 Charles
Schwab’s recent advice
to “buy index
funds” sets a great tone for investing for the
New Year—and for the years to come. IFA Index investors
surely agree with Schwab as they continue to enjoy risk-appropriate
results.
The market activity of 2006 affirmed that risk-appropriate
investing in a globally diversified blend of indexes
is the best way to capture the returns of capitalism.
IFA’s Index Portfolio 90 shined brightly with a 23%+
gain. IFA Index Portfolio 80 turned out a 21%+ gain.
The S&P
500 Index sported a 15.7% return, enough to outshine
81% of all active fund managers, according to a December
29, 2006 article in The Wall Street Journal, the title
of which, "Strong Year Had Few Losers."
The year 2006 bid farewell to Bill Miller’s supposed
streak, the only fund manager the media credits with
beating the S&P 500 Index for 15-years straight.
The media loves a story. Bill Miller’s so-called “streak” has
been the subject of too many stories that credit him
with possessing stock-picking prowess to beat the S&P
when it all comes down to bad benchmarking. Take a look
at the chart below. Miller’s fund, Legg Mason Value
Trust (LM) underperformed the IFA Large Value Index—its
more likely benchmark. Legg Mason Value Trust
is not a large-blend fund. As its name implies, it invests
with a lean toward large value, improving
on the returns of the S&P
500 by taking on more risk than that index. Take a look
at this figure. It clearly shows that Legg Mason Value
Trust had slightly less returns than
the IFA Large Value Index. Proper benchmarking
is the missing link of investing.
The
media is at it again—casting predictions as
to whom might be the next fund manager to “beat” the
S&P. In fact, the December 4, 2006 issue of The
Wall Street Journal asks the seemingly burning
question, “Who
Will Carry Bill Miller’s Mantle?” The article
painstakingly lists 93 contenders whom it considers potential “beaters” of
the S&P 500. However, of the 93 funds listed, just
five of them are even designated “large blend” funds.
Upon closer examination, we see that they too are badly
benchmarked. When comparing funds against the S&P
500, an investor should only compare funds that invest
exclusively in U.S.-based large companies. These funds
should be broadly-diversified blends of large-cap growth
and large-cap value companies. A suitable comparison
is against funds that offer similar standard deviation
of returns and similar exposure to risk factors such
as market cap and value orientations. The funds listed
as “large blend” are not even large blend.
Some have international allocations and some have mid-cap
and small-cap, as well. The 5-year risk and return measures
for these five funds, as well as for five IFA Indexfolios,
Large-Cap, Large-Value and S&P Indexes are plotted
on the chart below. As you can see, in all cases IFA
captured greater returns than the Journal’s proposed "leaders." Overwhelmingly,
IFA Indexfolios did so with less risk than their active
counterparts. The other 88 funds the article suggests
must be completely dismissed because they are in no way
comparable to the S&P 500. Many are labeled “Specialty-Natural
Resources,” “Small Blend,” “Mid-Cap
Growth,” “World Stock,” or even “Specialty-Real
Estate.” The Wall
Street Journal meticulously details the “total
returns” of each fund, while nowhere does the article
describe the risk factor exposures or the standard deviation
of returns associated with holding those funds. Numerous
investors look to this publication for guidance, and
yet, no apples to apples comparison has been made—further
obfuscating the significant issue of risk and return.
See the figure below.
Risk,
the uncertainty of expected returns, is an essential
measure, but one that is utterly neglected by active
investors. As a result, these investors become confused
and concerned when they watch their investments ebb
and flow—a completely natural fallout of
risky investments. Primarily consumed by
the lure of quick riches, investors give no consideration
to appropriate risk exposure. Essentially, they put
their returns cart before their risk horse. In doing
so, they end up going nowhere. Studies show that active
investors buy at the high and sell in capitulation
when the stock or mutual fund falls. However, when
investors understand the risk involved in an investment,
they are far more willing and able to stay the course
to achieve their expected returns.
Risk is the source of returns. You can achieve the
highest expected returns if you take on the risk that
is appropriate for your situation. Wise investors know
that you cannot compare returns without comparing risk.
The mainstream media titillates investors with alluring
potential returns without bringing to light the risks
they must endure to get those returns. As a result,
most investors are ill-prepared to stomach the wild
ride, and they never see the returns they could have
had if they had just bought a risk-appropriate blend
of index funds, and held on.
And so, let’s
invest with an understanding about “why” we earn returns.
The best way to plan for long-term security is to save
as much as you can and invest in a risk exposure that matches your risk capacity.
> to
learn more, visit ifa.com
____________________________________________________
How much
risk is right for you? Take the Risk Capacity Survey.
It takes about 15 minutes to learn the right blend of assets
to match your ability to take on risk. You may have already
taken the survey. If so, call an advisor and talk about the
Portfolio that’s right for you.
____________________________________________________ |
