the lowest eight percent by size, as well as the highest 25th percentile by book-to-market ratio (value).

DFA funds are now available to individual investors through a small qualified group of registered investment advisors who have demonstrated their understanding and commitment to the concepts described in this 12-Step Program.

The overwhelming majority of investors are active investors. Extensive research by many academics and investment professionals has shown that investors cannot beat a market in the long run with stock, time, manager, or style picking. It is disconcerting that about seventy percent of all institutional money invested in U.S. stocks is still actively managed.

1.2.3

Comparison Table

The table below summarizes the differences between the two approaches to investing.

Table 1-1

1.2.4

Beating a Market

We reference the phrase “ beating a market” throughout this 12-step Program. This is defined as the attempt to obtain a higher net return on investments from a portfolio of stocks, bonds, or mutual funds than from a relevant and investable index or benchmark. The net return includes adjustments for all commissions, loads, fees, expenses, risks, and federal and state taxes. It is calculated over a reasonable period of at least five years, but preferably over 20 years. The net return of an active investor’s stock portfolio can then be paralleled to the index fund of a comparable index. The index may consist of the entire stock market or a more specific index, such as small capitalization value stocks. No investor over or underperforms an index. They simply invest in something other than the index. Since the index is the only source of long-term risk and return data, why would an investor subject hard earned savings to anything other than the index?

The most basic tenet of all investing is that exposure of your money to a higher level of risk should be rewarded with a higher expected return. In contrast, lower levels of risk should correlate to a lower expected return. One of the problems with measuring the performance of stock market investing is the lack of a standardized system of benchmarks from which to measure performance. This lack of benchmarking is the black hole of investing. If there is no definitive benchmark, it is impossible to determine if exposure to risk has been properly rewarded. In other words, has the active investor really beaten a market with repeatable skill, or can it just be attributed to luck?

1.2.5

Risk

There are many terms used by investment professionals and academics in their quest to define risk. These include markets, benchmarks, asset classes, styles, style boxes, investment objectives, risk factors, market dimensions, market segments, categories, market averages, buckets of stocks, rules of ownership, slices of the market, industry classifications, and indexes such as Dow Jones Indexes, Standard and Poor's Indexes, Russell Indexes, Wilshire Indexes, Morgan Stanley Capital Indexes, Wired Index, and many more. Diversification and measures of volatility, such as standard deviation, are also used to describe risk. Every one of these is an attempt to identify common risk and return characteristics among groups of stocks included in that classification. To reduce confusion, market or index will often be substituted for these terms.

An appropriate challenge to the investment industry is a call to action to develop an SEC-approved standard to measure the risk of various investments. The three-factor model proposed by Eugene Fama and Kenneth French in 1992 would be an excellent starting point. This model is discussed later in Step 8: Riskese™.

1.3

Problems

1.3.1

Active Investors are Everywhere

About 85% of investors are active investors. The most popular strategies in attempting to beat a market include stock, time, manager, and style picking. Steps 3, 4, 5, and 6 describe these strategies and explain the futility of all these methods.

Stock pickers try to pick winning stocks rather than diversify their portfolio.

Market timers, or time pickers, try to make money by timing the markets. They think they can strategically pick specific times to get in and out of a market, believing this approach is more profitable than a buy-and-hold strategy. Time picking also refers to the purchase or sale of individual stocks.

Manager pickers buy stock portfolios or mutual funds managed by the money managers who seem to have the best recent performance record.

Style pickers identify which style, such as large growth or small value, is the next style to perform above and beyond the others.

The majority of individuals in the U.S. who are currently invested in stock mutual funds holds shares of an actively managed mutual fund. However, according to data from Strategic Insight, about three out of every five dollars invested in stock funds in 2001 were invested in index funds - nearly 60% of stock fund cash flow. This means more investors are understanding the benefits of indexing.

1.3.2

Active Investors are Gamblers

Active Investor

Active investors believe they are in control. They delude themselves that they have a special understanding of the market, a superior edge over less knowledgeable investors, making them immune to disaster. The truth is that all investors can access the same information as professional money managers through the Internet and many other sources. Still, many investors believe they are smarter and more sophisticated than the average investor. Those under this illusion fail to realize how much investment performance depends on luck. Most of them eventually pay dearly for this mistake.

Active investing in the stock market is a lot like casino gambling. Take a look at the numerous comparisons in the various news articles below. (Note the references to addiction.)

Las Vegas Review-Journal; June 29, 1998, SOS: STUCK ON STOCKS. "By far, the most gambling performed in the world is performed in the stock markets," said Paul Ashe, president of the National Council on Problem Gambling. "More money is lost in the stock market than in legal and illegal casino gambling combined," said Marvin Steinberg, a Connecticut psychologist who specializes in treating compulsive investment gamblers.
Northern New Jersey Record: February 2, 1998, High-Risk Investments Online Internet Trading Can Be Addictive and Costly. Dan Gaffney liked the odds. A $1,200 wager, a $150,000 score. He came so close to winning, too. But somehow, he lost. And it didn’t feel like losing $1,200. It felt like $150,000 had just slipped through his fingers.
ABC NEWS, February 1, 1999; The Craving to Buy and Sell; Online Trading Becoming Addiction for Some
San Francisco Business Times; Options junkies get treatment as chronic gamblers
www.800gambler.org January 25, 1999, this article titled "Stock Market Gambling" and Stock Market Gambling and The Addiction Of The Millennium
See 20 Questions for Compulsive Gambling? Note Stock market check box at the bottom?
The San Francisco Chronicle, August 16, 1999, Losing Your Shirt For Day Traders. For those risk-loving hunters of the stock market, gambling is the essence of their trade


Fidelity Outlook, Summer 1999; Cover Story, The New Psychology of Investing; Obsessive, Compulsive, and so far Successful	Forbes, September 13, 1999: Addicted to the Click, How my on-line trading frenzy ended in a lingerie department in Paris	San Francisco Examiner; Wrapped up in risk; Compulsion to gamble can blind even the best investors to bets gone bad

Paul Samuelson, Nobel Laureate, MIT Economist

"My guess is that indexing will have a larger role if you call me ten years from now than it does now. But it will still be a minority mode of investing. Why? There is something in people; you might even call it a little bit of a gambling instinct. They want to be interested in the process of investing, and it's traditionally been difficult to get too jazzed up about indexing. I tell people [investing] should be dull. It shouldn't be exciting. Investing should be more like watching paint dry or watching grass grow," he says. "If you want excitement, take $800 and go to Las Vegas." - Paul Samuelson, Nobel Laureate, MIT Economist, The Guide to Ultimate Indexing: To make the most of a growing array of index investments, you need to look beyond the obvious. By Daniel McGinn, September 1999

Watching the Grass Grow

The title speaks for itself. by James Cramer, 2002, Cramer in Stockaholic Recovery Mode

The active investor's addiction to beating the odds is often as strong as any other addiction. Like gambling, active investing can be extraordinarily exciting for investors who get carried away by the adrenaline of winning. Of course, it can create significant agony for those who experience the losing side of risk. One of the biggest mistakes made by the active investor is believing there is skill involved when the stock market proves profitable. Many of today’s day traders are learning this the hard way. There are now approximately 15 million online trading accounts in the United States. Stories of mounting losses are becoming more prevalent as the odds of playing the markets take their toll on this new breed of investors. Just like casino gambling, there are more tales about the winners than the losers, but the stories rarely give an accurate accounting of true net profit.

New studies in the field of neuroeconomics confirm the release of dopamine when presented with the opportunity of a surging stock. This validates and confirms the addictive nature of Stockaholics™. The powerful allure of monetary reward leads to the overwhelming urge to trade stocks or funds. It has now been shown through brain imaging studies that the circuits that switch on at the prospect of big profits are the same as the ones that lead to the addictive nature of cocaine, casino gambling, alcohol, chocolate, and sex, just to name a few. The brain images below tell the story.

Figure 1-A (Chart Link) Expecting Dough vs. Expecting Dope

In the October 2002 issue of Money Magazine, the highly respected journalist Jason Zweig writes a ground-breaking article about the new evidence of the release of addiction related dopamine in our brains. He declares, "the dopamine rush we get from long shots is why we play lotto, invest in IPOs, keep too much money in too few stocks and invest with active portfolio managers instead of index funds." He goes on to say that, "our brains are wired to force us into forecasting; it is a biological imperative. In fact, humans are born with what I've come to call "the prediction addiction." Zweig reports that there are several researchers working on nueroeconomics at this time. At Harvard, Hans Breiter is leading a project and has stated that they have discovered a "striking" similarity between the brain's reaction to cocaine, morphine, and the prediction of financial rewards. Please take the time to read Jason's new book on this subject, Your Money & Your Brain. Also see Center for Neuroeconomic Studies Duke University.

Follow up on above video: Tim Sykes, 25, ran a top-ranked, short-bias fund called Cilantro Fund Partners, which he founded in 2003 in his senior year at Tulane University in New Orleans. After suffering a roughly 35% loss over two years, on October 1, 2007, Timothy closed his hedge fund.

Meir Statman talked about his new book, What Investors Really Want: Know What Drives Investor Behavior and Make Smarter Financial Decisions, on Morningstar.com. When asked about index funds, he stated, "Well, index funds are fabulous. Now you say well can I do better than average? Can I perhaps exploit other people's cognitive errors? And the answer to that is probably yes. But the question really is how much does it cost you to exploit the cognitive errors of the others. Think about somebody who says there are $100 bills some place in the streets, so this is the equivalent of a cognitive error of other people, because they have left it lying down. Well, but it will probably take you three days to find that one $100 bill, if that. And so you're going to waste too much money looking to exploit other people's cognitive errors, and in the process you're going to really shortchange yourself by getting lower returns." Watch the full interview below.

In this new report from Barclays, The Role of Control in Financial Decision Making, the emotional mistakes investors make have been discussed and analyzed.

1.3.3

Active Investors Lose

In the June 2002 edition of Money Magazine, once again Jason Zweig gets to the bottom of what investors really earn. He describes the difference between the returns that mutual funds report and the actual returns of the average investor in those funds. Active investors chase hot funds. As a consequence, they end up with less than one fifth the funds' annual returns. When inflation and our estimate of taxes are deducted, it is not a pretty picture for active investors. See figure 1-1 below.

Figure 1-1

Table 1-2 illustrates some of the details of this unique study. The large gap between the funds' and shareholders' returns was a shock to even the researchers. The reason for this gap is attributed to active investors who followed the destructive behavioral patterns that Dalbar Research had been describing since 1994. These patterns include waiting for funds to have a good year or two followed by pouring in a flood of cash just before the fund reaches its peak. Then they ride the fund to near bottom and sell.

One encouraging exception was the Dimensional Fund Advisors (DFA) institutional index funds. DFA investors are limited to either large institutional investors or individuals who have been educated by specially trained investment advisors. Because the shareholders of these funds buy and hold diversified portfolios at all times, they ride out the market gyrations and end up obtaining market rates of returns. The table below shows the worst big funds ranked by how investors performed relative to the funds and five DFA funds listed in the article.

Table 1-2

In one example from the study, the Firsthand Technology Value fund racked up an impressive annualized return of 16% from 1998 to 2001. However, the investor return over this period was a devastating 31.6% loss. In total it was estimated that investors lost $1.9 Billion in this fund over this period, while the fund reported time-weighted returns of 16%. The head of fund marketing for Firsthand stated, "... people lost a lot of money because they took oversized bets in technology at the wrong time." At some funds, investors missed the glory days and piled in just in time for disaster. Firsthand Technology Value earned fantastic returns for a relative handful of early investors. But fund's late, giant losses were shared by many more. A careful analysis of the chart below will reveal the tragedy of active investors behavior.

Figure 1-A

Back in 2006, Morningstar posted a short article on the differences between what funds earned and what investors earned. The article found further evidence that investors chase returns and that behaviors goes against their best interest.

A few definitions may help in the understanding of the differences between dollar-weighted returns and time-weighted returns.
Holding Period Return: The percent change in a portfolio’s total market value over a given period. It is a single-period version of Dollar-Weighted Return.

Dollar-Weighted Rate of Return: Dollar-weighted rate of return, or “DWRR” for short, is also known as "Internal Rate of Return" or simply "IRR." It is used to determine the rate of return on an investment that has variance in cash flows. It is useful in determining the results of chasing fund returns overtime and provides an average "investor return" of mutual funds over a specified period, in contrast to just the change in price of the investment over time, which is the time-weighted return. IRR equates the present value of an investment's cash inflows (dividends, interest, and sales proceeds received) or outflows with the present cost of the investment. That is, for an investment that has a number of cash inflows or outflows over time, the IRR is defined to be the discount rate that makes the net present value of those cash flows equal to zero. Stated another way, the IRR is “…the interest rate that will make the present value of the cash flows from all the sub-periods in the evaluation period plus the terminal market value of the portfolio equal to the initial market value of the portfolio.” (Fabozzi, Frank J., Fixed Income Mathematics, ©1993 1997, pp 157)

Time-Weighted Rate of Return: A time-weighted rate of return measures the return of an investment over a certain holding period. The average investor in the investment may have waited until after the investment did well, then added lots of capital, only to be heavily invested during the decline, thereby having an average dollar-weighted return substantially below the reported time-weighted return. The opposite flows would create dollar weighted returns in excess of the time weighted returns. Cash flows moving in and out of the investment do not affect the time-weighted rate of return (unlike with dollar-weighted rates of return or “IRR”).

An annual study called the Quantitative Analysis of Investor Behavior (QAIB), which has been conducted by Dalbar since 1994, measures the impact of investor decisions to buy, sell, and switch in and out of mutual funds. Each year, the study has shown the average mutual fund investor earns significantly less than the mutual funds over the same time period. In fact, the report issued in March 2011 carried this headline: "Investor Behaviors Continue to Fall Prey to Market Forces." The study further concluded, "As this report has shown for the 17th time in as many years, mutual fund investors consistently underperform the relevant index. The report also shows that most of this loss in performance is due to psychological factors that translate into poor timing of their buys and sells (investor behavior)."

Figure 1-2 illustrates the results of the most recent 20-year Dalbar study, a comparison of the returns of an average equity fund investor to the returns of the market from 1991 to 2010. Permitting their decisions to be driven by short-term volatility, the average equity fund investor earned returns of only 3.83%, while the S&P 500 returned 9.14%. An investment of $100,000 made in 1991 grew to an inflation adjusted amount of $129,106 over the 20-year period for an average equity fund investor, while the same amount invested in the S&P 500 grew to an inflation adjusted amount of $350,141. Even better, an investor who owned an all-equity, small-value tilted, globally diversified index portfolio such as IFA's Index Portfolio 100 would have grown a $100,000 investment to an inflation adjusted amount of $555,538. Clearly, investor behavior can have a far more negative impact on investment performance than investors realize.

Dalbar has conducted previous similar studies. (See these Dalbar QAIB Charts created by IFA).

Figure 1-2

In John C. Bogle's classic book, Common Sense on Mutual Funds, Fully Updated 10th Anniversary Edition, Mr. Bogle provides color highlighted sections with all the updates to the original 1999 edition. On page 331, he comments that back in 1999 he did not reference the fact that both individuals and most advisors tend to show up late for mutual fund returns and just-in-time for losses. In other words, they were more heavily invested before periods that declined than periods that had increased in value. He states that the average time-weighted return for 200 large mutual funds for the 10 years from January 1, 1994 to December 31, 2003 was 9.8%, but the average investors in those funds only earned a dollar-weighted return of 6.5%.

This means that the bad behavior of investors and most advisors resulted in only capturing 66.3% of the fund's returns over the 10-year period. Compounded over this period, the average of the 200 funds earned a total of 152% or turned $100,000 into $254,697, while the returns-chasing whipsawed average investor only earned 88% or turned $100,000 into just $187,714. A whopping $66,983 difference.

Over this same period, a full equity IFA Index Portfolio 90 grew $100,000 to $264,163, net of IFA and DFA fees, and a S&P 500 Index Fund (DFA US Large Company, Symbol: DFLCX), net of fund expenses and an advisor's fee of 0.9%, grew to $256,609. As you will see in the discussion that follows, do-it-yourself indexers were shown to only capture about 82% of the index fund return due to the same, but somewhat reduced, behavioral finance problems. So without a purely passive advisor, the S&P 500 index fund return for the average do-it-yourself indexer would have hypothetically grown to $235,005 at a rate of 8.92% annualized, which is 82% of the 10.88% return for the S&P 500 from 1994 to 2003.

In John Bogle's Little Book of Common Sense Investing, Chapter 5 is titled the Grand Illusion: Surprise! The Returns Reported by Mutual Funds Aren't Actually Earned by Mutual Fund Investors. In this chapter he refers to two studies on this subject. Also on page 50, a 25-year period is referenced when the average fund investor earned a dollar weighted return of 7.3%, while the fund had time-weighted returns of 10.0%. So the average investor only earned 73% of the funds returns over this 25 year period. Also, an S&P 500 Index Fund earned a 12.3% return in this period, while the investors in that fund only earned 10.8%, only capturing 88% if the index fund return.

On page 56, an analysis of 5 Aggressive Growth Funds revealed that the average investor did not capture any of the 7.8% annualized returns over the 10 years from 1995-2005. Instead, they actually lost 0.5% annualized for the 10 years. The average investor in the Vanguard Index 500 only capture 78% of that fund's return over this period, earning 7.1% of the 9.1% annualized return.

Investors can benefit from hiring a purely passive investment advisor, who provides quality education and mentoring, focused on changing their investing behavior, encouraging long-term investing, and discouraging the speculation and gambling practices of trying to beat a market.

Morningstar, a fund tracking service, started disclosing these "investor returns" in 2006. On the Data Definition page of their web site, they state that "Morningstar investor returns (also known as dollar-weighted returns) measure how the typical investor in that fund fared over time, incorporating the impact of cash inflows and outflows from purchases and sales. In contrast to total returns, investor returns account for all cash flows into and out of the fund to measure how the average investor performed over time. Investor return is calculated in a similar manner as internal rate of return. Investor return measures the compound growth rate in the value of all dollars invested in the fund over the evaluation period. Investor return is the growth rate that will link the beginning total net assets plus all intermediate cash flows to the ending total net assets."

Now that Morningstar is tracking such data, investors' bad behavior is finally quantified, as well the advantages of using a passive advisor who helps reduce investor error. In the Morningstar Indexes Yearbook: 2005, they analyzed how the average index investor did on their own versus those that are guided by an advisor using asset class index-type funds from Dimensional Fund Advisors. Here is what they had to say:

"Consider the success Dimensional Fund Advisors (DFA) has had in selling its funds through advisors who undergo training on the merits of passive investing and in portfolio construction theory. Consider that over the past decade the dollar-weighted return of all index funds was just 82% of the time-weighted return investors could have gotten with those funds. Yet, the figures for DFA are much better. In fact, the dollar-weighted returns of DFA funds over the past 10 years are actually higher than their time-weighted returns [see Table 1-3], suggesting advisors who use DFA encourage very smart behavior among their clients, even buying more out-of-favor segments of the market and riding them up, rather than buying at the peak and riding the trend down, which is usually the case with fund investors."

Table 1-3

Carl Richards maintains a website that deals with what he calls the Behavior Gap. In his book Richards further drives home the point that investors, as a group, are doing much worse than the returns reported by the funds.

A related paper is titled, Behavioral Portfolio Analysis of Individual Investors, by A. O. I. Hoffmann and Joost M.E. Pennings of University of Maastricht - School of Business and Economics - Department of Finance and Hersh Shefrin of Santa Clara University - Leavey School of Business and the National Bureau of Economic Research (NBER) (published June 24, 2010). In the abstract they state, " In line with our expectations, we find that investors driven by objectives related to speculation have higher aspirations and turnover, take more risk, judge themselves to be more advanced, and underperform relative to investors driven by the need to build a financial buffer or save for retirement."

Russ Kinnel from Morningstar wrote another article on how Bad Timing Eats Away at Investor Returns on Feb. 15, 2010. In the article Mr. Kinnel explained how Investor Returns are calculated:

"Investor returns tell you how the average investor in a fund fared. We take monthly cash inflows and outflows and then calculate the returns earned on those flows. As with an internal rate of return calculation, investor return is the constant monthly rate of return that makes the beginning assets equal to the ending assets with all monthly cash flows accounted for. The gap between investor returns and total returns shows you how well investors timed their purchases and sales. (For all the details on the calculation, you can check out the two-page fact sheet here or the 10-page methodology document here.)"

The conclusion of the analysis of the first decade of the new millennium was that "the whipsaw of the past two years has meant that, in most categories and in the aggregate, investors have done worse than the average fund. ... The grand total for the average investor in all funds in the aughts was a 1.68% annualized return, compared with 3.18% for the average fund." That meant that the average investor only captured 53% of the average funds total return. See the details HERE. Note that among US Equity Funds, investors only captured 14% of the 1.59% total return of the decade.

Broad Asset Classes
Note: This represents the 10 years ending 12/31/2009 Source: Morningstar

To compare this data with the IFA Index Portfolios, see below and HERE, and for a sample client over most of this period see HERE.

The emotions of active investors go up and down like a roller coaster, leading them to negative returns on average, after expenses and taxes are deducted. The lessons in this 12-Step Program should allow investors to resist the behaviors that have caused them such despair and poor results in the past.

Figure 1-4

As a contrast, passive investors invest whenever they have the money to invest, regardless of market conditions, as seen below.

Figure 1-4a

To make things even better for passive rebalancers, they do the opposite of active investors and sell a portion of indexes that have grown beyond their target allocation and buy more of indexes that end up being under their target allocation. (see Step 12, paragraph 12.2.3 Rebalancing Portfolios) In addition, there are added tax savings for taxable accounts due to tax loss harvesting.

Figure 1-4b

We have created this chart to summarize the above studies.

Figure 1-4C

^{1. Bogle, John C. The Little Book of Common Sense Investing: the Only Way to Guarantee Your Fair Share of Market Returns. Hoboken, NJ: John Wiley & Sons, 2007. 56. Print.

2. Dalbar. "Helping Investors Change Behavior to Capture Alpha." Quantitative Analysis of Investor Behavior. 25 Mar. 2011. Web. 14 Nov. 2011. 3. <http://www.qaib.com/>.

3. Zweig, Jason. "What Fund Investors Really Need To Know. OUR EXCLUSIVE STUDY OF MUTUAL FUND RETURNS SHOWS WHICH ONES REALLY MADE MONEY FOR INVESTORS AND WHICH ONES TOOK SHAREHOLDERS FOR A COSTLY RIDE." CNNMoney - Business, Financial and Personal Finance News. June 1, 2002. Web. 14 Nov. 2011. 10. <http://money.cnn.com/magazines/moneymag/moneymag_archive/2002/06/01/323312/index.htm>.

4. Bogle, John C. "Bogle Financial Markets Research Center." Vanguard - Mutual Funds, IRAs, ETFs, 401(k) Plans, and More. 8 Jan. 2010. Web. 14 Nov. 2011. <http://vanguard.com/bogle_site/sp20071015.html>.

5. Dalbar. "Helping Investors Change Behavior to Capture Alpha." Quantitative Analysis of Investor Behavior. 25 Mar. 2011. Web. 14 Nov. 2011. 3. <http://www.qaib.com/>.

6. Kinnel, Russell. "Bad Timing Eats Away at Investor Returns." Morningstar. 15 Feb. 2010. Web. 14 Nov. 2011. <http://news.morningstar.com/articlenet/article.aspx?id=325664>.

7. Bogle, John C. Common Sense on Mutual Funds. Hoboken, NJ: Wiley, 2010. 331. Print.

8. Bogle, John C. The Little Book of Common Sense Investing: the Only Way to Guarantee Your Fair Share of Market Returns. Hoboken, NJ: John Wiley & Sons, 2007. 51. Print.

9. Bogle, John C. The Little Book of Common Sense Investing: the Only Way to Guarantee Your Fair Share of Market Returns. Hoboken, NJ: John Wiley & Sons, 2007. 56. Print.

10. Morningstar. "Morningstar Index Yearbook 2005." Morningstar, 12 May 2006. Web. 14 Nov. 2011. 3. <http://indexes.morningstar.com/Index/PDF/MorningstarIndexesYearbook2005.pdf>.

11. Bogle, John C. The Little Book of Common Sense Investing: the Only Way to Guarantee Your Fair Share of Market Returns. Hoboken, NJ: John Wiley & Sons, 2007. 51. Print.

12. Morningstar. "Morningstar Index Yearbook 2005." Morningstar, 12 May 2006. Web. 14 Nov. 2011. 3. <http://indexes.morningstar.com/Index/PDF/MorningstarIndexesYearbook2005.pdf>.}

Backtested Performance Info

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WARNING: Past performance does not guarantee future results. Investment returns and principal value will fluctuate, so that investors' shares, when sold, may be worth more or less than their original cost. Investing in any mutual fund, index or actively managed, does not guarantee that an investor will make money, avoid losing capital, or indicate that the investment is risk-free. Actively managed funds sometimes outperform index funds. You just don't know in advance which actively managed fund will outperform the appropriate index. Just because a mutual fund is an index mutual fund, it does not guarantee a performance superior to an actively managed mutual fund. There are no absolute guarantees in investing. When reviewing any backtested performance information on this internet site, please read the Disclosure for Backtested Performance Information (click here to read the Disclosure for Backtested Performance Information.) For a copy of the Index Funds Advisors, Inc. Privacy Policy, click here.

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Index Funds Advisors, Inc. — 19200 Von Karman Ave., Suite 150 — Irvine, CA 92612
Call Toll Free: 888-643-3133 — Local Phone: 949-502-0050 — Fax: 949-502-0048 — Email: info @ ifa . com
For several other offices and representative locations, see About Us.