Several years ago, I bought a international mutual fund. One of those 5 star-rated funds. The mutual fund manager had about 10 letters after his name denoting his many designations. Must know what he is doing with all that education. Glossy brochure. It performed better than the MSCI World Index (which tracks the World’s biggest stocks). Great newsletter. Bunch of stodgy old white guys on the cover. Must mean stodgy old stability. Even the colors scheme is safe (IBM blue and hospital white). In other words, it had all the trappings of a great investment product and a world-class international mutual fund.
It did well for a few years. Bought in all the right markets at the right times. But, alas, as with all mutual funds, success is sometimes the harbinger of impending mediocrity. The mutual fund got stellar reviews. People bought it and… it became an average mutual fund (see my previous post on why big mutual funds under-perform the market). As with all things, you truly find out about people, life, business and mutual funds when things are going sideways or backwards (isn’t the true test of one’s character not to live with them only but to see them under stress- while you live with them?). So I began to look at the mutual fund closely.
Same glossy brochure. Same stodgy, albeit slight older, white guys. Same stability. Same colors.
But a MER of 2.41% payable regardless of whether the fund is doing well or poorly?!? You mean for every $1,000 I invest, you get $24.10 of it no matter what? One of its largest holdings is in Muenchener Rueckversicherungs?!? A nice household name we all know and trust (if your computer is wet, it is dripping with sarcasm right now). Performance worse than the MCSI World Index the last little while? What exactly am I getting for my money and what did they teach the fund manager when he got all these designations? Probably, get your fees first no matter what.
I have learned many rules of investing from other blogs and two of them are:
- Control your expenses; and
- Buy what you know.
So… basically I was giving away almost 2.5% of my return immediately for someone to invest in companies I know nothing about. Not a great way to control my expenses or buying what I know. This was no one’s fault but my own. Advisors can sell you heaven and earth but I am the one handing over the cheque at the end of the day.
So….goodbye mutual fund and old stodgy guys. Hello exchange traded fund tracking the MSCI EAFE Index with an MER of 0.49%. Might as well track a market I don’t know than give money to someone who may or may not beat it.
I continue to be an active investor domestically. I know the market better and, even if I don’t beat the market, I have loaded up on dividend-yield stocks as an inflation hedge and, frankly, active investing is fun and personal finance should be fun and not stressful. But I am now moving my portfolio to passive investing.
Anyone else who made the switch recently? What was the tipping point for you?
June 5th, 2008 at 7:32 am
This is an interesting discussion. I have been an active investor for years, but recently have gained interest in passive index tracking ETF’s and portfolio theory. Which ETF’s are you watching?
June 5th, 2008 at 8:02 am
Thanks for the link. I have the exact same philosophy as you: active management (i.e. directly holding stocks) for Canadian equities and the rest is indexed. I’ve been making the switch over the past few years and I completed it earlier this year.
June 5th, 2008 at 9:16 am
As an advisor, I made the switch after seeing the data pile up. Mutual funds have kept the same basic structure since the 1920’s - I’m sure back then when there was no negotiating commissions (and they were much, much higher) and much less access to up to date information, they were probably fantastic. A lot of things in life have evolved quite a bit since the last (almost) 100 years, but mutual funds do not fall under this category.
Anyways, to answer your question, I made the switch to incorporating passive investing about the time I switched from my last firm (who did not have the ability to offer them), which was about 2 years ago. Not only are they better off, I can focus on actual planning and service as the investing is on auto-pilot.
Mark Yamada (of PUR investing) put it best: planning is the true “alpha” an advisor can bring to the table.
June 5th, 2008 at 10:30 am
Thanks for the comments.
MDJ- I basically track the iShares family of ETF’s but the board based indexes and not specific countries or sectors. The whole point of purchasing an ETF to me is to get broad exposure so trying to limit myself to sectors or geographic locations is self-defeating to what a true passive investor is.
Preet and MDJ: I know you guys have blogged or discussed fundamental indexes but I would like to see some track record to see proof in the pudding. The fees on FI also worry me. Seems like the industry knows the mutual fund is a dying product and are trying to get their hands on other things now.
June 5th, 2008 at 11:05 am
I completed the transition just before the beginning of this year. I was sold based on the same things as the rest of you, plus one simple mathematical proof. I didn’t invent this proof, but it needs to get more circulation. The great thing is it applies in an efficient or in-efficient market, which many people seem to miss. Quickly, it goes as follows. By definition the passive investors will get the average return of the market. Therefore the average active investor will also gross the average return of the market. Conclusion? The average investor will net the market return less transaction costs and expenses. QED.
The counterargument most people use is that they’re an above average investors, I can hear it in your comments! But you don’t have to be just above average to outperform the market. You have to be able to outperform the market by your expenses just to break even, let alone make any additional money. Have a look at the histogram of stock market returns to see how few people/investments can actually do this. Your odds are terrible. And this doesn’t even include the additional risk your taking on. It’s a losers game.
The only real argument for active investing is the fun, and so we all keep a few active investments.
June 5th, 2008 at 12:02 pm
I’ve been a (mostly) passive investor since I went DIY a couple years back. The “other” part of the “mostly” has performed rather poorly so it seems my choice to be a passive investor is the right one.
June 6th, 2008 at 12:28 am
[…] Thicken My Wallet on why he became a passive investor. […]
June 6th, 2008 at 1:04 am
I like the passive approach through low MER funds or ETFs. But one thing I’ve been thinking about lately is what happens if this approach becomes very popular and more and more people pile on board doing the same? Will that drive up the value of the underlying stocks in any given index beyond their historically “proper” valuation levels? Effectively creating a bubble in the index itself? If buying the index drives up the index, then it gets even harder for fund managers to beat that index, causing more people to bail on those managed funds and invest in the index causing a positive feedback loop and potentially a very nasty index bubble. Am I missing something?
June 7th, 2008 at 10:47 am
[…] investing is cool - because of the reduced fees and reduced research […]
June 7th, 2008 at 5:19 pm
Another excellent post. I have a long comment here but maybe it can present pros and cons to active investing so I hope the moderator is okay with this long post…
I want to use this post for some guidance here. Long story short: A financial planning and sales firm with the letters E and J in the name has had a poor time keeping advisers in the office I choose to contribute too. I have only been saving for 2 years (Started 0ct 2006) and E and J closed down my local office after 2 advisers left and then consolidated the office into a more stable one. I stopped contributions after year one (jun 2007) and did my own contributions, registared and non registared, using TD E-SERIES index funds.
Well I met the new advisor (June 2008) who at least has stayed in his office for 7 years and he agreed with my asset mix and passiveness but reminded me of what we ALL know: Index funds cannot MATCH index returns because of the fees alone and the imperfections of attempting to match indexes plus taxes if they are required.
I am perfectly fine with underperforming indexes by 1/2% but the new advisor suggest a percentage of my contributions go towards active investing to “push” me over the hump and beat the indexes by 1/2% instead of trailing it.
After me complaining about sales fees and break-up fees and all that overhead those active managers require and me stubbornly refusing to participate in actively manged funds, he suggested that only a percentage of my forward contributions (not using any of my current investments or switching or cashing out any of them) should be postitioned to compensate my passive investment’s shortfall.
Anyone have a comment about his idea?
June 7th, 2008 at 10:25 pm
Just tell the so-called advisor “no thanks”. He’s trying to pull a fast one on you because his commissions will be much better on the actively managed funds. The reason you’re using index funds in the first place is that over the long term they beat 75% of the actively managed funds out there. So why put any money into something which is 75% likely to give you a worse return?
June 8th, 2008 at 10:54 am
David: It is true that after payment of MER, you are going to be a little off the index but, as Jim pointed out, statistically speaking, you will perform much worse than those fees on MER in active managed vehicles (especially if they are exotic like PPN’s).
It seems like nothing more than a tactic to make some commission off of you. Has he ever disclosed how much commission he would make with his proposal? If you really want to do it I would off him this deal- if he outperform the index then he can keep his commission, if he can’t then he has to return it to you. Now let’s see what his advice would be!
I would also point you seem to have a larger issue. You appear to be nothing but a number to your advisory firm (lots of turn-over, office closings, commission friendly advice). Are you really enjoying your relationship with your advisor?