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
Issue 5 January
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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.
Let's begin with brief explanations of active and passive
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
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
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%
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.
actively managed funds produce greater long-term returns for
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
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?
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
And remember, it's impossible for any investor to consistently
beat the market. Even Warren Buffett has bad days.
funds are increasingly popular among investors.
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!