The Wall Street Journal reports this
morning (“Investors Pile Into Vanguard, Eschewing Stock Pickers”, page A1,
8/21/14) that investors are buying into index funds big time, driving Vanguard’s assets under management
(“AUM”) to almost $3 trillion and making Vanguard’s
Total Stock Market Index Fund the largest mutual fund in the world. (A note is in order here; Vanguard, a firm
that I advocate and highly respect is widely known as THE passive manager. While it is the premier passive manager, and
the virtual inventor of the index fund in practice, Vanguard has a big actively
managed fund business, just about all of which is done through sub-advisors. Further, you don’t have to invest with
Vanguard to invest in passively managed index funds; most fund managers, even
those, like Fidelity, who pride
themselves in being great active managers, have substantial businesses running
passive index funds. Most of you knew
that, but my readers span a wide range of financial sophistication, so I wanted
to clarify that.) Further, money flowing
into index funds exceeded money flowing into actively managed funds by a factor
of 6 last year and by a factor of over 2 this year.
Some of this influx has been attributed to something Warren Buffett, one of the few active
(in his case, VERY active) managers who has beaten the indices over long
periods of time, wrote in Berkshire
Hathaway’s letter to investors in March.
He stated that he gave the following advice to the trustee of his
estate:
“…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.)”
Great minds apparently think alike (See below.); some just
get to the party later than others, but getting there, not when they get there,
is the key. But I digress.
The world seems to have caught onto the argument, long
advocated by yours truly (See, inter alia,
EXOTIC INVESTMENT PRODUCTS FOR THE “AVERAGE GUY”: WHAT’S THE POINT?, 8/16/13 and the posts to which it will refer
you.), that index funds are the way to go.
Combine the inherent efficiency of the financial markets with the low
cost and lack of manager risk of index
funds and you are nearly sure to beat active managers over meaningful
periods of time by investing in index funds.
Just about all my money is in index funds.
(A point of digression here:
So why do I have any actively
managed money? That’s a long and not all
that interesting story that I will save for another time. For now, suffice to say that almost all of my
non-index money is invested in funds that use screening techniques and thus
eliminate, or at least minimize, manager
risk, much like index funds, and keep costs reasonably low, though not as
low as index funds. I like to refer to
them as “index-like” products and they play a limited role in my portfolio. Much of my remaining non-index money is there
to entertain myself, to indulge my market prognostication propensities while
keeping my acting on those propensities away from amounts of money that would
really matter. So, while I don’t have ALL
my money in index funds, I eat my own cooking; just about all of it is in index
funds. Of course, lately, all my money
doesn’t amount to very much, but that is another issue.)
Many years ago, when I was managing portfolios at a big
Chicago bank, I appeared at a forum sponsored by a major mutual fund company
with whom we did business. This
particular family of funds, which will remain nameless, was and is primarily an
active manager and an advocate for active management. At this forum, I was there to represent the
passive investing argument and the deck was stacked against me, but the
sponsoring fund family was, and is, good people and I was confident enough in
my argument that the set-up didn’t bother me.
After I made my pitch for index funds, the firm’s
representative said something like (paraphrasing, not quoting; it was a long
time ago):
What Mark is
advocating is putting your money with a manager who has no brain. Does that make any sense?
It looked as though he had me, until I retorted
Yes, I agree that an
index fund has no brain. But it also has
no heart; it invests without emotions.
In your life, when you’ve made mistakes, was it because you weren’t
smart enough to avoid those mistakes or because you let your emotions get the
better of you?
The answer, to most people was obvious. I went on.
It’s the same with
investing. For the most part, money
managers are very smart people. (Perhaps
I exaggerated a bit here, but I digress.) It’s not a lack of intellect that gets them
into trouble. It’s their emotions. They won’t sell a losing position that is
getting worse. They won’t add to a
losing position that is only becoming an even more compelling value. They continue to add to a winning position
that has gotten way too rich. It’s human
nature that leads to investment mistakes.
Index funds eliminate the emotion from the process. So, yes, I would rather invest with a manager
with no brain…as long as it also lacked a heart.
I don’t know whether I won the day there, but I was quite
happy with my defense of index funds and passive investing. I have more or less stuck to that philosophy
until this very day and probably will for the rest of my life, with at least one
caveat:
Index investing does not entirely remove the emotion from
investing. Effective index investing (or
even active investing) still requires nearly religious rebalancing (See, inter alia,
Bill Gross Has A “Bad” Year: Lessons For Your Portfolio, Rant
Lifestyle, 1/4/14 ) and emotion can certainly get in the way of effective rebalancing;
who wants to sell “winners” to buy “losers,” which is one of the things rebalancing
forces us to do. So to nearly eliminate
all emotion from investing, even the dangerous emotions that come into play at
rebalancing time, one would have to invest in a balanced index fund, or set up an arrangement in which your index
funds are automatically rebalanced for you by the fund company. Such arrangements are growing increasingly
common. Or you can do what my clients
(at the time, mostly institutions) did:
hire a manager to do the emotionally wrenching things for you.
If you want to entertain yourself, do what I do: watch “The
Godfather” again, read a compendium of the musings of H.L. Mencken, watch “Shark
Tank,” drive long distances in a car with a manual transmission and satellite radio, watch Big 10 football and basketball, read
and write about politics…and maybe trade a few dollars like a scalded dog and
hope to keep your underperformance, or outright losses, reasonable. If you want to invest sensibly, buy index
funds and religiously rebalance.
No comments:
Post a Comment