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Pursuing a Better Investment Experience with Index Fund Advisors

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The wide world of investing is complex. For most of us, it’s a vague concept that is seemingly associated with the uber-wealthy like Warren Buffett. We all understand the concept of having our money grow for future financial goals like retirement, but connecting the dots from earning a paycheck to having a secure financial future often seems convoluted.

Seeking help from a financial professional is equally as opaque. Horror stories about financial fraud or deception have become all too apparent, and while the vast majority of financial professionals are in it for the right reasons, we do not know whom to trust.

To compound the situation, a constant barrage of media frenzy has taken a historically disciplined process and turned it into a casino, enticing investors to get rich quick. False promises, misinformation, and conflicts of interest have only left an overwhelming percentage of the population underfunded for their retirement.

So how do we fix it?

The famous quote from Maimonides tells us, “Give a man a fish and you feed him for a day; teach a man to fish and you feed him for a lifetime.” Likewise, educating the masses on how to invest versus simply telling them what to do is our answer to solving the problem.

Following the simple steps presented below will help to connect the dots of the investment process and ultimately lead to a better investment experience.

1: Embrace Market Pricing

The market is a very powerful entity. It takes the information held by millions of market participants around the world and conveys the combined knowledge into a single piece of information: the price. The price is in fact more than just a number. It represents the millions of estimates made about the value of a company into a single and continuously updated figure.

 

2: Work With the Market Not Against It

While the financial media may highlight the performance of any one manager as being stellar by picking the right stocks or correctly timing when to get in or when to get out, more often than not professional money managers fail to outperform their respective benchmark over long periods of time. Thus, capturing the market in a low-cost index fund is more likely to be a winning proposition for investors. As of the end of 2016, only 17% of U.S. equity mutual funds survived and outperformed their respective benchmarks for the 15 year period. Similarly, only 18% of U.S. bond fund managers survived and outperformed their respective benchmarks over the same period.

 


The sample includes funds at the beginning of the 15-year period ending December 31, 2016. Each fund is evaluated relative to the Morningstar benchmark assigned to the fund’s category at the start of the evaluation period. Surviving funds are those with return observations for every month of the sample period. Winner funds are those that survived and whose cumulative net return over the period exceeded that of their respective Morningstar category benchmark. US-domiciled open-end mutual fund data is from Morningstar and Center for Research in Security Prices (CRSP) from the University of Chicago. Index funds and fund-of-funds are excluded from the sample. Equity fund sample includes the Morningstar historical categories: Diversified Emerging Markets, Europe Stock, Foreign Large Blend, Foreign Large Growth, Foreign Large Value, Foreign Small/Mid Blend, Foreign Small/Mid Growth, Foreign Small/Mid Value, Japan Stock, Large Blend, Large Growth, Large Value, Mid-Cap Blend, Mid-Cap Value, Miscellaneous Region, Pacific/Asia ex-Japan Stock, Small Blend, Small Growth, Small Value, and World Stock. Fixed income fund sample includes the Morningstar historical categories: Corporate Bond, Inflation-Protected Bond, Intermediate Government, Intermediate-Term Bond, Muni California Intermediate, Muni National Intermediate, Muni National Short, Muni New York Intermediate, Muni Single State Short, Short Government, Short-Term Bond, Ultrashort Bond, and World Bond. See Dimensional’s “Mutual Fund Landscape 2017” for more detail. Benchmark data provided by Bloomberg Barclays, MSCI, Russell, Citigroup, and S&P. Bloomberg Barclays data provided by Bloomberg. MSCI data © MSCI 2017, all rights reserved. Frank Russell Company is the source and owner of the trademarks, service marks, and copyrights related to the Russell Indexes. Citi fixed income indices © 2017 by Citigroup. The S&P data is provided by Standard & Poor’s Index Services Group. Benchmark indices are not available for direct investment. Their performance does not reflect the expenses associated with management of an actual portfolio. There is no guarantee investment strategies will be successful. Past performance is no guarantee of future results.

3: Chasing Past Performance is a Recipe for Disaster

Rating companies like Morningstar and Lipper will provide an annual scorecard of mutual funds, rating them in terms of performance. Unfortunately, this information is completely unreliable as an indicator for a future investment strategy. Why? Most short-term outperformance is random luck versus an act of skill. Of the the fund managers who found themselves in the top quartile in any given year, only 23% of equity fund managers and 27% bond fund managers found themselves in the top quartile 5 years later, on average. 

At the end of each year, funds are sorted within their category based on their five-year total return. Funds in the top quartile (25%) of returns are evaluated again in the following year based on one-year performance in order to determine the percentage of funds that maintained a top-quartile ranking. The analysis is repeated each year from 2007–2016. The chart shows average persistence of top-quartile funds during the 10-year period. US-domiciled open-end mutual fund data is from Morningstar and Center for Research in Security Prices (CRSP) from the University of Chicago. Index funds and fund-of-funds are excluded from the sample. Equity fund sample includes the Morningstar historical categories: Diversified Emerging Markets, Europe Stock, Foreign Large Blend, Foreign Large Growth, Foreign Large Value, Foreign Small/Mid Blend, Foreign Small/Mid Growth, Foreign Small/Mid Value, Japan Stock, Large Blend, Large Growth, Large Value, Mid-Cap Blend, Mid-Cap Value, Miscellaneous Region, Pacific/Asia ex-Japan Stock, Small Blend, Small Growth, Small Value, and World Stock. Fixed income fund sample includes the Morningstar historical categories: Corporate Bond, Inflation-Protected Bond, Intermediate Government, Intermediate-Term Bond, Muni California Intermediate, Muni National Intermediate, Muni National Short, Muni New York Intermediate, Muni Single State Short, Short Government, Short-Term Bond, Ultrashort Bond, and World Bond. See Dimensional’s “Mutual Fund Landscape 2017” for more detail. Benchmark data provided by Bloomberg Barclays, MSCI, Russell, Citigroup, and S&P. Bloomberg Barclays data provided by Bloomberg. MSCI data © MSCI 2017, all rights reserved. Frank Russell Company is the source and owner of the trademarks, service marks, and copyrights related to the Russell Indexes. Citi fixed income indices © 2017 by Citigroup. The S&P data is provided by Standard & Poor’s Index Services Group. Benchmark indices are not available for direct investment. Their performance does not reflect the expenses associated with management of an actual portfolio. There is no guarantee investment strategies will be successful. Past performance is no guarantee of future results.

4: Markets Reward Investors in the Long-Run

The history of the capital markets has shown to reward investors with a long-run mindset. Although there are certain periods of extreme volatility, the markets are a long-term ally for the investor who rides them out. Because investors always require a positive return on the capital they supply, the pricing mechanism inherent in the stock market will always ensure that investors are expected to earn a positive return. For stocks, the historical return has been close to 10% over the last 91 years. 

In US dollars. US Small Cap is the CRSP 6–10 Index. US Large Cap is the S&P 500 Index. Long-Term Government Bonds is the IA SBBI US LT Govt TR USD. Treasury Bills is the IA SBBI US 30 Day TBill TR USD. US Inflation is measured as changes in the US Consumer Price Index. CRSP data is provided by the Center for Research in Security Prices, University of Chicago. The S&P data is provided by Standard & Poor’s Index Services Group. Long-term government bonds and Treasury bills data provided by Ibbotson Associates via Morningstar Direct. US Consumer Price Index data is provided by the US Department of Labor Bureau of Labor Statistics. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is no guarantee of future results.

5: Learn to Speak “Riskese”

Decades of academic research have identified certain risk factors in stocks and bonds that have compensated investors over long periods of time. These risk factors have identified differences in expected return between different groups of stocks and bonds. Building a portfolio that focuses on exposure to these factors will give you the highest expected return for the amount of risk taken.

Diversification does not eliminate the risk of market loss. Relative price is measured by the price-to-book ratio; value stocks are those with lower price-to-book ratios.
Profitability is a measure of current profitability, based on information from individual companies’ income statements.

6: Don’t Put All of Your Eggs In One Basket

As Nobel Laureate, Merton Miller, always said, “Diversification is your buddy.” IFA’s Index Portfolios are globally diversified across 46 countries and approximately 13,000 individual companies as to increase the reliability of capturing the benefits provided by capitalism around the world.

Number of holdings and countries for the S&P 500 Index and MSCI ACWI (All Country World Index) Investable Market Index (IMI) as of December 31, 2016. The S&P data is provided by Standard & Poor’s Index Services Group. MSCI data © MSCI 2017, all rights reserved. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. International investing involves special risks such as currency fluctuation and political instability. Investing in emerging markets may accentuate these risks. Past performance is not a guarantee of future results. Diversification does not eliminate the risk of market loss.

7: Timing the Market is a Fool’s Errand

Because nobody can accurately predict what is going to happen in the future, it is best not to try and figure out when is a good time to be in and out of the market or certain market segments. Being globally diversified means you always get to own the winner.

In US dollars. US Large Cap is the S&P 500 Index. US Large Cap Value is the Russell 1000 Value Index. US Small Cap is the Russell 2000 Index. US Small Cap Value is the Russell 2000 Value Index. US Real Estate is the Dow Jones US Select REIT Index. International Large Cap Value is the MSCI World ex USA Value Index (net dividends). International Small Cap Value is the MSCI World ex USA Small Cap Value Index (net dividends). Emerging Markets is the MSCI Emerging Markets Index (net dividends). Five-Year US Government Fixed is the Bloomberg Barclays US TIPS Index 1–5 Years. The S&P data is provided by Standard & Poor’s Index Services Group. Frank Russell Company is the source and owner of the trademarks, service marks, and copyrights related to the Russell Indexes. Dow Jones data provided by Dow Jones Indices. MSCI data © MSCI 2017, all rights reserved. Bloomberg Barclays data provided by Bloomberg. Chart is for illustrative purposes only. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results. Diversification does not eliminate the risk of market loss.

8: Partner with an IFA Wealth Advisor

The biggest value of working with an advisor is having someone to help control your emotions. Let’s face it, when times are turbulent our emotions will often trump our logic leading to devastating financial decisions. Having someone there when times get tough is ultimately an insurance policy against yourself.

9: Avoid the Siren Songs of the Financial Media

The media is in the business of selling stories, not investment advice. Stories are meant to be exciting. In contrast, as Nobel Laureate Paul Samuelson always said, “investing should be more like watching paint dry or watching grass grow. If you want excitement, take $800 and go to Las Vegas.” Like Ulysses in the epic poem The Odyssey, avoid the siren songs enticing you to actively invest and tie yourself to the mast of a long-term investment plan.

10: Invest and Relax

Once you have worked with an IFA Wealth Advisor to establish a long-term investment policy statement based on your individual capacity to take risk, relax. Your team at IFA will monitor your portfolio for rebalancing and tax loss harvesting opportunities as well as report on your portfolio’s performance. And, while all of that is taking place, your advisor is available to help with an array of additional wealth services.