Odds For Investment Success Worsen When Investors Select Two Or More Actively Managed Funds In An Asset Class
Thursday, October 31, 2013 09:59

Guest post from index fund expert Rick Ferri:  Portfolios holding only actively managed funds have a low probability of outperforming a comparable all-index-fund portfolio. In A Case for Index Fund Portfolios, a whitepaper I co-authored with Alex Benke, CFP© of Betterment, we show that portfolios of actively managed funds have a low probability of outperforming an all-index-fund portfolio.  (On Friday, I am speaking at an Advisors4Advisors webinar about the results of the study.)  
Our research shows that when investors select two or more actively managed funds in an asset class, they reduce the chances of outperforming an all–index fund portfolio.  Figure 1 illustrates the outcome of one scenario in our study. It covers three asset classes over the 16-year period from 1997 to 2012. The benchmark portfolio invested 40% of its assets in the Vanguard Total Bond Market Index (VBMFX), 40% in the Vanguard Total Stock Market Index (VTSMX), and 20% in the Vanguard Total International Stock Index (VGTSX).
Probability of an all-index-fund portfolio outperforming an all-actively-managed fund portfolio.
Figure 1: Probability of an all-index-fund portfolio outperforming an all-actively-managed fund portfolio.   

The three-index-fund portfolio outperformed the one actively managed fund portfolio 82.9% of the time. When two actively managed funds were selected in each of the three asset classes (a total of six funds), the odds in favor of the all-index-fund portfolio increased to 87.1%.  Finally, when three actively managed funds were selected in each asset class (a total of nine funds), the odds reached 91.0% in favor of the all-index-fund portfolio.  


This finding has meaningful implications for mutual fund investors, and should be of particular importance for participants in self-directed employer sponsored retirement plans.  An all-index fund portfolio has a high probability of outperforming actively managed funds. However, if actively managed funds are selected, it’s generally better to pick one fund per asset class and hope for the best.


Past performance does not guarantee of future results. Portfolio Solutions® will make a list of all recommendations within the immediately preceding period of at least one year available upon request.

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Retirement Experts Recommend Startling New Approach: Increase Equity Exposure After Retiring
Tuesday, October 29, 2013 11:03

Tags: asset allocation | retirement | retirement income | retirement planning | risk

Talk about turning conventional wisdom on its head: A new study advocates a U-shaped investment strategy through life, with high risk at a young age giving way to low risk near retirement, followed by increasing risk during retirement.

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Conventional wisdom on retirement glidepaths is to reduce exposure to risk continuously, starting with high risk at a young age and giving way to lower risk as retirement approaches and even lower risk post-retirement.
The provocatively titled study, “Reducing Retirement Risk with a Rising Equity Glidepath,” was published by Wade Pfau and Michael Kitces. Pfau is a professor of retirement income in the new Ph.D. program for financial and retirement planning at The American College in Bryn Mawr, Penn., and Kitces is an author and speaker.
“We find, surprisingly, that rising equity glide-paths in retirement – where the portfolio starts out conservative and becomes more aggressive through the retirement time horizon – have the potential to actually reduce both the probability of failure and the magnitude of failure for client portfolios,” the study’s synopsis reads. “This result may appear counter-intuitive from the traditional perspective, which is that equity exposure should decrease throughout retirement as the retiree’s time horizon (and life expectancy) shrinks and mortality looms. Yet the conclusion is actually entirely logical when viewed from the perspective of what scenarios cause a client’s retirement to ‘fail’ in the first place.”
Pfau and Kitces point out that an extended period of poor returns in the first half of retirement will lead a retiree to hold few stocks if and when higher returns come back. Conversely, when equity returns are good in the first half of retirement, the retiree gets ahead of their income goals so that later asset allocation choices have little impact, even if returns fall off.
I agree with this advice up to a point. However, I believe that retirement years are too complex to offer a generalized, one-size-fits-all solution. For example, academics recommend a “pockets of money” approach in retirement, while others advocate a mix of annuities and self-insurance (personal investing). And now we have Pfau and Kitces recommending a pattern of increasing risk.
My research and experience shows that investors are best served by a glidepath that actually reaches the point of transition from the accumulation phase
to the distribution phase with all of the investor’s accumulated savings intact, plus reasonable growth in those savings. Only then, at entry into retirement, should investors plan how they will secure the remainder of their lifetimes with dignity. It is only at this point of transition that enough information is available (e.g., amount of accumulated savings, health status, amount of debt) to properly construct an investment plan for the third stage of the U-shape.
For a more detailed explanation, see my 2012 article, “The 3 Stages of Individual Investing are like a Journey into Space.”
You can be the judge of the best course of action for you and your clients.
Three American Professors Awarded Nobel In Economics; Fama Of DFA Is Recognized
Monday, October 14, 2013 10:28

Tags: advisor industry people | asset allocation | portfolio management

Three American professors — Eugene F. Fama, Lars Peter Hansen and Robert J. Shiller — were awarded the Nobel Memorial Prize in Economic Science on Monday for competing theories about the movements of asset prices.

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The three men, who worked independently, were described as having collectively illuminated the financial markets by showing that stock and bond prices moved unpredictably in the short term but with greater predictability over longer periods. The prize committee said these findings showed that markets were moved by a mix of rational calculus and human behavior.
The New York Times points out that the decision to honor Mr. Fama and Mr. Shiller as contributors to a shared understanding of financial markets, however, papered over differences in their work that have been enormously consequential in recent years. Mr. Fama was honored for his work in the 1960s showing that market prices are accurate reflections of available information. Mr. Shiller was honored for circumscribing that theory in the 1980s by showing that prices deviate from rationality.


U.S. Stock Performance Remains Red Hot In The 3rd Quarter, Moving Into A 5th Year Of Rising Returns
Tuesday, October 08, 2013 09:45

Tags: asset allocation | growth investing | sector investing | stocks | value investing

U.S. stocks earned 6% in the third quarter and were up a stellar 21% in the first nine months of 2013. That performance caps off a 145% run-up in the S&P 500 over the past 4½ years, in the face of serious headwinds. Here’s what’s been working, and not working, in 2013.


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In the first nine months of 2013, growth stocks, especially smaller growth stocks, have led the way with a 35% return, despite anemic economic growth, rising debt and global social unrest. Large-cap core companies earned 13% and large value earned 17%. Other than these extremes, style returns clustered around 23%, a pretty good place to be. On the sector front, consumer discretionary and health care companies have been hot with returns above 30%, while materials and utilities have not.



In foreign markets, Japan has outperformed the United States with a 27% return, and Europe has matched the United States’ 21% return. The rest of the world lagged, with Latin America losing 4% and Emerging Markets flat.




The most interesting details lie in the cross-sections of styles with sectors, especially if we are interested in exploiting momentum effects. Looking forward to the fourth quarter, I am forecasting winners in large-value consumer discretionary, mid-cap value health care and small-cap value industrials, and laggards in small-cap growth materials, small-cap core utilities & telephone, and large-cap core technology.


To see more details, including my results in forecasting winners and losers for the third quarter, check out the full version of my third-quarter market commentary. The full version also includes a survey and forecast for foreign stocks, special commentary on target date funds and hedge funds, and a link to an amusing new video that exposes the charade of hedge fund due diligence performed via peer groups and indexes.

Stocks Stay Strong Despite Government Shutdown
Thursday, October 03, 2013 14:55

The Wall Street Journal  didn’t run the very postive headline to this post, but it could have.


Instead, WSJ went with, "Washington’s Grim Face-Off.”

Nonetheless, the stock market's reaction to the government shutdown is a bit suprising. 
Politicians and pundits have been throwing around all kinds of scary stuff labout how the shutdown will “crash the economy,”  “throw people out of work,” and “cause a debt default.”

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You’d need to suffering from amnesia to think this shutdown is an aberration in American politics.


And, while unsettling, the history of Washington’s playing chicken with the budget and debt ceiling is that partial government shutdowns have not, in reality, created material economic or market dislocations as both sides factions like to suggest as a scare tactic. The market knows this.

The market’s reaction to previous shutdowns was summarized earlier this week in Investor’s Business Daily:
“If the government shutters its doors, it wouldn’t be the first time. A research report from U.S. Trust noted 17 such instances since 1976. Shutdowns have been as short as one day to as long as three weeks. Nine of those times, the S&P 500 was flat to up 2.5% over the period of the shutdown.”
Looking past the "crisis" in Washington, some of the most important of the latest economic data have, in fact, strengthened and are key to the strength of stocks.
  • Leading economic indicators both in the U.S. and abroad have picked up.
  • Key US purchasing managers indexes remain very strong.
  • Unemployment claims have broken to the downside and ADP’s September employment figure continued the slow but steady new jobs trend.
  • Household net worth back to trend and hitting new highs. The Fed just released new household balance sheet data.

Please join me for our October 8 webinar for a complete tour of the latest economic and market data, addressing these data point as well as the following:

  • Earnings, P/E multiples and stock prices. Can stocks go higher this year? Next year? And, Wall Street’s latest forecasts.
  • Are record profit margins sustainable?  Analysts are expecting higher-still margins in 2014 from 2013’s record high levels.
  • Fed’s QE taper. What does it mean for the economy and stocks?
  • The Fed is printing money. What does this mean and why does inflation keep dropping instead of surging?
  • The fiscal crisis. CBO just released a new set of federal income and spending


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