Every now and then (okay, every week) I run into someone with a different investment philosophy from my own. Occasionally, the exchange is jaw-dropping. For instance, I kind of thought the passive vs actively managed investment argument had been pretty much decided for the last 10-20 years. Apparently, not everyone feels that way, despite what I consider fairly overwhelming evidence. I had lunch the other day with a well-educated, pleasant, articulate investment advisor who works for one of the big investment banks. He wanted to meet with me because he was exploring becoming a “specialist” in advising physicians. His thought was that because he had some optometrists in his family, that this would be a good idea, never mind that he had no idea how PAYE/PSLF worked, thought the costs of dealing with HIPAA were insignificant, and didn't think it was important to spend a few weeks or months getting a CFP or CFA. He also thought the investment management was far more important than the financial planning for doctors (“we don't even charge for financial plans in our office.”) Well, that's fine. I suppose advisors have to start somewhere. But then he starting talking about how he actually believed in active management. At this point, 95% of the respect I had for him went out the window. His arguments were:
- I've looked at the data and I believe it shows active management works better.
- Studies showing active management doesn't work include mutual fund loads, which we don't charge.
- Although 2/3 of academics believe in passive management, 1/3 of academics believe in active management.
- Sure, doctors can retire on market returns, but an engineer making $70K needs higher returns in order to have a comfortable retirement.
- Warren Buffett can beat the market.
- The best predictor of future returns is past returns (not low costs.)
Let's start with his first argument and take a quick look at some of the evidence, just in case any regular readers were still in doubt. Exhibit A is the SPIVA annual report card. I wish these went back for 10 or 20 years, but unfortunately they only go back five years. Still, it's a pretty damning indictment. Here's a chart of the end 2013 report card:
| 5 Year Data- 2009-2013 | ||||
| Asset Class | % Beating Index | % Disappeared | % Changed Style | |
| LC Growth | 33% | 25% | 41% | |
| LC Blend | 20% | 28% | 45% | |
| LC Value | 29% | 25% | 44% | |
| MC Growth | 14% | 32% | 51% | |
| MC Blend | 16% | 25% | 55% | |
| MC Value | 33% | 22% | 68% | |
| SC Growth | 30% | 27% | 39% | |
| SC Blend | 25% | 26% | 45% | |
| SC Value | 39% | 16% | 56% | |
| Multi- Cap G | 31% | 28% | 61% | |
| Multi-Cap B | 23% | 25% | 48% | |
| Mult-Cap V | 32% | 26% | 72% | |
| Real Estate | 20% | 11% | 11% | |
| Global | 34% | 31% | 32% | |
| International | 29% | 26% | 27% | |
| Small International | 55% | 12% | 22% | |
| Emerging Markets | 20% | 18% | 19% | |
| Long Treasuries | 53% | 23% | 28% | |
| Int Treasuries | 53% | 21% | 33% | |
| Short Treasuries | 58% | 14% | 16% | |
| Long Corporates | 48% | 18% | 37% | |
| Int Corporates | 43% | 26% | 29% | |
| Short Corporates | 71% | 22% | 23% | |
| Junk Bonds | 9% | 16% | 17% | |
| Mortgage Backed Bonds | 60% | 4% | 7% | |
| Global Income | 54% | 21% | 23% | |
| Emerging Markets | 36% | 4% | 4% | |
| Muni Bonds | 60% | 16% | 17% | |
For those looking at this type of report for the first time, the first column is the asset class. The second column is the percentage of funds in the asset class that beat their respective index. The third column is the percentage of funds that went out of business during this 5 year time period. The last column is the percentage of funds that changed their style-i.e. weren't investing in the same asset class at the end of the period as at the beginning.
The interesting thing about data like this is that as a general rule, the further you go out, the lower the percentages get. For example, after one year, the numbers are usually pretty close to 50% of the funds beat their index. But as you go out to 5, 10, or more years, it becomes much harder for an actively managed fund to beat its benchmark. But this chart just shows the 5 year results. The results are very damning for equity funds. In only a single equity asset class (1 out of 17), did active managers beat their index on average. Typically, about 1/5th to 1/3rd of managers managed to beat the index over 5 years. However, 11-32% of them went out of business all together and another 11-68% decided they didn't want to invest in the same asset class. Thought you were investing in a mid cap value fund? Nope. It's now a small cap blend fund. Surprise!
Active bond fund managers did quite a bit better than the equity managers. The average manager in 7 out of 11 asset classes beat their respective index, although in only one of those categories was the victory particularly convincing. The natural conclusion would be that active fund management must really work in bonds, especially short term bonds. However, remember we're only looking at 5 years here. If you look at the SPIVA report for 2006, you'll see that it was only 3 out of 11 categories. In the five years ending 2012, only 30% of bond funds beat their indices.
As a long term investor, I find that data very compelling, especially for equities. I don't worry about the fixed income side as much, since I don't actually own a fixed income index fund! The most important factor there seems to be cost anyway, and I have very low cost bond funds. The data gets even stronger, by the way, when you compare a portfolio of index funds to a portfolio of actively managed funds. Rick Ferri's recent award-winning white paper showed that over a 16 year period, using an index strategy was superior to an actively managed portfolio.The index fund portfolio beat the actively managed portfolios 80% of the time. Interestingly, when the actively managed funds lost, they lost by 1.6% per year. But when they won, they only won by 0.7% per year. The index funds still win when you adjust for risk and when you only use low-cost active funds.
Let's move on to my opponent's next argument.
Doesn't Include Loads?
My opponent suggests this data includes those pesky loads. Well, if you actually read the methods section, it says this:
Fees
The fund returns are net of fees, excluding loads.
Well, that pretty much puts that argument to rest, no?
1/3 of Academics Believe in Active Management
His next argument was that only 2/3 of academics believe passive management is the way to go. Apparently, 1/3 of them have never seen a SPIVA report card. Perhaps there is a poll out there (I couldn't find one) suggesting this is true, but if you were going to invest based on a poll of academics, why wouldn't you go with the majority?
Only High Earners Can Settle for Market Returns
I found this argument pretty funny, especially considering how many engineers there are on the Bogleheads forum. Either you can beat the market reliably or you can't. Your desire or need to do so has nothing to do with whether it is likely. Once you have accepted that trying to beat the market is either unlikely or not worth the time, effort, and money, investment management becomes a far easier and more profitable exercise. If beating the market were likely, doctors would like to do it just as much as engineers, I assure you. But it isn't. So smart doctors and engineers don't waste their time, energy, and money trying. They invest their time actively and their money passively. Besides, whether you make $100K or $200K, if you save the same percentage of your gross income for the same number of years (the engineers actually get a few more due to less time training), and invest the same way, that retirement portfolio will replace exactly the same percentage of your pre-retirement gross income. Simple math and truly a silly argument.
But Warren Buffett Can Do It!
Ahh..the tried and true Warren Buffett argument. The question has never been “What about Warren Buffett?” The question is why aren't there more Warren Buffetts? On a purely statistical basis of random luck, there should be ten times as many Warren Buffetts as there seem to be. Besides, how does Warren Buffett recommend you invest?
1996- “Most investors, both institutional and individual, will find that the best way to own common stocks (shares') is through an index fund that charges minimal fees. Those following this path are sure to beat the net results (after fees and expenses) of the great majority of investment professionals.”
2007- “The active investors will have their returns diminished by a far greater percentage than will their inactive brethren. That means that the passive group – the “know-nothings” – must win….The best way in my view is to just buy a low-cost index fund and keep buying it regularly over time, because you'll be buying into a wonderful industry, which in effect is all of American industry…People ought to sit back and relax and keep accumulating over time.”
2008- “The American economy is going to do fine. But it won't do fine every year and every week and every month. I mean, if you don't believe that, forget about buying stocks anyway… It's a positive-sum game, long term. And the only way an investor can get killed is by high fees or by trying to outsmart the market.”
2014- “What I advise here is essentially identical to certain instructions I've laid out in my will. One bequest provides that cash will be delivered to a trustee for my wife's benefit….My advice to the trustee could not be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard's.) I believe the trust's long-term results from this policy will be superior to those attained by most investors – whether pension funds, institutions or individuals – who employ high-fee managers.
You're not Warren Buffett. Neither is your adviser. So do what Warren recommends and invest passively.
Best Predictor of Future Returns
In addition to the above report card, SPIVA also publishes a persistency report. It turns out that only poor past performance is predictive. If a fund was terrible in the past, it will be terrible in the future. In it was great in the past, that has no predictive value. In fact, it may even have negative predictive value. I won't post a table, but here's the summary:
Very few funds can consistently stay at the top. Out of the 687 funds that were in the top quartile as of March 2012, only 3.78% managed to stay there by the end of March 2014. Further, 1.90% of the large-cap funds, 3.16% of the mid-cap funds and 4.11% of the small-cap funds remain in the top quartile.
For the three years ended March 2014, 14.10% of large-cap funds, 16.32% of mid-cap funds and 25.00% of small-cap funds maintained a top-half ranking over three consecutive 12-month periods. Random expectations would suggest a rate of 25%.
An inverse relationship exists between the measurement time horizon and the ability of top-performing funds to maintain their status. It is worth noting that no large-cap or mid-cap funds managed to remain in the top quartile at the end of the five-year measurement period. The figures paint a poor picture of the lack of long-term persistence in mutual fund returns.
Similarly, only 3.09% of large-cap funds, 3.6% of mid-cap funds and 5.48% of small-cap funds maintained top-half performance over five consecutive 12-month periods. Random expectations would suggest a repeat rate of 6.25%.
So what does predict future returns? Russell Kinnel, the director of research at Morningstar, says this after studying the data extensively:
If there's anything in the whole world of mutual funds that you can take to the bank, it's that expense ratios help you make a better decision. In every single time period and data point tested, low-cost funds beat high-cost funds….Expense ratios are strong predictors of performance. In every asset class over every time period, the cheapest quintile produced higher total returns than the most expensive quintile.
I'm not sure what they're teaching in MBA school or at the big bank and brokerage companies, and I'm well aware that there is a momentum factor out there, but the best predictor of future mutual fund returns remains low costs, not past performance. There's a reason the SEC requires a mutual fund prospectus has to say “Past performance does not necessarily predict future results.”
A Great Question For A Potential Adviser
Yes, there truly are people out there who still believe in active management. So when interviewing potential advisers, one of the first questions I would ask is “Can beat the market yourself or choose mutual fund managers who can?” If the answer is yes, stand up and walk out. The “value-add” you're looking for in an advisor isn't an unsuccessful attempt to beat the market.
What do you think? Do you consider the active vs passive debate to be settled? If not, what do you think is the best way to use active management? Comment below!
The Warren Buffet argument apparently is even weaker once you find out how Mr Buffet actually beats the market- he uses other people’s money. He takes in money for insurance. That is basically borrowing money that you have to pay back in the form of claims paid. If you pay out less than you take in you are borrowing money at a negative interest rate, but even if you get unlucky and pay out more, you can be fairly sure it is a low rate of interest. So what does he do with that money while he “borrows it?” He invests. Say he invests $100 in a stock and it goes up to $105. Up 5% like everyone else in the stock, right? Nope. Because he only put $50 of his money in and $50 from his borrowed money in –but he takes out all $5 of the profit on his $50 investment? He is up 10% while the rest of the investors in the same stock or index or anything only made 5%. No wonder he can beat the market. Its called using leverage. And he has figured out how to do it very well. THAT is how Warren beats the market, not by brilliant active management.
No reputable insurance company would willy nilly use the money for investment speculatively. They do use the float money, that is the money not set aside for likely claims. This is probably not even close to being a major contributor of their free cash flow. BrkHwy owns many many business outright (which provide cash flow) as well as some very large stakes in other ones. From his stake in Coca-Cola alone he received over 50% Yield on Cost last year, something like 400 million dollars. He has a similar set up with many other investments, redeploying the capital to further investments. Buffet is brilliant, and shrewd.
Its just as easy to lose other peoples money as your own, even easier. That distinction has no bearing on his ability.
Paul,
It almost sounds like your are discounting Warren’s prowess as an investor, by saying he wins by using leverage. I would hope you know this isn’t what makes him a great investor, because anyone can use leverage, but because leverage works both ways it will magnify your loses as well as your gains.
Dave
I am discounting his return numbers. Those who invest exactly as Warren does will not get the same return without using the same leverage. He invests well, but it is use of borrowed money that creates the extraordinary returns above the market return.
Paul,
It is pretty much a mute point as you can’t invest exactly like Warren, because he doesn’t make his investments known at the time.
Your logic is however flawed in the fact that it is NOT the leverage that makes the investment better – leverage only multiplies the affect. If you underperform the market, the leverage will make your investment underperform by more. If you out perform the market then the leverage will magnify that.
fd
I believe in my own retirement plan and I am going with passing index investing with the appropriate re-balancing to keep things even and moving forward while minimizing my risk. I am in the $70k a year earnings that this guy spoke of. Of course I’d love to get a higher return and chase after it but I’ve learned with a little more time and patience and cutting your own costs you can compound that savings and see a great result!!!
I consider the active vs passive debate as settled. However, I know a number of very smart people (some of whom are in the financial industry) who simply haven’t done their research and assume active management provides added value.
I wanted to make one correction. A CFA charter cannot be earned in a matter of weeks or months and usually takes a minimum of three years to pass all three exams (often more given the low pass rates).
From the wikipedia page on the subject: The CFA Institute estimates that at least 250 hours of independent study is necessary to pass each exam.
250 hours of studying is 5 weeks of 50 hours a week. Multiply by three and you get to 15 weeks. That certainly falls into my definition of “weeks or months.” Just because most people who take the test have a full-time job and are studying on the side, and just because they take tests months or years apart does not mean it takes more than “weeks or months” to study for the test.
Sorry, I’ve studied 250 hours for a test before. I know exactly what it is like. Heck, I spent that long just reviewing for USMLE Step I. Not counting the two years of classwork I spent learning the stuff in the first place.
You are right that almost everyone taking the CFA exams already has a full-time job (and perhaps a family), which makes studying 50 hours per week very difficult. However, it’s 250 hours per exam, and the exams are only offered every six months. You don’t earn a partial designation for passing each exam; you need to pass all three exams. So, at best, a person could pass all three in a year and a half. But I have never heard of it being done, especially with pass rates generally ranging from 35%-45%.
On average it will take a person 3 years to complete the CFA if you start at CFA I and take the next level each year. It definitely is a commitment.
Right. But mostly because they people taking it have a full time job and because the tests are only offered on certain dates.
1) a person convinced against their will is of the same opinion still.
It is bizarre, but many people still choose to take a course of action in spite of overwhelming statistical evidence to the contrary. Like the vaccine issue.
2) some people simply can’t handle the facts that doing nothing essentially is better than doing something. It flies in the face of almost everything else in life.
On the same token many people still can’t accept that computers/machines are better than people.
3) there is too much money at stake for advisors that need to perpetuate the myth.
4) far too many people couldn’t even tell you of their money was passively or actively managed or really what those terms even mean. They just know their guy is doing an ok job.
#4 is the biggest reason active management won’t go away. If you are financially literate enough to read and comprehend this article you don’t need the advice in it. But too many smart people unfortunately this is written in Greek.
3 things:
1. There seems to be a proliferation of financial advisors who say that they specialize in doctors. When queried, most seem to know little about the specific financial plight and circumstances of docs, only that we have a decent income that they could easily convert to a revenue stream for them!
2. It is my opinion that the financial advisor of the future will be heavy on the planning and light on the investing advice. As in, “here’s a link to Vanguard (or Betterment), here’s what I think you should do, and we’ll review it all next year.”
3. Since YOU brought it up, I am about a third of the way through Antonacci’s Dual Momentum Investing and increasingly of the opinion that the momentum effect is real and actionable (based on this book and earlier reading). While it might add complexity to a simple and academically vetted buy-and-hold low cost Vanguard or DFA investment plan, I am probably going to have difficulty ignoring it going forward.
How have you decided to implement it?
I have not yet decided, but I expect that I will take a portion of my Vanguard Roth IRA and establish some trend following rules protocol. I am unlikely to use an established momentum fund (AQR funds) or ETF (MTUM) as I believe that the momentum effect is diluted by trading and management expense and staying within one asset class, based on what I have read so far. It might be best for me to work with Vanguard ETFs with low fees and no trading costs within the Vanguard account.
If you would like, when I finish the book, I will post my plan.
I have read the book and it is a very very compelling strategy. I’m very tempted to go with the Global Equity Momentum strategy, at least in non taxable accounts, but have not done so. The reason? I’m not sure it’s such a good idea to dump a strategy that works well, and has a long history of working well, (passive indexing) for one that has much less of a history.
Why not just do it with 10% of your portfolio in a Roth IRA for a few years?
I’m considering doing that actually, using my “play money”, but on the other hand it’s not going to move the needle much doing it that way, so would really be just for fun. I’ve got as far as watching the appropriate ETFs (I’m in Canada, so VUN, VCN, XEF and BIL) on stockcharts.com
Sounds great. You could also do a book review and send me that as a guest post.
Will plan on it. 🙂
Robert,
I’d be very interested in seeing how you thought of the book. It looks like Dual Momentum is the latest hot craze in the active management world.
I’m listening to an interview of Antonacci right now and he mentioned he first got exposure to a quasi “momentum/trend following” technique back in the 1970s when he first started out as a young stock broker.
And I’ve also looked at youtube videos 3-4-5 years ago where people talk about momentum investing…so the elephant in the room is….if this is such a surefire way to get greater returns AND at lower risk than indexing….then why is it that all the professionals on wall street not beating the pulp out of the indexes/market year after year? Why is this such a new thing now?
Why would someone write a book divulging the secrets to such an awesome tehcnique? Unless he’s just selling snake oil again?
I’m skeptical so I will see how this thing turns out. I will not fork over $40 to buy an active management book that promises almost something too good to be true. I’m waiting for book reviews and waiting for it to show up in the public libraries
WCI,
I saw that a fellow MD financial blogger, Miles Dividend MD, seems to have bought into the Dual Momentum Investing practice and his blog post is in full support of this.
So I will be interesting to have a discussion or a blog post over this new active management strategy.
Will this be another fad or something that actually may defy the indexing theory?
I’m listening to a podcast of interview of Antonacci, and looks like he rejects the Efficient Market Hypothesis.
I’ve invited several people to submit a guest post/book review about it. None have done so yet.
I’m skeptically and cautiously optimistic about momentum based investing.
I promise that I will write a review. It might take a couple weeks.
RK
Don’t anyone get too excited. I’m 2+ months out on guest posts right now and 3 months out on my own posts!
Indeed, that is a good way to put it….I’m usually a hopeful guy and am also cautiously optimistic as well.
Looks like Mr. Robert K may be the first one and I look forward to it!
Awesome to hear a review will be coming! Can’t wait to see the comments section of that one…I’ll have my popcorn ready, going to be a fun one.
Ming, even though there’s plenty of reviews, just read the book. Don’t depend on “others” to convince you. If there is doubt or any skepticism in your mind, even the slightest, don’t use the philosophy. This holds for any philosophy/strategy. Systematic investing will NOT work unless you’re 110% bought into the concepts, unfortunately to the point of almost arrogance, and have the iron-clad psychological discipline to stick to it for 40+ years. It’s ok to have doubt, this stuff isn’t for everyone.
But it doesn’t hurt to keep reading and learning as much as you can about all types of strategies and philosophies until you find what fits you perfectly–that’s the “Holy Grail” of investing and the returns (both monetarily and psychologically) can be incredible once you find it.
Ut oh, blasphemy, don’t mention a peep about that book here 🙂 But I’m glad you’ve found it though. And whether or not you implement that exact strategy or tweak it to your liking doesn’t really matter. The main point is that it will re-wire your brain to “think” differently/unconventionally, and more in line what the winners do, which should have a profoundly positive impact on the rest of your financial/investing career. Congrats for opening your mind to it and objectively seeing it for what it is.
Couple thoughts on the article:
1). I wonder why active management works in every other field (medicine, sports, business, etc…) but not investing? I mean for those who saw the movie Money Ball, or know the story of Oakland A’s manager Billy Bean, he clearly knew how to actively manage a baseball team, and the game has been forever changed because of his unconventional way of thinking. I agree active management wouldn’t work anywhere, in any field, if all the pieces (players, people, etc…) had random outputs, but clearly they do not…some players, doctors, what have you, end up being better than others. Always. Same with stocks, or any market; some will be better than others, and the outputs are not random. Apple, for example, will not be profitable today, and then unprofitable tomorrow randomly.
1). Academia and evidence based research increasingly is pointing towards markets being inefficient (ie not random ) with a propensity to have “winners,” large trends and “fat-tail” type returns structures due to many factors including market participant irrationality (the whole “behavior finance” field).
2). This allows for the “right” type of active management to do well and create alpha or “beat” markets.
3.) Bad news is, it’s extremely difficult, there’s only a few Billy Bean’s out there, but unlike in other professions, many enter the financial management game due to low barriers to entry and high potential financial reward, yet only very few are able to do it successfully, repeatedly.
4) So at the end of the day, we all basically agree that passive investing is best for the vast majority of people. But be careful saying “active management is impossible” to defend your position of passively investing. It makes more sense to say: “the odds are extremely low that I can be successful at active management, and also extremely low that advisors themselves can be successful, and so I’ll be a passive investor which will do just fine.”
That didn’t take long. I figured you’d be along shortly with a 500 word comment about momentum!
I think your last sentence precisely sums up my position on the matter:
Haha, thought I was having a nightmare when I saw the article headline come across my email this morning!
Agreed, the odds are just too low (and risks too high) for most to mess with active mgmt. I like your exhibit A, that’s really a nice representation of it…wish it went back for decades too.
I had never heard of this book before, so I just went and read the Amazon summary and some reviews. How is this not a fancy dressed-up version of market timing that gets you to buy high? I would be interested to read some debate about it. Personally, when I rebalance I think to myself, “If my target allocation is low on emerging markets, and everyone on CNBC says to stay away from emerging markets, isn’t that exactly where I should prioritize my rebalancing or new contributions?” So it seems to me that I think the opposite of ‘momentum’, but admittedly I haven’t read the book.
Hi, Josh,
If you want to have an intelligent discussion of momentum and its role in investing, I recommend that you read the book, not just someone’s comments about the book.
Another excellent book in this area is the Ivy League Portfolio. You can borrow it from the library, but here is the Amazon link-http://www.amazon.com/The-Ivy-Portfolio-Endowments-Markets/dp/1118008855. I do not recall if they discuss momentum, per se, but their trend following strategy shares elements of momentum investing.
All that said, most are still better off with a buy-hold-rebalance strategy that is set to an asset allocation that you can stick with through thick and thin. Lately, we have had mostly thick. It will be interesting to see how the younger investors, those who have joined the market in the last five years, handle the thin.
Faber (author of Ivy League Portfolio) is one of the good guys in the industry. Faber, Antonacci, Swedroe, myself, among others have each recently done podcasts with Michael Covel in case anyone wants free access to some of the thinking surrounding this paradigm of active management/momentum: http://www.trendfollowing.com/podcasts/ The podcast series is full of academics, psychologists, authors, Nobel Prize winners, and professional traders/investors who discuss it.
Thanks for the podcast recommendation!
“Do you consider the active vs passive debate to be settled?”
i think a more primary question is, “can the active vs passive debate even be settled?” – and right now the answer is “no,” for the reason ‘z’ indicated above:
“4) far too many people couldn’t even tell you of their money was passively or actively managed or really what those terms even mean. They just know their guy is doing an ok job….#4 is the biggest reason active management won’t go away. If you are financially literate enough to read and comprehend this article you don’t need the advice in it. But too many smart people unfortunately this is written in Greek.”
it is theoretically possible for such a debate over efficacy to be settled by appeals to data and results. however, in order for it to be practically settled, there has to be widespread first-hand experience with the options in question.
so long as the norm is for people to rely on advisers to manage their portfolios, i don’t think the debate will be sufficiently relevant – or even understood – for it to be settled with any kind of finality.
the proof is in the pudding as dollars going into index funds has skyrocketed over the last 30-40yrs. a NO BRAINER
These dopes who believe otherwise are liars or uneducated fools preying on the uneducated
The investors paying commissioned based advisors are fools as well
Curiosity question: Do financial advisors provide some sort of financial incentive to their current clients if said client “recruits” other physicians within their own practice? My husband noticed as soon as new physicians joined the practice, the senior partners encouraged them to meet with their own advisors. I can see how easy it is to fall for active management when you know very little about investing and your older colleague is driving a Porsche to work.
I doubt it. Most likely, the senior partner is just trying to be a good mentor. Perhaps the senior partner is friends with the people at the advisory firm. Our group has an arrangement with an advisory firm for management of retirement accounts, and gets access to DFA funds and excellent advice for a very low cost (relatively speaking). By considering all if the assets together for the purpose of calculating the management fee, everyone gets a break, and the younger partners with fewer AUM benefit more than the senior partners.
From what I have witnessed in 20 years of private practice, many docs would be better off with an honest financial planner using active funds than left to their own devices. Ideally, docs should learn about low cost investing, take an interest in personal finance, live frugally, etc.
I agree, the senior partner is most likely to trying to be helpful. But the problem is, he/she just doesn’t know how much is being lost to high fee active management. And with a high income there is still plenty of money for the Porsche. Many docs will benefit from having a financial advisor, but one that practices evidence based investing and charges a flat fee.
One of my partners pimps out every new doctor to his private banker/investment guy. When I got into town I said not interested and they looked at me like I was batcrap crazy. I do believe he gets some kick back from recruiting new people, dinners, tickets stuff like that. Probably paid for the loads that the ‘investment guy’ sells the new people.
Actually, an adviser can pay for referrals only if your partner is REGISTERED himself as a solicitor, and he has to disclose this to every prospect. Advisers are not allowed to pay solicitors unless they are registered as solicitors. Anything else would be illegal.
For more information:
http://www.ria-compliance-consultants.com/faq_investment_adviser_investment_advisor_solicitor_referral_arrangements.html
Yeah but this guy isn’t an adviser, he is a private banker who then passes the clients to another guy in wealth management department. It is shady as hell. I stay way out of it.
Are there rules for manners in which to disclose being a solicitor? Does it have to be verbalized? Or can it be something as simple as handing someone a tchotchke? Years ago a colleague urged me to see his advisor and handed me a pen/calendar with his advisor’s name on it. I went to see the advisor who then encouraged me to buy variable universal life insurance. I didn’t go again but I always wondered what was in it for my colleague. He even set up a presentation with the advisor specifically geared to the new hire engineers.
A simple notebook/pen sounds like advertising (especially if it has the firm’s name on it), so that’s fine. A solicitor is someone who gets paid a specific amount for getting referrals. They have to give you a written disclosure with the terms of that payment. Advisers also can not gift more than a certain amount, so expensive gifts are considered payment (I don’t remember the details on this one, but pretty sure this is on the books). There are some enthusiastic clients who might advertise for their advisers on their own. This does happen from time to time, and it is not a bad thing, except when the client has been tricked into buying an inappropriate product and they are not aware of it themselves. In this business, everything is relative, that’s why it is great to have this form so that all of the dirty little details come to light – full disclosure is always a good thing.
I think you’re probably right that many docs would be better off with just about any planner than doing it themselves. However, I think the bad advisors justify their advice/fees by using that fact.
I have been researching and examining this issue for a few years now. Passive versus active is really and interesting dilemma. Passive seems counterintuitive to me but once you really understand it then you see the value. It reminds me of the Monty Hall Problem (https://www.youtube.com/watch?v=mhlc7peGlGg). Our emotions and intuitions sometimes cloud our ability to use probability to make good choices.
That being said, I don’t think the issue is as black and white as presented. A main problem that I have with passive supporters is that a passive strategy is not really passive – there are active decisions that are involved and assumptions that are made. They are not wrong, but pretending that it is without assumptions (that may or may not play out) and without any active decisions is not true.
For the vast majority of people I do believe a passive strategy is best. I think the main issue is how much you save, not as much what you do with it once you save it. Trying to do better than the market is never a good strategy and doesn’t even make sense to me – you need to be clear about what you are trying to achieve with your investments and not just try and make as much return as possible. This took me some time to realize myself.
I think there is a bias against active management because many people who are advisors don’t know anything and have no expertise. They are sales people, not people with an expertise in selecting god investments for you. The example is a classic case I have seem many times over. Guy has minimal skills but needs a “career”. Has many friends and maybe Mom or Dad is a Doctor, Dentist etc. Decides he will leverage his “network” and sell everyone much needed active management. Here is an example (http://www.hcplive.com/physicians-money-digest/blogs/the-doctor-report). This guy’s CV basically says he is the son of a doctor? Not very convincing of an expert to me. Well … no wonder this will fail. If people with no skills did open-heart surgery for a living there would be a lot of dead bodies but would you say “open-heart surgery doesn’t work” or simply, “that guy should not be doing that”. I think active management requires a very specific skill and expertise and few people have it. The few that do have it are servicing high net work clients and most of us do not have access to them. But I do believe they exist.
There are expert poker players out there. They have a very special skill. They use probability, psychology, and decision making and timing to their advantage. They will beat a non-expert easily. They are somewhat rare people but they do exist. They will beat a passive computer algorithm easily as well if played against them.
My point is that passive strategies are a miracle to the general public and should be embraced by almost everyone. But we need to be careful to examine why that is the case. Active management can be very successful as well, and it is also possible that in times of great volatility (perhaps the next 20 years?), an expert active strategy will be much better. Fees can be as low as 0.5% AUM. Once you retire you can ride your portfolio with no fees as you will actually own the equities themselves.
For me, a self-directed passive strategy will not work as I know I will somehow turn into into my own version of an active strategy.
Yes, not only are skilled active managers rare and inaccessible, but they’re extremely difficult to identify in advance.
There is no way to identify a great manager because even if we have 100 years worth of data, that may not be enough to make a good decision. Deciding who’s a good manager can only be done in hindsight. If we select 1000 such managers, we know for sure that one or two will end up being amazing, but this is nothing more than buying lottery tickets, with most of them leading to market under-performance. Passive strategies work precisely because we depend on the markets to produce returns. There is nobody alive who knows how to consistently beat the market, because if they knew how to do this, they could teach others, but we know that it is impossible to teach this because it is not a skill that depends on a repeatable process that can be taught. The ‘best’ managers are not the ones who beat the market, but the ones who get the most assets and charge asset-based fees. In fact, going to a manager who beat the market in the past might be a mistake – because this was not due to skill, chances are they are taking excessive risks, so in the future one can expect them to underperform.
I know what you are saying and agree. But the same can be said for self-directed passive strategies. You won’t know that you won’t screw it up yourself until its too late. Past performance doesn’t always predict future performance – this applies to all the past data on passive approaches that make assumptions about the market. You don’t have to try and beat the market with an active strategy – maybe if this is your definition of active than I understand your point and agree. You also don’t need to find your adviser based on random chance – there are other ways to find someone trustworthy who charges reasonable fees – same as finding a good doctor. Things like reputation, experience, and past performance are relevant metrics. Its not a guarantee but its also not random chance. I am somewhat uncomfortable with a completely passive approach. I think a careful adviser can get you market returns (and enough to cover their fees) allowing you some oversight into what you own while allowing you the benefit of not doing it yourself. So far its working that way for me. I guess I will say this – passive approaches are right, active approaches are not always wrong! I think most docs if they are saving enough should be just fine with market returns from passive approaches. I also think the fees, if paid or not, will make a big difference on their retirement if they save enough.
As discussed before, historical performance is not very useful, unless the adviser can demonstrate that they always invest in a passive/index strategy and their asset-based fees are not taking a chunk out of your compounding. If they always stick to their strategy and use low cost funds, then it doesn’t matter what their past performance is. Being disciplined about investing is important, and unfortunately I find that a lot of active-management mindset is creeping into some docs’ minds if they are not educated enough. So an adviser can act as a buffer between them and the market, and that alone can help improve their returns.
Just to clarify – my “active” strategy using an adviser is paying 1.0% AUM and he uses a very conservative approach of buying large cap dividend and growth equities. Buy and hold mostly. So not sure how active this really is. In some ways I’m just slowly building my own passive fund. Let me know if his is a bad strategy – seems pretty safe to me and so far my returns are enough over index funds to cover the fees.
I don’t buy actively managed funds.
I’m sure your adviser is a great guy, but I have a huge problem with AUM fees, and I wrote a long article on this topic:
http://litovskymanagement.com/2012/08/no-aum-fees/
To have above market returns, you have to take above-market risk (or just get lucky). It is risky enough to invest in the markets. So paying someone 1% to take much bigger than market risk isn’t a good idea. I would not invest in individual stocks because this is way too risky for individual investors (and there is no way to manage risk given that even 10,000 stocks may not be enough), while most such portfolios would not have more than a handful of stocks.
If you can pay someone a flat fee so that they use low cost ETFs to build a diversified (and risk-managed) global portfolio for a fraction of the fee (~0.15% is not hard to do), this might be a better LONG TERM idea. Excessive risk is commonly taken by advisers who charge AUM fees because they simply MUST justify their fees by trying to show that they beat the market net of fees. But this is a recipe for a disaster. None of these advisers can possibly beat the market in the long term, and the more risk they take with individual stocks, the worse it is for you in the long term, because they often end up making market timing mistakes, and also because 1% expense ratio is guaranteed to cost you more and more as time goes on.
So my rule of thumb is to make extremely sure that your adviser is using the right strategy (that is mistake-proof in the sense that it is not depending on the adviser to make ‘correct’ calls), and also to make sure that you are not paying any asset-based fees for investment advice (and are getting the right level of financial planning advice, too).
10,000 isn’t enough? How many publicly traded stocks do you think there are in the world? There are less than 5000 in the US right now.
That’s right! Index fund portfolio might have several thousand stocks, and that’s something that can’t be done with individual stocks. All stock markets can fall, so having just stocks is not enough (even if you have 10,000 stocks you are still not diversified enough). Advisers taking excessive risk rarely use bonds – this is the second strike against them.
Oh, you’re saying stocks aren’t enough, not that 10,000 stocks aren’t enough stocks.
Assuming you’re comparing to an appropriate benchmark, your adviser is either lucky or good. The money spends just fine either way, but only one is likely to persist going forward.
CV, for an active manager to give you a return that makes up for his fees that means he/she must outperform the market by the amount of the fees. It is extremely unlikely that a financial advisor can do this, excluding luck. FA’s are not exactly qualified to pick stocks; they don’t speak to management, read 10-Q’s, model the next 3 years in excel, etc…they generally get their “ideas” filtered down from their company’s research department, who, despite their lousy record, are qualified to pick stocks.
You could easily duplicate a high dividend paying equity portfolio for just a few bps and actually improve your expected return and reduce your risk – not a bad combo for less than free. Paying 1% to get an expected return of 6-8% is a losers game.
I think you are probably right. I imagine I could simply buy ETFs that index myself and save costs. I looked into this but you still need to decide what specific ETFs, how many ETFs, and how and when you will redistribute them. Does anyone have a good strategy for this part that will ensure a market return? I figure that I could easily screw this up by 1% so paying fees for someone to do it is reasonable. Would appreciate people’s insights on this. I think for some of us, even simple passive indexing seems difficult as we don’t know where to start. I looked at some couch potato strategies and there are many of them, not sure what the differences are etc.
You don’t have to pay an asset-based fee to a high risk active manager. You can pay a flat fee and get a comprehensive financial planning services that include investment advice. Just make sure that your adviser practices passive indexing strategies. Not everyone has the time or the inclination to learn about how to do this, but you need to know enough to select your adviser wisely.
Here are two options that will cost you MUCH less than 1%.
Betterment– 0.15% for an individualized mix of low cost ETFs, tailored to your time horizon and risk tolerance.
FPL Capital, an advertiser on this site, which will put you in passive funds for a flat rate as low as $1000/year.
Neither would provide comprehensive financial planning, manage your retirement plan assets, suggest the use of brokerage windows inside retirement plans, help you set up backdoor Roth contributions or do anything outside a single managed account, which has to be either an IRA or an after-tax brokerage. Neither will help you with tax planning, 1099 income and solo 401k plan, 529 plans, HSAs, estate planning, insurance planning, etc. etc., so you will get what you pay for.
This article was nominally on active vs. passive investment management and has morphed into a conversation on the role of the advisor. Active or passive (i.e.. index) investing can be done on one’s own or with an advisor. You can have a bare bones advisor charge you a pittance to assist with investing or pay a king’s ransom to do the investing piece and way more.
In the past, I have worked a variety of advisors and planners, paying a pittance (currently) and a king’s ransom (in the past).
When I paid a king’s ransom, I learned the following:
1. No one cares more about your financial situation than you do.
2. Once an advisor gets a percentage of your AUM, they want more.
3. Most of what you need to learn you can learn on your own and where you need help, you can buy it a la carte.
4. Many advisors are no more than glorified sales people. Of course, we can say the same for docs, too. 😉
I guess my issue is that paying a fee to someone to do passive indexing seems worse than paying someone to actively build a portfolio of buy and hold dividend paying equities for me. I can buy index ETFs easily on my own and save the money. The alternative requires more effort and expertise so I am more comfortable paying for that. Interestingly I asked what index ETFs and in what combination one should consider. The two answers I got led me to paying fees but did not tell me what specific ETFs to use. If there is specific expertise in doing a passive index strategy than its really not that passive is it? If there is not expertise required than why should I pay someone to do it?
Maybe some advisers who are hourly do not help you with the implementation, but I find that this is not a good idea since not everyone is an expert on how to go about doing this. I always help my clients implement any recommended strategy across multiple accounts because they may need to have Schwab account advice and a Vanguard one, so while the strategy might be the same, ETFs will be different. If you have multiple accounts, there will be a large number of investment choices, so someone would have to go through it all and put together a comprehensive investment strategy and also help you implement it.
Investing is only one part of comprehensive financial planning, so I highly recommend that you work with someone who can look at the whole picture and address your entire financial situation, not just pick investments and go away, because a more complex situation will require ongoing support and continuous advice.
Thanks, I understand your points. Although I pay AUM fees I also get expert comprehensive financial planning. They are not mutually exclusive. I also don’t consider my advisor who is building my portfolio to be “high risk” because he buys individual equities for me, many of which are a big part of the index ETFs anyways.
I looked at your website and I think your approach also looks very good. I imagine you do a good job for your clients. How much do you charge for your services?
I agree with Konstantin. I would add that if you want someone to do comprehensive financial planning and look at your entire financial picture then you should highly consider hiring a CFP professional, that is what the CFP certification is all about.
I used to charge asset-based fees, but I found that this creates a huge conflict of interest (which I described in detail here):
http://litovskymanagement.com/2012/08/no-aum-fees/
I also found that many asset-based advisers offered ‘financial planning’ for free, but they aren’t providing quality planning on assets that are not part of their AUM and ‘free’ won’t buy good planning. I also didn’t want to use a broker/dealer and instead I use Vanguard directly, which very few advisers do.
When I realized how much asset-based fees would cost to my clients (for no added benefit to them!), I switched to flat fee pricing. I charge a flat annual retainer that depends on the amount of time I need to allocate to provide proactive year-long advice. The fee varies depending on the complexity, and a typical engagement is about $400 a month.
Many doctors/dentists also have their own practice, so the other half of what I do is setting up low cost retirement plans for small and medium-size practices. Advice truly has to be comprehensive, and even though I do not sell insurance, do taxes or prepare estate planning documents, I do take time to oversee these areas as well.
Switching advisers simply because they are lower cost is probably not the best idea, because there are always advisers who will try to cut corners and try to compete on cost alone. There are a number of good advisers around, so once you really understand what is possible vs. what you are actually getting, you can use that knowledge to find the one that best fits your situation.
Passive investing doesn’t mean it can be done with zero knowledge. It means the investment is trying to match the market, not beat it. You’ve got a few options. 1) Be a passive investor yourself. 2) Be an active investor yourself. 3) Pay someone else to be a passive manager for you. 4) Pay someone else to be an active manager for you. As far as costs, it stacks up like this:
1) Passive no advisor
2) Active no advisor
3) Passive advisor
4) Active advisor
Your after-fee returns, assuming you learn how to do this reasonably well, should look like this:
1) Passive no advisor
2) Passive advisor
3) Active no advisor
4) Active advisor
If you don’t learn how to do it well yourself, then the after-fee returns look like this:
1) Passive advisor
2) Active advisor
3) Passive no advisor
4) Active no advisor
Notice how in no scenario does active come out on top. That’s the reason you do passive- the returns are better. Whether or not you use an advisor or not depends on your level of expertise. It doesn’t take a ton of expertise to set up a reasonable portfolio of index funds/ETFs (see here for details: https://www.whitecoatinvestor.com/150-portfolios-better-than-yours/) but it does take some. If you’re not willing to acquire that expertise, then find the lowest cost you can pay someone who has that expertise to do it for you. If you need additional services as noted by Mr. Litovsky, you can pay more to get that from the same person, or go somewhere else to get those services.
While I totally agree with Jim (and I personally believe neither I nor anybody else possesses the skills necessary to beat the market), I think that this debate should be re-framed. It is 100% true that financial planning is key for doctors and dentists in the first decade of their career (for one thing, loan repayment is a much bigger issue than return at that point). That said, I think that chasing return is exactly the wrong approach (and that’s what the active industry is actively selling). If you can save significant amount of money and invest it with just enough risk to beat inflation by a point or two, you would do much better than those trying to chase returns. By doing this you’ll accomplish 2 goals:
1) You will not depend entirely on the stock market for your returns (especially if the market does not cooperate).
2) Your savings rate will dictate how much money you will accumulate, and a good portion of it can be kept relatively safe, so even if you won’t hit the market return, you also won’t experience the market declines, which will allow for much better planning opportunities.
3) No need to pay any asset-based fees to advisers who will not be able to beat the markets, and who will not give you the right level of service that you actually need more. Flat fee can get you everything you need, including financial and tax planning and investment management.
You will do better in the long term with a balanced portfolio of low cost index funds and a simple investment strategy, not the fancy and/or expensive strategies that in hindsight might under-perform the markets or worse. When it comes to investing, the most important rule is to understand the limitations of any investment strategy, and to realize that future returns will have no relation to historical returns. Any investment strategy has to survive future market turbulence, so being more conservative than the herd might not be a bad idea (and doing so at the lowest possible cost is the best way to go).
I disagree that beating inflation by 1% is adequate to meet the retirement goals of most investors. That means you’re money only doubles in real terms every 7 decades. What savings rate are you planning to couple that return with?
Not saying 1% – nobody can be this precise. I think that there is a risk threshold that very few should cross. It is a tradeoff, of course, and it will depend on each person’s circumstances. Some people will be able to live with taking more risk, while others might be better of not taking excessive risk if they can save vs. trying to get higher return.
Of course they can’t be that precise. My point is that accepting a relatively low return has consequences-primarily a higher required savings rate as I blogged about here:
https://www.whitecoatinvestor.com/the-reason-you-take-market-risk/
Agreed. The flip side is the extra risk. I’m sure you’ve seen Wade Pfau’s list of market crashes and how long the crashes have lasted. I don’t want to end up in one of those long recessions with too much exposure to the markets at just the wrong time (especially in retirement) – it wouldn’t matter to me at that point what the history was (or will be).
Well, nobody would want to. But the question is what you’ll be giving up to avoid the crashes. I’d rather weather 5 or 6 crashes over my investment horizon than have an average return 2% a year lower over that period, for instance.
The problem is that we don’t know which one of them would last 2 decades. If that’s the case, then your IRR might be similar or lower than if you had a more conservative portfolio to start with. I’ve observed this effect during crashes. The more volatile portfolio will vary a lot more (both ways), so during crashes a more conservative one can catch up. I know this is all hypothetical, and I’m sure more than one PhD can be earned doing this analysis, so we won’t end this discussion here. This is just another risk management approach that does not depend on any type of timing or assumes any kind of future return. My contention is that as long as that is enough return, it would be fine to have a 2% smaller return than a more aggressive portfolio. But that’s just the worst case scenario – you hit your goals and under-perform the market. On the other hand, if your goals are loftier and you under-perform the market, that could be a bigger problem (and we know that the final portfolio value could be much lower than anticipated if one lands in a long recession).
Sure, if there’s “enough return”, then you can stop at enough and don’t have to be more aggressive than that. My point is 1% real probably isn’t enough return.
Well, if you are retired with $5M-$10M in savings, it just might be! As before, it depends what the goal is. If the goal is not to lose the money, 1% real return might actually be just fine. I think the conversation should be about planning vs. investing. Any investment strategy has to work as part of a plan. If someone’s plan is to create a Roth IRA that they pass on to their children, then of course they can just let it coast at a particular allocation, regardless of how old they are. If they want to start withdrawing money in retirement (and they are close), then they might be content with that pool of money returning inflation or even under (if they would need it in under 5 years for example). Just goes to show that investing is a subordinate of planning.
Good general thoughts on why passive investing should be the default.
Question- is your comment “spend a few weeks or months getting a CFP or CFA” your honest understanding of the time needed and required for the designations, or intended as a backhanded slight? As it stands, it reads as an MD’s condescending shot. First off, there are work experience requirements (3yrs/4yr.s), time periods between exams (I think the fastest you could possibly do the CFA due to testing schedule is 18mo, most take 3 years, CFP average is 2 years to complete coursework, 50% pass rate on comprehensive), and then the reality of how much time smart people actually need to study for and complete the test. Is studying for the CFP/CFA similar to medical school? No, I’m sure it’s not, but there is a significant body of knowledge that needs to be learned.
I was extremely surprised at this comment as well. The CFA program requires passing 3 difficult exams in succession and, as mentioned, a 4 year qualifying work experience requirement. It is a rigorous program that many consider superior to an MBA or masters in finance for certain types of work.
I don’t disagree. But 750 hours is 750 hours. Think about a college class. If it is a 3 credit class, you might spend 3 hours in class and 6 hours out of class every week for 16 weeks. That’s 144 hours. ~15 credit hours is full time, so multiply 144 x 5 = 720 hours. The CFA is like a semester of college. That’s a “few months.”
The work experience requirements, especially for CFP, are not particularly hard. 2 years of knocking doors trolling for clients for Edward Jones counts for instance.
http://www.cfp.net/become-a-cfp-professional/cfp-certification-requirements/experience-requirement
The CFP is even less time studying than the CFA, which is basically a semester worth of work. This guy: http://wealthmanagement.com/forums/general/question-everyone-who-has-passed-cfp-exam says he spent 205 hours studying for the CFP. That’s a 4 credit hour class.
My point is that these are not the minimum designations in the field, they’re the HIGHEST ones. And you could knock them both out in the equivalent of one tough semester.
Is the 205 hours in reference to the CFP Board exam or the Board exam and all the classes needed prior to being eligible? 205 hours seems like a lot for just the exam. It took me a year to take all the classes and pass the Board exam.
Financial planning is not medicine, but the CFP is the best there is for financial planning. The CFA from what I understand is strictly investments. I don’t think the CFP is even relevant in this discussion of investment theory, and I am a CFP.
Funny how one tiny phrase in the post has generated so much in the comments section.
I actually agree with your assessment of our “profession” and our credentials. I read the link you posted and there is a comment that is truly telling of my profession. One post said not to take the courses or study at all until you are a “Producer” and to wait at least 3 years before even considering the CFP. That is the problem and why we get a bad rap. MDs, attorney’s, CPA’s, must get a baseline education before helping patients, clients. We are told to get as many clients as possible before getting the education you need to actually help clients best.
If anyone (Mds included) has a true passion for all things finance then you could take the courses and pass the CFP Board exam in 2-3 semesters. I do think that it takes at least a year for CFA primarily due to the timing of the exams. I may be tempted to take the CFA tests when my business has more investments than planning for everything else.
I think this reader response is due to two reasons:
1. Your phrasing “a few weeks or months” is misleading as nobody reading your post would come away with an understanding that it is not possible to complete the CFA Program in under 2.5 years (level I exam is offered in June and December, level II and III only every June – and this is assuming you already have obtained the required 4 years of qualifying work experience). People would likely read this at face value and think it takes weeks or months from start to finish, not years. So informed readers want to correct this likely misunderstanding of less informed readers.
2. Your phrasing makes it seem as if obtaining these credentials is easy and trivial, something anyone worth their salt would do. I am not familiar with the CFP credential, but I am a CFA charterholder and I know what a large undertaking the program is. Many people who are accomplished, smart, hard working, and great at their jobs do not enter the program because it is simply too large an undertaking. So, people want to “defend” what most view as a really high quality program and curriculum, and what is definitely not a trivial undertaking.
Three questions for you regarding the context of my phrase:
1) How many weeks is 250 hours of studying to you? To me that’s ~5 weeks. Certainly within the “weeks to months” phrase.
2) Do you think a financial advisor who is in his 30s should have taken the time out at some point, whether it’s 15 weeks or 2.5 years, to have gotten a CFP, ChFC, CFA, or CPA/PFS? If so, why are you defending this advisor who has not done so (which is my main point?)
3) Why is financial advising the only profession where it is acceptable to get the education AFTER you start working instead of before? Why is it even acceptable to be able to practice without any significant education and training?
As far as “easy or trivial” I guess I’ll leave that to the readers to decide, most of whom spent 8 years in school and 3-7 years working 80+ hour weeks to learn their profession, as to whether 15 weeks of studying over 2.5 years is trivial and easy or not. And that’s the hardest designation in the field. Most are a weekend course. The second hardest one is a single month’s worth of studying (although 2-3 years of experience required.)
Have to agree with WCI here. If you want to tell me what to do with my money, you have better put in the time first. If you haven’t had time to get it yet, you might be to wet behind the ears to be managing anyone’s money, especially mine.
I have to chuckle about the time it takes. Try taking a national board exam. You put in the time it takes because if you don’t pass, you don’t practice, and may not be able to retake it for a while….
I totally agree the hurdles are very low. But I do find it fascinating that people think time spent studying, or passing certain exams, or having such and such experience, is correlated with money management success. This isn’t medicine folks. With medicine, yeah, IQ, or time spent studying the books, or carving away at a cadaver, or passing Boards, is correlated with physicians’ success, but this is not the case in asset management. Investing is ridiculously simple (read simple, not easy), and success has much more to do with a manager’s psychological makeup, discipline, and objective reasoning than any CFA, MBA, or other random combination of letters after a name. Give me a NAVY Seal and 10 hours of their time, and I bet I could make him a better investor/advisor than 95% of the ones out there…
So now it only takes 10 hours to learn how to be an adviser? Or is that only after BUDS training? Why the heck would anyone pay an adviser thousands a year if it only takes 10 hours to learn how to do it?
It’s not difficult. Heck, spending just a couple hours reading your great book gets you at least half way there!
Why do people spend thousands for it? Simple. Supply and Demand. There’s a market for it, and people pay it. Don’t beat yourself up over it. And if it’s a financial jealousy thing, it’s not too late to make a career change; many docs do.
Same reason people will pay thousands a year to have a personal physical trainer, tutor, life coach, chef, or pool boy. This attitude of “if they haven’t spent as much time as I have studying so they should get paid less” does NOT apply in a market forces environment, as much as many docs think it should. This is especially true if a buyer (docs) tends to be very bad at the thing needed (asset mgmt).
I am going to agree with my new friend, DW.
Docs, myself included, tend to have an over inflated sense of what we are capable and are over confident in areas like investing, practice management, football picks, just about everything. Go into any hospital’s doctor’s lounge, and they are filled with people who believe that just because we survived medical school, we could run Apple, coach the New England Patriots, be the Mayor of the cities in which we live, etc.
Many of the docs that I know who have done the best financially over the years have found competent and ethical advisors early in their careers and focused instead on their practice of medicine.
While I don’t disagree that you can make a great deal in financial services with very little education, I don’t think you can be a good advisor in just 10 hours.
Are you equating a more profitable advisor with being a better advisor? Yes, the people who know little may actually really believe that they are doing a great job. There is a company that does just this, it scours for veterans looking for jobs and makes them into financial advisors. These advisors then go get all their veteran mates to sign up for whole life insurance and mutual fund sales. Talk about a horrible deal, at least docs actually get some tax and asset protection benefits from these products. Many of these veterans are doing well to reach the 25-28% tax bracket. So, yes, one of these guys maybe highly profitable but probably not very good for their clients.
Are you talking planners or advisors, or are they both the same? Anyone can call themselves an advisor or financial planner, so titles are meaningless. Only title they cannot use is the CFP, which is copyrighted. CFA is the best designation in the industry, and most brokers or advisors do not have it. This designation is usually what analysts get. Salespeople don’t get it. Many have their own firms, but most work for big brokerage firms. I suggest all new investors read “Backstage Wall Street” to learn about the industry. There are no formal education requirements. Licensing is a joke and doesn’t make one an ‘expert’ on investing. Most advisors are salespeople and get only sales training. The guy you discuss here is a perfect example. He targets doctors because he believes they are affluent. Smart vertical marketing in his eyes. He has no formal training and eschews it, as you point out. Firms that do financial planning free usually do so because they make their money selling investment products. Best bet is to run, not walk, from firms that work that way.
I’ve been in this industry in many capacities, and can tell you it is a sales job first. The true planners and advisors do not sell products and do not even attempt to beat the market. Or at least they shouldn’t if they want to eliminate conflict of interest. WCI has it right. Passive is the way to go. I work for one of the biggest and financially successful investment firms in the world, and they can’t come close to matching the markets over time, never mind beat it.
Fidelity advisors in their Investor Centers are licensed salespeople. That’s it. I used to work there
The CFP course has one class on Investing. Haven’t looked at it in a while but in the past it was called ‘Introduction to Investment Planning’ . CFP’s are not trained to be money managers or even investment advisors. Many if not most sell investments, unless they are fee only planners. I would never go to a financial planner for investment advice. Most of the big brokerage firms incent their salespeople to get this degree, as a form of credibility. Then go out and sell, sell, sell. Notice how the tile ‘stock broker’ has disappeared? Now they are Financial Advisors, Financial Planners, Senior Vice Presidents…..whatever might impress you
Oh, and yes it is an MD’s condescending backhanded slight, not particularly against the CFA or the CFP (I think all advisors should get one or preferably both honestly) but against the advisor discussed in the post who didn’t bother getting either.
Passive management will beat active management as long as there are enough active managers to establish a market price. Think about it this way, you have two very educated traders on both sides of the market establishing a price, a price that a passive manager can take advantage of without having to pay for the research. However, if at any point in time passive managers begin to become the price setters (because they outgrew the active manager) it will favor the active manager. We’re a long way off from that time given how prominent active managemenet is, but its worth noting that if 99% of the market is passive investors, the 1% will have an advantage.
Do you really think you need more than 1% of the market to establish the price?
I do. If the majority of the market is based purely off of inflows and outflows of passive investors then they are making the market prices. An active investor that is buying and selling from a market based solely off inflows/outflows can benefit based off of information. Think about if a fraud occurred in a company, the passive investors are still buying that security whereas the active investors can sell their stock to the passive investors.
Again, not saying that passive investing is wrong. Just that it won’t beat active investors if they control the market. We’re nowhere near that point yet.
Usually the analysts at the firms get the CFA, not the advisors themselves. Advisors, and I use that word lightly, get the CFP?
That’s a fair assessment of what happens in practice.
I find it funny that this adviser wanted to meet with you! A doctor in his family, OK, but if he read even 10% of the post on this clog he would know that he needed some qualifications, financial planning is important and you will choose lower over higher fees. Silly silly.
No bond index funds? How are you owning bonds then?
10% TSP G Fund Expense ratio 0.02%
10% Schwab TIPS Fund (SCHP) Expense Ratio 0.07%
5% Peer 2 Peer Loans Expense Ratio 1%
I guess that’s not entirely true. SCHP is an index fund. The fund I used to use in this asset class, the Vanguard TIPS fund, is not an index fund. They both are passive. The TSP G Fund is passive, but not technically an index fund. The P2P Loans are actively managed (although entirely passively using an outside service) because active management still works in this relatively illiquid and inefficient asset class.
http://www.mymoneyblog.com/hedge-funds-buffett-bet-2015.html
Very timely post on another good money blog. If this doesn’t convince even the most hardened skeptics than they are hopeless.
It’s not as sexy but you should have called yourself the WhiteCoatPlanner, besides this post you have a ton of pure financial planning (non-investment) related content. I agree, anyone advising doctors who doesn’t understand PSLF, IBR, PAYE, HSA, B/D Roth is a joke to me. Having a doctor somewhere in your family tree is not a reason to “advise” doctors, it may help but the advisor has to learn a lot about these different programs.
Lower costs and better returns… What’s not to love about passive investing?
I simply think you got the whole premise of the article absolutely incorrect. Active management of a fund is indeed far superior to passive, if you are the manager of course. Otherwise it makes no sense, whether you’re indexing or picking your own index (this is what I do).
What will be interesting as more people come into indexing is that the whole s/p becomes correlated with the stocks within, which will bring up some brief inefficiencies in the market which some smart managers will take advantage of until its gone.
I recently was recommended your site — thank you for all the informative articles. I had a conversation with an adviser at Fidelity. I’m looking for shorter-term investing for possible house, car, etc. in 2-3 years, and she was telling me that an asset allocation fund such as Fidelity Asset Manager 20% or 30% sounded like it would meet my needs. Based on your recommendations, I told her I was looking for an index fund, which the Fidelity AM is not, and she told me that the Fidelity AM was basically a passively managed fund because (what I gather) the fund has a low turnover and there’s always a fixed allocation %. What do you think? Thank you!
I don’t know why I’d pay Fidelity 0.53% for a fund like this when I could get it from Vanguard for 1/3 that price. Are you paying a load for this fund too? Is the adviser you’re seeing at Fidelity a commissioned salesman masquerading as a financial advisor or something? How are you paying your advisor?
Fidelity Asset Manager is an actively managed mutual fund, with a targeted equity allocation indicated by the number after the name of the fund. Fidelity Asset Manager 50 indicates that the targeted equity exposure is 50%, for example.
These funds are actively managed mutual fund, not passive. Period.
Even at 20 to 30% equity exposure, these are not the appropriate vehicle for a 2-3 year holding period, unless one is willing to risk the possibility of not purchasing a home or car in 2-3 years or the possibility having to settle for a less expensive home or car in 2-3 years. If there were a 50% equity drawdown, even at 20% exposure, you could be down 10%…or more.
I would recommend a a CD at Ally bank for a 2-3 year hold.
To WCI, I suspect that the fund was offered by a Fidelity rep, on the phone or in the retail “store”, and that there was no sales commission for the buyer. Perhaps Fidelity incentivizes its reps for selling certain products, but I would expect that this cost would not be directly borne by the OP.
WCI: It was one of the people in Fidelity’s advising center or something, I don’t know exactly. It was “free” advice, and I never have to talk to them again or buy through them. My hospital has the 403(b) with Fidelity so I made my Roth with them too and figured I would keep everything under the same umbrella for convenience. Though I obviously don’t have to. Fidelity has other index funds too, like their Spartan lineup.
Robert K: Thank you for the detailed advice. I’m not exactly enamored by the 1.4%-range APY of the current CD’s on the market. I was thinking more along the lines of an 80-20 index fund (like Fidelity’s offering of the Wells Fargo Advantage Index Asset Allocation Fund Class A – though 1.15% expense ratio so I guess not) or or investing 80% in one of the Spartan 100% bond funds (.2% expense ratio) and 20% in in one of the Spartan 100% stock funds. Btw, The one recommended by Vanguard.com based on my “risk tolerance,” etc. was Vanguard LifeStrategy Conservative Growth Fund (VSCGX).
J,
Listen to what Robert is saying, it is not a very wise decision to invest in the stock market for something you want within 2-3 years unless you are willing to take the risk that you won’t get it. As I am sure you know over 2 years it is quite possible the market goes down by 40%, or maybe it just goes down 3% for each of the next 3 years – would make your CD look pretty good in that case.
There is another option – consider half your money in a 3 year CD and the other half in a good balanced fund like the Wellington Fund from Vanguard. This will limit your downside, but still give you a chance for some upside.
The biggest issue is you have to consider the market has essentially been going up for 6 years now – can it continue for another 3, maybe, but if you really want to get into a house, the safer route is the better route!
Dave
How timely: http://news.yahoo.com/buffett-way-ahead-1-mn-wager-against-hedge-193649849.html
WCI,
Great article. I too find on a daily basis people who believe they can do what Warren does, and ignore what he recommends you do (index.)
Dave
No sure if it’s taboo to reply to a months old post, but here goes…
I’m curious why some of the rows in the table near the top add up to more than 100%. Shouldn’t they be 100% or less? If a fund disappeared, obviously it can’t beat the index, so those are mutually exclusive. But if a fund changed style, can it still be compared against its initial (or final) respective index? I suppose the answer is “yes” per the table, but my inclination would have been to disqualify them.
Separately, I think it would be informative to see some slightly different stats than those described in the Best Predictor of Future Returns section. I’m interested in how many active funds that beat their index over one five year period went on to also beat their index over the next five year period (or also did so the previous five years). For example, of the 33% of actively managed LC Growth funds that beat the index in 2009-2013, how many also did so in 2004-2008? That could really drive home the point about past results and future returns.
I think you would really enjoy Rick Ferri’s The Power of Passive Investing, Swedroe’s The Quest for Alpha, and Bogles Common Sense on Mutual Funds. They get way out into the weeds with questions like yours if you’re still not convinced of the merits of indexing.
Oh, I’m plenty convinced. I just think being able to show that such a (presumably) small number of funds that did well over the past five years will be likely to do it again over the next five would be a helpful story for convincing others, like my wife, who can point to several years of outperformance with an active fund and question my adherence to passive funds. Thanks for the book pointers, though; I may check them out if I need ammo and find some time.
You can play the following game with her:
1) Select 10 funds that outperformed in the past 5,10,20 years.
2) Predict which ones will continue outperforming in the next 5,10,20 years.
3) See which ones of your predictions are correct.
These studies have been done. By the laws of probability, there will be a handful of funds that ALWAYS outperform. Will they be the same ones? No. Can you tell which ones will do so based on the past history? No. Only by chance you can. Why? Because a manager mistake, a handful of good or bad years can potentially change the 30-year annualized return in a single year or a handful of years. This is a very ‘normal’ effect in a very ‘non-normal’ market that is governed by power laws and fat-tailed statistics.
Hedge funds are a perfect example – they are ‘unconstrained’, meaning that they can do whatever they want. Most don’t do very well at all. Some do amazingly well. Even fewer have done amazingly well throughout their entire tenure. However, if you were to put money into one of these funds, past history means absolutely nothing! You can lose a huge amount of money in a 30-year outperforming fund. So that’s the second issue: even if you can find a fund that outperforms, making money with it might prove impossible. Maybe you can outperform if you hold for 20 years, but maybe after 25 years the fund will underperform again. But over the next 50+ years the fund might beat the competition hands down. This is not a contradiction but a statement of fact, having to do with the type of statistics that governs the markets.
Statistics (especially that which governs the markets) is an amazing field, and our brains are not designed to process this type of randomness (Wild vs. Mild), so we are constantly fooled by randomness. I highly recommend that anyone who wants to calibrate their brains to think probabilistically read Nassim Taleb’s Fooled by Randomness book.
> I kind of thought the passive vs actively managed investment argument had been pretty much decided for the last 10-20 years.
you thought wrong.
https://www8.gsb.columbia.edu/sites/valueinvesting/files/files/Buffett1984.pdf
https://www.dodgeandcox.com/pdf/white_papers/the-case-for-active-management.pdf
I disagree. But hey, your money.
I have been trading small caps with 10 stock portfolios plus market timing Since 2008 I have been achieving 20% a year. This is the way to beat the market. There are far more small caps to invest in so the choices are better.
So why aren’t you running a hedge fund and charging 2 and 20 for it? You could be a billionaire by now if you’re really as good as you say you are.