Friday, January 29, 2016

The Frugal Planner's Weekly Dispatch, Volume 2, Issue 5 -- from Bloomingdale resident Chuck Donalies



From: Chuck Donalies, CFP®
Sent: Friday, January 29, 2016 9:00 AM
Subject: The Frugal Planner's Weekly Dispatch, Volume 2, Issue 5



The Frugal Planner's Weekly Dispatch
Personal Finance, News, Ideas, and Things I Find Interesting

Volume 2, Issue 5
January 29, 2016


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The Pendulum Swings

Two articles this week, one in The Wall Street Journal and one in Fortune magazine, highlight investors increasing preference for index funds rather than actively managed funds. Why the shift? Because investors are questioning the ability of fund managers to consistently beat the market.

Active Versus Passive
Let's begin with brief explanations of active and passive investments:

Active investments, such as mutual funds and hedge funds, are run by a manager and a team of analysts. The team analyzes companies, bonds, etc. and invests with the goal of providing better returns than the market.

Passive investments, also known as index funds, are pegged to an index, such as the S&P 500, and try to match its performance.

A Difference in Fees

The passive approach is less expensive for a variety of reasons, but primarily because there's less overhead needed to pick stocks in an attempt to beat the market. Actively managed investments have to pay for managers, analysts, admin staff, and marketing costs.

Here's an example to better illustrate the pricing differences. You've probably heard of the S&P 500 Index, so we'll compare funds in this category.
  • Active: T. Rowe Price US Large-Cap Core (TRULX) = 1.15%
  • Passive: Vanguard 500 Index Admiral (VFIAX) = 0.05%
That's a difference of 1.10%! Think about how an extra 1.10% could affect your portfolio if compounded over many years. Hint: You'd have more money.

The Obvious Question

Do actively managed funds produce greater long-term returns for investors?


This question has been debated for years. Numerous studies have shown the average active manager underperforms the passive benchmark after fees. The key word here is average. There will always be managers who are above average. Think Warren Buffett, Benjamin Graham, Carl Icahn, or George Soros. But how do you know if the manager you've selected is above average?


Mutual and hedge fund managers often point out that there are periods when one method is superior to the other. (Above average) managers often perform better during bear markets, while passive investments tend to perform better during bull markets. Again, how do you know if the manager you've selected is above average?

Key Takeaway
If the markets continue to decline I'm positive we'll read about active managers beating the markets. If that happens, we'll probably see cash flow from index funds back to actively-managed funds. However, don't be quick to jump on the bandwagon without understanding the impact on your long-term investment goals. Refer to your financial plan before you make any changes.

And remember, it's impossible for any investor to consistently beat the market. Even Warren Buffett has bad days.


 


Index funds are increasingly popular among investors.


Donald Trump vs. the Index Fund

While I'm on the topic of index funds, I'll take this opportunity to point out an interesting article that's been circulating since last summer. Someone went to the trouble of calculating how much Donald Trump would be worth if he had parked his inheritance in an index fund rather than invest in his many businesses.

There's no easy way to verify this, but Trump claims his net worth is $10 billion (Forbes estimates "only" $4.1 billion). For the sake of argument, we'll use Trump's number. The article suggests Trump's net worth would be $20 billion today if he had invested his inheritance in an index fund.

I guess we can say this is one investment 'The Donald can't trump'. I'll be here all week folks!



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