Gallery:Step 1|12-Step Painting

New 12-Step Program for Indexers

Gallery:Step 1|12-Step Painting

Last Updated: 12:10 AM ET Apr 26, 2002
12-step program for investing in index funds

LOS ANGELES (CBS.MW)I love surfing the web. You go looking for one thing, and you run across a new gem that's so good it makes you forget what you're looking for.

Like the "12-Step Program to Index Funds: Active Investors Anonymous™," a unique 12-Step Program created as an investment education program. Perfect for active investors wondering why you can't beat the averages through market timing and active trading.

The site's the brainchild of Mark Hebner, the founder of Index Fund Advisors. IFA is a fee-based financial adviser using Dimensional Fund Advisors' (DFA) no-load mutual funds. One of the encouraging things about IFA is that they work with portfolios as small as $25,000. Most advisers won't touch anything less than $100,000 or even $250,000.

So here's an introduction to this new version of "The Program." Check it out if you're growing weary of active investing -- there's plenty more information available beyond this brief summary:

Step 1: Active Investors The original 12-Step Programs begin with an upfront admission that you're powerless and your life is unmanageable. IFA's program is what members of the original Program call the slower, "educational variety."

That is, the actual decision to swear off the bad stuff doesn't come until after you work through IFA's educational program on how the "disease" of market timing and active investing is negatively affecting the health of your portfolio. So jump in and test yourself.

Step 2: Nobel Laureates Fascinating reading here about research by Nobel prizewinners and their buddies, consistently proving that active investing is a losing game that can't beat the Modern Portfolio Theory's risk allocation principles.

This section summarizes the conclusions of the leading investment researchers, Sharpe, Markowitz, Modigliani, Malkeil, Fama and others like Paul Samuelson: "It is not easy to get rich in Las Vegas, at Churchill Downs, or at the local Merrill Lynch office."

Step 3: Stock Pickers Wall Street brags about the stock-picking talents of active managers. Unfortunately, it's random luck not skill. One study reveals "the chances of the active manager beating the appropriate index are one in thirty-six, the same long shot as throwing snake eyes at the craps table."

And William Bernstein says: "Ninety-nine percent of fund managers demonstrate no evidence of skill whatsoever." Eugene Fama is harsher: "I'd compare stock-pickers to astrologers, but I don't want to bad-mouth the astrologers."

Step 4: Time Pickers Market timing is the ultimate fool's game. Benjamin Graham put it this way: "If I have noticed anything over these 60 years on Wall Street, it is that people do not succeed in forecasting what's going to happen to the stock market."

Some other key facts: Over a decade, 88 percent of your returns will benefit from a mere 40 days. Similarly, 95 percent of market timing newsletters went out of business during one 12-year period. You cannot consistently pick the right time to be in or out of the market.

Step 5: Manager Pickers They expose one of the greatest myths: "The performance of managers is randomly distributed and lacks consistency." IFA notes that top money managers "attract about 75 percent of new mutual fund investors," yet within three years most "fall from the sky." So investors blindly chase these hot-shots, buying at peaks and selling on panic at bottoms.

Step 6: Style Drifters Active managers play fast and loose with your money, constantly churning portfolios. Fund data is perpetually old. Holdings were reported to the SEC months ago. That small-cap value, may be a mid-cap blend now. You don't know what's really in a fund. Or in your portfolio!

Step 7: Silent Partners Institutional money manager Ted Aronson knows: "Once you introduce taxes, active management probably has an insurmountable hurdle. We've been asked to manage taxable money - and declined." Between taxes, commissions and higher fees active managers lose about 40 percent of your returns.

Step 8: Riskese™ The "odds are, you don't know what the odds are," says Belsky and Gilovich, in Why Smart People Make Big Money Mistakes. Truth is, most investors don't know what they're doing. They chase short-term returns, follow hot tips, never truly understanding the impact risk and time have on returns.

Step 9: History Managers come and go, and fund performance drifts randomly and unpredictably over the short-term. Indexes are the only reliable source of data, going back 74 years. Indexes, not funds, help assess the long-term risks inherent in building portfolios.

Step 10: Risk Capacity™ You have a unique risk "capacity." Each investor's Risk Capacity™ is measured on five dimensions: Personal tolerance for risk, investment IQ, net worth, income and savings rate, plus your time horizon. Together they're your unique profile.

Step 11: Risk Exposure Earlier studies say asset allocation accounts for 92 percent of your return. DFA's cites research showing that the impact is actually more than 100 percent of your total return! Why? Because active management actually has a negative effect on returns. Finally IFA offers a set of 20 portfolios from conservative to aggressive, to fit your unique profile.

Step 12: Invest & Relax "The joy of living is the theme" of the 12th Step in the original 12-Step Program, "and action is its key word." Same here. If you understand IFA's first 11 steps, any rational investor will realize active investing is a losing game. So admit you're powerless over market timing and active trading and surrender to "The Program."

Active investor or confirmed indexer, you owe it to yourself to check out this new site. It's a continuing education program that deserves your attention. I wish it had non-DFA fund alternatives. For example, the three no-load "lazy-man's" portfolios we reviewed recently, or the Schwab, Vanguard and Fidelity indexing portfolios on FundAdvice.com. That aside, IFA's site is a fabulous educational experience, visually exciting, and fun to play in.