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"Invest
with rules, not intuition. Calculate. Don't speculate."
- Mark Hebner |
Definition:
Index funds are mutual funds with specific and clearly defined rules of ownership and the rules are held constant regardless of market conditions.
For example, a Small Value Index Fund will have a clear set of rules
that define small and value. However, those rules are not the same
for all small value indexes. Vanguard (S&P 600 Barra Value),
Dimensional Fund Advisors, Russell, and Wilshire all have small
value indexes. However, each one of them has a different set of
rules of ownership and therefore different risk and returns.
Index Fund Advantages:
 The
annual expenses and fees of index funds are one-tenth to one-third
that of actively managed mutual funds.
Actively
managed funds, when adjusted for risk, do not outperform the appropriate
index by enough to cover the cost of their higher trading costs
and taxes.
If
a fund claims higher returns than an index, they took more
risk, either through stock concentration or style drift.
Lower
returns are the result of higher transaction costs and higher
fees or lower risk.
Claims of higher returns are the result of inaccurate benchmarking,
which is the measurment of risk. Also, many costs of actively managed
funds are overlooked, such as loads and taxes.
Index
fund managers don't buy and sell as often as managers of active
funds, resulting in lower capital gains distributions and therefore
lower taxes. Tax-managed index funds nearly eliminate all tax liability,
due to dividend and capital gains management.
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| Comparison
Table |
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Active
Investing |
Index
Funds Investing |
| Return
Objective |
Beat
a market |
Obtain
the market rate of returns for an index or asset class |
| Style
Definition |
One
study indicates 40% drift from style classification. Actually 100%
drift since they buy stocks other than what are in the index. |
Pure
and consistent classification and risk exposure. |
| Individual
Average Equity Investor Returns over 17 years |
5.32%
annualized |
S&P
500 = 16.29% |
| Approach |
Picking
stocks, times, managers or styles. |
Buy
and hold a globally diversified portfolio index funds |
| State
of Mind |
Stressed |
Relaxed |
| Taxes
and Portfolio Turnover |
High
taxes of about 2.7% of assets (eating up about 20% of return over
10 years) Turnover averages about 70% |
Low
taxes with tax-managed index funds of about 0.6% Turnover averages
about 10%. |
| Net
Performance |
Well
below the index, by the amount of fees, expenses and taxes |
Very
close to the index or asset
class. |
| Individual
Investors |
Currently
about 85% of individual investors are active. |
Currently
about 2% are indexers and growing rapidly, since 1999. |
| Institutional
Investors |
Currently
about 56% are active investors and declining. |
Currently
about 44% are indexers and growing. |
| Proponents |
Virtually
all Brokerage Firms, Mutual Fund Companies, Market Timing Services,
Investment Press and Brokerage Training Programs. |
The
Univ. of Chicago, Nobel Prize Recipients, Vanguard Group, Dimensional
Fund Advisors, Barclays Global Investors and recently, Charles Schwab
& Company |
| Analytical
Techniques |
Art,
Speculation, Qualitative, Disregard for Risk, Forecasting, Predicting
the Future, Feelings, Intuition, Luck, Betting, Gambling, Like going
to Las Vegas. |
Science
- Quantitative, Risk Management, Long Term Statistical Analysis, Accurate
Performance Measurements, Like Insurance Companies. |
| *DFA
Equity Balanced: a Globally Diversified Portfolio of Index Funds All
of the above will be substantiated throughout the 12-Step Program.
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1.
Maximize Worldwide Rates of Returns
2. Maximize Historical Market Data
3. Maximize Asset Allocation Precision
4. Maximize Rewarded Risk Exposure
5. Maximize Portfolio Diversification
6. Maximize Investment Style Purity
7. Maximize Risk Management
8. Maximize Tax Efficiency
9. Minimize Stock and Time Picking
10 Minimize Manager and Style Picking
11 Minimize Unrewarded Risk Exposure
12 Minimize Capital Gains & Dividends
13 Minimize Cash Drag on Returns
14 Minimize Market Impact Costs
15 Minimize Market Data Errors
16 Minimize Transaction Costs
17 Minimize Portfolio Turnover
18 Minimize Portfolio Volatility
19 Minimize Expense Ratios
20 Minimize Silent Partners
21 Minimize Style Drift
22 Minimize Investor Stress |
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