Jason Zweig, The Wall Street Journal’s “Intelligent Investor” columnist, recently wrote about a curious trend among financial advisors — holding index-style exchange-traded funds.
That’s right, owning the index, yet still charging a premium for advice because, well, why not?
The argument from the managers is disarmingly simple: While they still make some bets on specific stocks, it’s getting too difficult to ensure that investors get a return that’s consistent and comparable to the overall market. So they buy ETFs.
Consider this quote, from a money manager Zweig interviewed, which I am sure was not meant to come off as ironic as it seems on first read. “Controlling risk and getting performance consistency relative to the market, that’s what managers can’t do very well, and that’s what ETFs help with.”
In a few words, investing is hard. Holding an index fund is easy.
For a lot of investors, the very idea of making investing easy is just unacceptable. They love and value complexity. There is no shortage of financial advisors willing to sell complexity as a feature.
Advisors also love to sell access, the idea that they know which mutual fund manager is going to do best. That’s “manager selection.”
Yet past performance is not only no guarantee of future results, as the prospectuses warn. In fact, there’s a pretty strong inverse correlation. Great performance can be a big flashing warning sign.
So says John Bogle, the founder of Vanguard Group and a pioneer of index investing.
“People hawking a particular fund have no idea how long it will continue to do well,” he told TIME. “They’ll say, ‘Our fund went up 500% in the last 10 years, and the index fund only went up 320%, so indexes are overrated.’ That’s usually the end for that fund.”
Now advisors are quitting even the manager selection business and going passive.
Bizarrely, though, the fees fund managers charge do not reflect the risks from active mutual fund investing. The more risk you run, it seems, the more you pay.
Consider two fund managers. One says, “I will charge you a minimum but don’t expect me to beat the market. I will keep up, though, every year.”
Fair enough, you say. The second says, “I will charge you much more and I might beat the market two times out of 10, but the other eight years you can expect me to lag the market, maybe by a lot.”
Bogle on risk
As Zweig explains, that second manager is far more common in the industry. Over 10 years, 80% of large-cap fund managers fell behind the S&P 500, their basic performance benchmark.
If you owned a slice of all the biggest funds, your experience was that of the second manager in our example. You lost money eight years of 10. If you hopped from winner to winner, as John Bogle warns against, it was worse. You likely bought just in time to lose big, and paid a premium for the privilege.
Index investing is not hard to do. Portfolio construction is thoughtful work but not overly complex. Risk management is well understood.
It’s reaching for the vanishingly rare — the consistent market-beating manager — that creates real risk for serious retirement investors.
