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February-28-17

Buying Actively Managed Mutual Funds Is Dumb

If you’re hoping to achievement the happy retirement reflected in this photo, and you’re investing in actively managed mutual funds, I don’t like your chances. Sorry to be so blunt, but buying these funds is dumb— really dumb. Here’s why.

Undisclosed conflicts and more

Don’t be bamboozled by all the confusing talk about the “fiduciary rule”, promulgated by the Department of Labor, and now delayed by the Trump administration. It makes absolutely no sense to entrust your savings to anyone who who won’t agree, in writing, to fully disclose all conflicts of interest and to always place your interest above both theirs and their firm’s.

Every registered investment advisor is required by law to do so. Brokers are not. They can, and often do, have undisclosed conflicts of interest and are permitted to recommend investment products that are more expensive and more profitable for them than lower cost, comparable products, as long as their recommendation is deemed “suitable” for you.

Brokers use this loophole to recommend actively managed funds, even though they are aware of the overwhelming data indicating these funds are likely to underperform far less expensive, comparable index funds — especially over the long term.

You don’t want to invest in “suitable” products. You should insist on recommendations that are solely in your best interest, which means that costs and fees are taken into account.

The one question every broker dreads

In 2016, there was a shift from active into passive (index-based) investments of almost $1 trillion. Clearly, the smart money isn’t buying the purported ability of brokers to prospectively select outperforming, expensive, actively managed mutual funds.

Here’s the question I want you to ask your broker when he or she recommends actively managed mutual funds: What are the odds this fund will beat the returns of a comparable index fund over a 10 and 20-year period? It’s important to insist on a response in writing.

Here’s what’s likely to happen: You’ll never get one. The broker will have a lot of excuses (like “my compliance department won’t let me”), but the real reason for dodging this question is because the answer is devastating to the business model of brokers. They understand that, if you knew the data, you wouldn’t own any actively managed mutual funds.

According to an excellent white paper from Vanguard:

At the beginning of 1998, there were 1,540 actively managed U.S. domestic stock funds;

  • Only 55% of them survived the ensuing 15-year period;
  • Only 18% of the survivors outperformed their benchmarks;
  • 97% of the outperforming funds unperformed their benchmark in at least 5 years of the 15-year period studied.

Here’s what this data tells you (and what your broker hopes you won’t learn). Your chance of selecting an outperforming mutual fund over a long period of time is exceedingly small. Even if you are successful, you will have to hold on to the fund for a number of years of underperformance. It will be a rocky ride, with an uncertain result.

The road to reaching your retirement goals is paved with low management fee index funds. The road to your broker reaching his or her retirement goals depends on persuading you to buy expensive, actively managed funds.

Buying Actively Managed Mutual Funds Is Dumb blog was originally posted on The Huffington Post website.

 

2014-04-01-Hiresfrontbookcover.jpgDan Solin is a New York Times bestselling author of the Smartest series of books, including The Smartest Investment Book You’ll Ever Read, The Smartest Retirement Book You’ll Ever Read, The Smartest 401(k) Book You’ll Ever Read and his latest, The Smartest Sales Book You’ll Ever Read. He is a wealth advisor with Buckingham and Director of Investor Advocacy for The BAM ALLIANCE.

The views of the author are his alone and may not represent the views of his affiliated firms. Any data, information and content on this blog is for information purposes only and should not be construed as an offer of advisory services.

 

 

By: Dan Solin | 0 comments
February-21-17

Bad Advice From A (Very) Good Economist

On February 17, 2017, the Dow Jones Industrial Average closed at 20,624. It is up 4.36 percent for so far in 2017. In 2016, when adjusted for dividend reinvestment, the DJIA returned 16.47 percent. Given these extraordinary gains, it’s not surprising that investors are nervous about a bubble that might soon burst.

In his first weekly column as the successor to Scott Burns (who retired), Laurence Kotlikoff, a highly respected economist who teaches at Boston University, didn’t mince words. Here’s his recommendation: “Sell your stocks (and your long-term bonds, too) until the dust settles.”

Here’s why this is bad advice.

No one knows

Professor Kotlikoff has sound reasons underlying his sell recommendation. He correctly notes that the bull market is long in the tooth, having lasted for 8 years. The price of stocks is “very high relative to profits”. The possibility of unsettling news (like a trade war or a boycott of U.S. goods, among other possibilities), given the turmoil caused by the policies of the Trump administration, could cause the market to crash. He correctly notes that “uncertainty and the stock market don’t mix.”

The harsh reality, as Professor Kotlikoff candidly acknowledges, is that “smart economists never predict the stock market” because the market is random and unpredictable. Why then does he make an exception? Because “economic theory is not perfect” and “...bubbles ... can burst at any moment because they aren’t based on fundamentals.”

He could be right....or wrong. No one knows.

A poor track record

The track record of economists who predict the direction of the market is not encouraging. Larry Swedroe, the Director of Research for The BAM Alliance, summarized the data in this blog post.

Remember the Great Recession in 2008? A survey of professional forecasters thought the chance of a recession was only 3 percent. Swedroe noted that “since 1990, economists have forecasted only two of the 60 recessions that occurred around the world a year in advance.”

Even if someone could tell you when to get out of the market, can they also predict when you should get back in? Stock markets tend to recover very rapidly. For example, in 2008, the S&P 500 index (dividends included) lost 37.2 percent. Let’s assume you relied on an economist and went to cash in 2007.

For the two-year period from 2009-2010, the S&P 500 index gained 46 percent. It’s been on an upward trajectory since that time. What are the chances the “guru” who predicted when to get out was also able to provide the optimal time for reentry?

A better way

There’s a better way to deal with current market conditions. Take a hard look at your asset allocation (the division of your portfolio between stocks and bonds). Given the run-up in stock returns, your portfolio has probably increased significantly in value over the past 8 years (assuming you have stayed the course and ignored most of the financial media!).

Do you really need to take as much risk? If not, reduce your allocation to stocks. Be sure you have enough short term, high quality bonds in your portfolio that you wouldn’t need to sell stocks at a loss for a 2-3 year period to fund your expenses.

The market may take off or tank. Intelligent investors focus on factors they can control, like their asset allocation, low fees and deferring or eliminating taxes. While I have a high regard for Professor Kotlikoff, relying on his predictions (or those of anyone else) about the direction of the market, is not a responsible way to invest.

Bad Advice From A (Very) Good Economist blog was originally posted on The Huffington Post website.

 

2014-04-01-Hiresfrontbookcover.jpgDan Solin is a New York Times bestselling author of the Smartest series of books, including The Smartest Investment Book You’ll Ever Read, The Smartest Retirement Book You’ll Ever Read, The Smartest 401(k) Book You’ll Ever Read and his latest, The Smartest Sales Book You’ll Ever Read. He is a wealth advisor with Buckingham and Director of Investor Advocacy for The BAM ALLIANCE.

The views of the author are his alone and may not represent the views of his affiliated firms. Any data, information and content on this blog is for information purposes only and should not be construed as an offer of advisory services.

 

 

By: Dan Solin | 0 comments
February-14-17

Desperate Times

Shakespeare could not have been more correct when he observed, “desperate times breed desperate measures.”

There’s a lot of desperation in the securities industry — and for good reason. You’re no longer a clueless victim and are abandoning active management in droves. According to an article in The Wall Street Journal, for the 3-year period ending August 30, 2016, $1.3 trillion flowed into passive strategies. Active strategies lost almost 25% of their total assets under management over the same time period.

You’ve figured out that investing in actively managed funds, stock picking and market timing enriches the securities industry at your expense. You understand you are paying for expensive funds that are likely to underperform a less expensive index fund and that performance of the “winning” funds is unlikely to persist.

You’re now aware of the “low and declining odds that active management will outperform”, as described by Larry Swedroe in this blog post.

The ramification of your knowledge is seismic for the financial media, your broker and actively managed funds. They’re fighting back with a series of desperate acts, designed to dissuade you from abandoning them. Here’s a sampling:

The financial media

If intelligent and responsible investing becomes mainstream (as it appears to be headed), watching breathless reporting from the floor of the NYSE, and listening to discredited pundits pick stocks and predict the future of the markets, becomes a counter-productive, irrelevant activity. This means viewership will continue to decline and revenues will erode.

The financial media is responding by largely ignoring the compelling data and doubling down on baseless stories that it hopes will keep you watching. Examples abound, but a recent blog on CNBC entitled: “Investors worried about President Trump should buy these stocks, Goldman Sachs says”, is illustrative.

Responsible journalism would require disclosure of the track record of the “strategist” quoted in the article. The underlying premise is also flawed. If an investor is genuinely “worried” about President Trump, the investor shouldn’t be picking stocks. Instead, he or she should have no stock market exposure.

But that sage advice doesn’t fit the false narrative that some “strategist” can predict which stocks will outperform in the future.

Don’t be fooled.

Brokers

When is the last time your broker recommended buying a globally diversified portfolio of low management fee index funds?

That’s not how they make money. They want you to believe they add value by selecting actively managed funds and outperforming stocks. Now that you’ve figured out this isn’t true, you have no reason to use them. You can purchase index funds, including ETFs, directly from low cost providers like Vanguard, Fidelity and Schwab, or use cost-effective robo-advisors, like Wealthfront and Betterment.

There is no reason to use a traditional broker or an advisor who claims the ability to “beat the market.”

You can expect them to inundate you with “advice” like this gem from JP Morgan, in which it “upgrades” Praxair (NYSE: PX) “to overweight from neutral, citing greater demand ahead because of Donald Trump’s economic policies.”

Since the information about Trump’s economic policies is public, it’s already factored in the share price of Praxair (and all other stocks). There’s no logical reason to believe this stock is mispriced at present.

Stating otherwise is a desperate act.

Actively managed funds

If everyone understood the low odds of actively managed funds outperforming a comparable index fund, many more funds would go out of business.

Vanguard’s chief, William McNabb, correctly observed “Over the decade ended in 2015, 82 percent of actively managed stock funds and 81 percent of active bond funds have either underperformed their benchmarks or shut down.”

The active fund industry will continue to obscure this data with the help of financial journalists who keep hope alive with silly articles like: “Why 2017 could be the year stock pickers regain their edge.”

This article validates the view that active investing is “the triumph of hope over experience.”

Active managers dread the possibility you will learn that a comprehensive analysis of major fund families found almost all of them underperformed comparable index funds from Vanguard and passively managed funds from Dimensional Fund Advisors.

This analysis reached this telling conclusion: “This data serves as strong evidence that, even though the markets may not be perfectly efficient, investors in most actively managed funds will not benefit from efforts to exploit supposed inefficiencies, especially once taxes are considered.”

Expect active managers to fight back with “advice“ like “Active or passive investing? Try both.”

Here’s what it won’t disclose: The most likely result of “trying both” is that your returns will be less than if you had limited your investments to only index funds. You could get lucky, but the odds are against you.

Desperate Times blog was originally posted on The Huffington Post website.

 

2014-04-01-Hiresfrontbookcover.jpgDan Solin is a New York Times bestselling author of the Smartest series of books, including The Smartest Investment Book You’ll Ever Read, The Smartest Retirement Book You’ll Ever Read, The Smartest 401(k) Book You’ll Ever Read and his latest, The Smartest Sales Book You’ll Ever Read. He is a wealth advisor with Buckingham and Director of Investor Advocacy for The BAM ALLIANCE.

The views of the author are his alone and may not represent the views of his affiliated firms. Any data, information and content on this blog is for information purposes only and should not be construed as an offer of advisory services.

 

 

By: Dan Solin | 0 comments
February-07-17

Why You Believe Lies

Here’s a subject of endless fascination for me. The securities industry is premised on a series of lies. The most pernicious one is that it can help you plan for retirement by “managing” your money.

The reality is quite different.

Do this comparison

Let’s assume you didn’t use any broker to “assist” you with your portfolio. Instead, you invested in Vanguard’s LifeStrategy Moderate Growth Fund (VSMGX). That fund invests 60% of its assets in stocks (including international stocks) and 40% in bonds, including international bonds. If this asset allocation isn’t suitable for you, you could invest in one of the other LifeStrategy funds, which offer both more conservative and more aggressive asset allocations.

A 60/40 asset allocation is suitable for many investors. Many defined benefit plans (remember them?) used this allocation as its default because of its general applicability.

Since inception on September 30, 1994, the Moderate Growth Fund had an average annual return (as of December 31, 2016) of 7.48%. You can find returns for other periods here.

Now, let’s do this simple experiment. Check your statements. Compare your returns to the returns of this index-based fund. I strongly suspect you underperformed, relying on the “insights” of your broker, who probably engaged in stock picking, market timing and recommend expensive, actively managed mutual funds.

Curious behavior

Not only did your portfolio likely underperform, but you continue to rely on brokers who have undisclosed conflicts of interest, which they can (and often do) resolve in their own favor. And let’s not even discuss the shocking ethics of these firms, who have been subject to innumerable criminal and civil actions, reflecting their utter disdain for your best interest.

The Securities and Exchange Commission complied a list of enforcement actions addressing misconduct that led to or arose from the financial crisis. You can find it here.

Why you believe lies

Curiously, despite their shocking, illegal conduct, investors continue to entrust their life savings to their care. Why do you believe their lies?

A recent article in Politico addresses this subject.

Initially, when confronted with a lie (like “you can trust us to manage your money in your best interest”), we accept the lie as true, because only then can we evaluate it. When the lies are compounded (“We have the ability to pick outperforming stocks”), our brains experience what is known as “cognitive load.” The brain becomes overwhelmed by the effort involved in debunking a steady stream of lies, causing us to “just give up trying to figure out what’s true.”

When the lies are repeated, the brain recalls the lie and it becomes part of our reality. As noted by Politico: “Repetition of any kind—even to refute the statement in question—only serves to solidify it.”

It turns out that “false beliefs, once established, are incredibly tricky to correct.”

Keep this in mind the next time your broker offers to “help” you reach your retirement goals.

Why You Believe Lies blog was originally posted on The Huffington Post website.

 

2014-04-01-Hiresfrontbookcover.jpgDan Solin is a New York Times bestselling author of the Smartest series of books, including The Smartest Investment Book You’ll Ever Read, The Smartest Retirement Book You’ll Ever Read, The Smartest 401(k) Book You’ll Ever Read and his latest, The Smartest Sales Book You’ll Ever Read. He is a wealth advisor with Buckingham and Director of Investor Advocacy for The BAM ALLIANCE.

The views of the author are his alone and may not represent the views of his affiliated firms. Any data, information and content on this blog is for information purposes only and should not be construed as an offer of advisory services.

 

 

By: Dan Solin | 0 comments