2015 Preview: Hard to say "Good Buy"

Healthcare has been golden.

With the change in calendars, short-term speculators will provide countless opinions on what sectors are ripe to benefit the most in the new year.  While short-term investing is not my true interest (despite my market predictions below), there is a benefit to investing before a market increases and the start of a year is as valid of a time as any to identify some of those markets.  If there is an industry with both recent losses and strong long-term prospects (e.g. a solid future), then it may be a better investment opportunity than an industry with recent gains fourfold over the rest of the market.  Even The Motley Fool (no relation) had a year-end article identifying the market's best and worst sectors of 2014.

Performance chasing is a horrible deterrent from long-term growth, yet so many novice investors naturally are lured into the pitfall (and the pitfall is not exclusive to novice investors).  Truthfully, there are valid reasons for “performance chasing” however, such as if an industry previously thought to be wholly unprofitable has proven otherwise.  But expectations of repeated gains at comparable levels should not be held.  To illustrate this point, consider the housing market in 2004, prior to its bubble filling with the hot air of performance chasers.  If real estate had never been viewed as a profitable market previously, then the subsequent years would have proven otherwise.

Gold market fell after 2 great years.

Energy's 2014 decline was in 4Q.

Likewise, also consider gold and precious metals market, which were vastly profitable in 2008 but its market has shown consecutive years of negative returns since then.  If anyone believes that the market itself is no longer viable (i.e. is gold becoming absolutely worthless?), then this downturn could signal the end of the industry as a whole, so it would not be a worthwhile investment. However, if the value of gold is merely decreasing but it will continue to maintain relevance in the future for years to come (i.e., will most value gold in the future?), then it may be a good buying opportunity for a longer range investment.

Granted, these ideas are by no means bulletproof.  For example, I believe the Healthcare industry has outpaced the market as a whole each year for the past 12 years or more.  Is it a bubble about to pop?  Maybe, but if any investors have bearishly avoided Healthcare for the past decade, then there was a substantial amount of profits missed.  About 230% to be exact.

In addition to market sectors, the economies of individual countries could also be considered.  Recently, Money.CNN.com posted a graph* showing the returns from each world economy.  It is worth a look-see.  While my theory would identify Russia as a promising market for 2015, whereas China and Argentina are potentially on the verge of a bubble, there are a lot more geopolitical factors involved in international investing.  While the theory is valid, I would be more bearish on poorly performing economies, but again, the theory still applies and any of those countries could see a reversal in fortunes in the next 12 months.  In this case, the validity of rebalancing become more evident.

CNN trolls are better used
for entertainment than knowledge.

Everyone says to “buy low, sell high,” but so few focus on how to accomplish those two seemingly simple steps.  As illustrated at left, even when a method of how is presented, there is often a public dismissal of the point of view.  For the record, the dissenting opinion presented was flawed: a rebalancing investor would have still benefit from the large cap appreciation, but merely reduced a portion of the portfolio’s exposure to the booming sector (i.e. “sell high”).  Additionally, the rebalancing investor will further benefit either from a future “boom” in small cap stock (buying before the increase) or a quick downturn in large cap (having already sold high).

In reality, no one knows what the markets can do and more often than not, individual years matter little over a lifetime (financially, just as well as personally).  But as I have noted in the past, predicting the forthcoming year is good fun!  While I expected the 2014 markets would clock in above 10%, following the increases in excess of 25% the prior year, it fell just short.  Coming into the last trading day of the year, it could have closed at 10% just as likely as it closed below, falling almost 1% today to close at 17,823 for a modest increase of 7.75% for the year (Nasdaq and S&P 500 increased 13.4% and 11.4%, respectively).

For 2015, there are a few factors involved.  The increases of year after year have to catch up, but the mechanics creating these increases have not really changed.  What I call the "laws of TINA" (There Is No Alternative) still apply, but interest rates are likely to increase during the coming year.  I still expect the Dow to increase this year, but I anticipate only modest gains from the Dow, Nasdaq, and S&P 500).  If the Dow were to increase exactly 10% in 2015, then it would be at 19,606.



* - graph notes:Countries with +/-20%
Argentina - 54.51%
China     - 43.32%            
India - 29.93%
Pakistan - 26.59%
Turkey - 24.61%
Indonesia - 20.24%
Nigeria - (20.67%)
Greece - (26.62%)
Russia - (44.9%)

North America
USA- 12.73%
Canada- 6.9%
Mexico- 0.79%
Brazil - (1.54%)

The Full Motley -- 4Q, 2014

Having now completed five years of quarterly rebalancing, this habit is well established and it feels natural.  In fact, it only takes me a couple minutes to calculate the moves that I need to make and submit them to make it official.  In this case, the movements were all less than 1% and hardly worth recounting here.

Although the market has not performed the way I expected, wanted, or planned (if it ever does, then it is merely a coincidence), I found it interesting that the amount my actively-managed large cap fund was up almost equaled the amount that my international index fund was down while my large cap index fund was up almost the same amount that the index bond fund was down.  Even the amount that the high-yield bond fund was down was comparable to the amount the actively-managed mid cap fund was up.  Instead of rebalancing this month, I could have been almost as well off by simply exchanging those amounts between the respective funds.

Outside of the 401(k), I have been amassing a slew of individual stocks.  My approach there has been taking it as an educational approach.  When I started investing in index funds, I had a strategy in mind based on what I had acquired from other people's experiences, but I felt truly knowledgeable after making it through my first market cycle.  I expect the same case will be said for individual stock picks.  Not many will be winners (as defined by outperforming the stock market) but I hope to be able to assess for myself what separated the ones that were winners from the ones that were not before I establish a true strategy.

So far, I have taken stock tips from The Motley Fool, from word of mouth, from Money CNN, and even from YouTube comments (of all places).  If my quarterly updates start getting thin based on my rebalancing activity, I may take the opportunity to address these individual stocks as well.

The 40-Year-Old Collector

Since the beginning of the year, the market expectations have been that there is only so high it can go before it retreats.  By the middle of the year, the focus of media attention was on its improbable upward mobility, citing that it had been nearing three years since the last market correction in October 2011 (defined as a 10% drop from its all-time high).  There were murmurs of QE3 causing the drop as it triggered previous sell-offs, but still, nothing more than 10%.  There were plenty of online articles to read predicting that the market would peter along through the rest of the year, continue to rise toward 18,000, or retreat into a bona fide correction, but as always, no one knew for sure.

Then, October 2014 started.  The volume of trading on the Dow went into overdrive, logging its best trading day of the year on Wednesday, October 8, 2014, and its worst on Thursday, October 9, 2014, moving 275 points and 334 points, respectively.  Even Tuesday, October 7, 2014, saw the Dow fall 272 points.  The following week, the Dow continued its slow and steady decline, despite Friday, October 17, 2014, being heralded as a market rally.

Myself, I have been patiently waiting for a market correction, preferably 15-20% to test my diversification strategies employed earlier this year, but also to buy in to a few individual stocks that I have been eyeing for the past several months.

While buying individual companies is new to me (hitherto, I have been strictly a mutual fund investor, and low-cost indexing for the most part), I have often been a collector.  Whether it was G. I. Joe toys, wrestling magazines, compact discs, or VHS/DVDs, I habitually buy and hold.  As I am pushing 40 now, my interests have simply changed from toys and other entertainment to a more lucrative hobby.

It fittingly started with $WWE.  After it plummeted from a $30+ high to almost $10 this May, I decided that, if the stock dropped below $10, I would buy it and hold until it reached $20, then pick it up again the next time it fell below $10 (a common trend for the stock price over its 15-year history). Unfortunately, the stock itself did not cooperate with my plans, remaining over $10 so far this year. However, I reasoned one key to individual stock trading over long-term ranges is patience. Additionally, I assumed a market correction was nearing, at which point the stock price would surely fall below $10.  (Still waiting.)

During this time, I started compiling a "wish list" of other companies that I would like to buy for the right price.  After deciding to buy $WWE, I considered what other companies would be like WWE, whose rise to $30 was highly improbably considering its $10-$20 historic range.  For the most part, $WWE went up so high because it had launched its innovative online WWE Network.  I pondered what other corporate brands could have the luxury to duplicate that product.  The only one that I could rationalize was $DIS.  Like WWE, which has monthly pay-per-view events, weekly television shows, and a long history for its fans' entertainment, Walt Disney Co. would have annual movies, an ongoing cable television channel, and a long history for its fans' entertainment.  Like WWE, Disney has an enviable amount of die-hard fanatics.

Additionally, I considered some of my personal favorite brands.  Leading the pack were $PEP and $YUM.  I also considered how the oncoming Internet revolution would continue to radically change the way consumers do business.  I almost immediately eliminated any "brick-and-mortar" business, aside from fast food, until I considered that grocery stores would probably be the longest surviving stores.  Therefore, I added $KR to my wish list since its national reach would likely keep it afloat for as long as feasible.

Aside from my favorite brands, I have stayed open-minded to some companies that I would have never considered but-for their high-risk/-reward stocks.  If you call a spade "a spade," then call my wavering interest in these companies "greed."  The Motley Fool (of which I am NOT affiliated, despite my surname) often encourages its readers to buy suppliers for future technological revolutions.  If television were replaced by Netflix or Roku and the like, but you are unsure which brand will succeed, then buy what they all have in common.  For example, GT Advanced Technologies Inc. ($GTATQ) was heralded as a sure-fire winner before $AAPL released its latest iPhone since they were contracted to supply the virtual scratch-proof sapphire screens. Unfortunately, things went horribly awry, and the iPhone did not use these screens, leading GT Advanced Technologies to close a plant in Mesa, Arizona, and file Chapter 11 bankruptcy shortly thereafter.  Its stock price went from a high of $20+ in July 2014 to under $1 in October.  I had a buy price of $10 for that stock, so I dodged my first massive loss in the market (for full disclosure, I have bought some of its shares, primarily to follow the company and for the high-reward element if the stock price recovers).

I will be interested to see how my wish list grows and, of course, how long it takes to buy them all!

Credit Where Credit's Due

This morning, CNN Money posted an article regarding this year's most popular credit card.  For the past seven years, American Express earned that distinction, but now it has to share the honor with Discover (my family has been a loyal to Discover since its first national roll-out campaign in the mid-80s). Not surprisingly, the CNN trolls (the commenters with more opinions than knowledge) chimed in on the subject of credit cards, but they were immediately shut down at every post. Two trolls in particular stuck out. One compared credit cards to a layaway plan, insisting that people who can pay off their monthly amount were better off using cash, and the other said credit cards were the shovel you use to dig your own financial grave.

I will discuss the first commentary in a moment as it was more relevant, but the second comment stuck with me because it was the perfect test for a hypothesis I had a few weeks ago. Imagine how much more agreeable we would be if we used first person in place of second person in our comments. For example, if that CNN troll had instead stated “credit cards were the shove I used to dig my own financial grave,” it would inspire more empathy instead of the barrage of defensive outrage (though, for all I know, outraged replies may be the gold that trolls treasure in the first place).

A lot of media outrage has been generated over the years about credit cards. Some of it is warranted, especially the predatory methods some companies used targeting fresh-faced college students who were falsely assured all their efforts today would be rewarded later, so they decided to spend a blue streak today, driving themselves into those aforementioned financial graves later.  There was also a slew of good, old-fashioned stupidity involved in consumer credit abuse, as the first comment mentioned, such as using credit cards to buy things now to pay off slowly.  Aside from the extraordinary fees charged for that irresponsible behavior, I still believe the resulting sensation of depression it can cause is more costly.

Personally, I got my first credit card as soon as I moved out to Arizona. It was through MBNA, which was a highly rated credit company until it was bought out by a highly disparaged credit company several years later. My credit card limit started at $3,000, and within a few years, it became a platinum card with an exponentially higher limit (as you may expect, that change occurred with the change in companies). I was offended by the increase, fearing that I would be more of a target for credit fraud, so I stopped using the card. In reality, the more unused credit you have in your name, the better it is reflected in your credit score. Canceling the card was a mistake, which may adversely affect me in the future.

Regardless, I was excited to apply for a Discover card to replace my Platinum card. Truthfully, Discover popularized the rewards gimmick that is an unspoken obligatory offer in every credit card today. The CNN troll who incorrectly stated that credit cards are mostly used for layaway purchases further defended her point by saying that the consumer is charged for those rewards vis-a-vis the monthly interest rate (finance) charges. Once again, her information was warped by the media-hyped fear mongering, and clearly not by personal experience.

In keeping with my previously mentioned “first person” theory, by paying off my credit card balance each month, I am not assessed a finance charge. I will still benefit from all the rewards though (and the credit card company still comes out ahead in the game) because those rewards are generated by the fees that credit companies charge the merchants. Truthfully, we are a society so grounded in credit that it is difficult for small businesses to survive without accepting credit. There are a few restaurants that I do not frequent simply because they do not accept Discover (and a few others that I never visit because they do not accept any credit).

Credit has gotten a bad wrap (for some good reasons) over the past few years, but the simple truth is that there is a way to use credit cards properly and responsibly, and the totality of those benefits is better than strictly hailing to the King (BTW, “cash is king”).

The Full Motley -- 3Q, 2014

I had reallocated my assets on Monday as I do each quarter, moving only a small fraction of my account (two-thirds of 1%, to be exact), and then at lunch on Tuesday, I happened to hear a discussion on Money Radio 1510, discussing the allegedly over-inflated research in favor of reallocating periodically, specifically noting that re-allocating monthly or quarterly was pointless. While I support some of that argument more than my actions would suggest (I honestly do not believe moving 0.67% of an account is critically important for long-term financial success), there are a lot of additional benefits to reallocating that the hosts of this talk radio program grossly (or, conveniently) overlooked.

First, periodic re-balancing keeps you thinking. Specifically, thinking about your future and your investments. Two things that, while I may not have any problem finding time to do so in the middle of the day, many others fail to consider. Granted, to the point of the show's hosts, over-thinking is a common pitfall for novice (and even expert) investors, but, to my point, neglecting it is on the opposite end of the spectrum and more detrimental in the long run.

Secondly, contrary to that program's apparent belief, not every piece of financial advice should be made in order to maximize profits. There are many things that are recommended solely to reinforce good habits and establish discipline.  That discipline in particular will prevail with cooler heads whenever the markets get particularly emotional (e.g., market corrections).  Periodic re-allocations can be one of those habits.

Furthermore, the downside of their argument against reallocating was that the initial allocation is completely arbitrary.  The hosts are professionals in the industry, so maybe they have clients often come to them devoted to a strict allocation, only to learn later that this allocation was generated by a computer program or an even more impersonal method.  Regardless, dismissing re-allocations based on the validity of the target allocation is where I mostly took a defensive stand.

The largest purpose of reallocating small amounts, such as monthly or weekly or daily reallocating will do, is to achieve rule #1 in investing: buy low, sell high. Until your target allocation changes significantly, generally due to the natural process of aging, there is no better method to move money out of inflated assets or move money into deflated assets than reallocation.  Because the amounts being moved are small and because these re-allocations are predesignated periodically, there should be no decisions to second-guess or no bad news to cause an adverse reaction in a temporary panic.

Another good habit for long-term financial success is diversification.  This year, I started adopting many more markets and sectors in my Roth IRA, including the gold (metals) market, healthcare sector, and 3D technology sector. Diversification can get you far, but there is a limit to its fruitfulness. Most people know that there is such a thing as over-diversification, but few would say that issue negates the benefit of diversification altogether. Same goes for re-allocations. Dismissing either strictly for its limitations is throwing the baby out with the bath water.

New Dimensions

"If you choose not to decide, you still have made a choice." -Rush

Recently, I wanted to invest in 3D Printing.  As soon as I heard about the concept, I knew the potential was limitless (for the next several years) and I would have jumped on investing into it at that time, except there were two major dissenting factors.  First, I had quit my job and my risk tolerance was minimal.  Secondly, the research I did on the subject unveiled three companies competing for supremacy in the industry.

Granted, the landscape was wide open enough for all three, but the memories of Beta and HD-DVD made the probability of it seem increasingly less likely.  Even if I picked the correct industry for a boom (3D Printing), I could have picked the wrong company and my investment would have ended up as a bust. Individual stock selection is high risk by its very nature, and I have never been involved in it.

Once I got hired back at my prior income level, my interest in 3D Printing rejuvenated.  Shortly thereafter I read a news article that the first 3D Printing Fund would be opened in February 2014.  I thought it was my lucky day!  By that point, I figured I would have restored my budgeting practices and I would be ready to invest again.

Unfortunately, the first article I read about the fund panned the investment because the fund manager had no experience in managing mutual funds, so I dismissed the investment idea altogether.  Besides, the Dow was slipping and I figured the losses would continue for the next several months.

Instead, things turned 180°.

After a strong finish to March and a stronger April, I saw an intriguing link to an article in late May suggesting that the end of cable television was near.  The presentation at hand would direct invested investors in where to put money to benefit for the new wave of television.  It turned out to be a link by Motley Fool (no relation) and the 3D Printing industry was their answer, which I found out for a small investment of $50 for a 12-month subscription price.

Now that I had invested money in the idea of investing in individual stocks, I figured it was the best time to invest in individual stocks.  Additionally, shares in $WWE (of whose programming, I have been a loyal viewer since 1988) crashed that month, so I thought for sure that I would invest in them and in one of the 3D Printing companies.  Once again, I hit the dilemma: which one of the three?  All three were recommended in the Motley Fool article.

That dilemma made me reconsider the 3D Printing Fund.  I figured if I were going to invest in an industry of which I knew nothing about, then my investment selections would likely pale in comparison to the selections of a professional.  The fund manager Alan Meckler was basically a journalist by trade, and his lack of experience as a fund manager was neutralized by the fact that my option was investing myself, and I did not have any experience either.  Therefore, I decided to invest in the 3D Printing Fund ($TDPNX).  Incidentally I canceled my subscription to Motley Fool in the initial grace period, and I got a full refund.

I talked to someone at work whose interest in discussing investments is equal to mine, and he asked why I would invest in a mutual fund for just three of its holdings when I could just invest in the three stocks myself without getting charged fees.  My answer was that I wanted to access to Mr. Meckler's knowledge about the rest of the industry, and my friend (an attorney by trade) immediately ceased questioning. I think he was testing my confidence in the decision, and I greatly appreciate it if so.  I did further research after investing, and I learned that the fund was registered as a global fund, so foreign companies creating advancements in the field would be on the fund's radar (if not in its portfolio holdings) long before residents in the United States would even heard the company's name.

Since I started my investment in the fund, it has increased 11%.  Although completely satisfied with the returns, I started looking at the individual returns of its top 10 holdings today.  The three stocks that I was torn among had returned 2%, 7%, and 15%.  Three of the other stocks in the top 10 that I never would have known about on my own had returned 20%, 25%, and 40%.

While the market is setting new all time highs, only 50 points away from crossing 17,000, I think most stocks are a bad purchase at this point (I expect the market to go through a correction soon, and an increasingly more severe correction the longer it stays afloat).  However, I want to diversify myself while the stock market is high to mitigate the impact and, ideally, find at least one industry that sustains its value while everything else around it crashes.

Maybe if the market fell below 15,000 again, I would reconsider buying individual stocks.  For now, mutual funds offer all the investing prowess I need.

CNNFN: From cancer survivor to millionaire

From cancer survivor to millionaire

By Matt Egan  @mattmegan5 June 21, 2014: 9:27 AM ET
http://money.cnn.com/2014/06/21/investing/cancer-survivor-investor/index.html?iid=HP_River

Tim Eimer defines 2008 in one word: Bleak.

The science teacher and textbook author was fighting off a rare and terminal form of cancer as he watched the Great Recession swallow up 40% of his investment portfolio. Friends in finance warned him to dump his stocks because they feared the Dow would soon plummet from its already depressed 8,000 level to 1,000.

Despite those daunting challenges and ominous warnings, Eimer poured cash into the stock market at the depths of the crisis, a decision that has left him and his wife Gayle on track to become millionaires.

"I didn't jump ship. It was scary buying back into the market at that time," said Eimer, who lives in Horsham, Pa., a suburb of Philadelphia.

Eimer, who in 2005 had been given just two years to live, said he stuck to his belief that you've got to be in the market to make money.

Besides, he said, "If the Dow goes down to 1,000, then all of us have a lot more problems than losses in stocks. You're talking about the collapse of our economy."

'Prepared for the worst' Eimer's courageous investing during the financial crisis was made possible by his family's frugal, debt-free lifestyle.

Unlike most Americans, he didn't lever up during the mid-2000s on luxury cars, over-the-top houses or second mortgages.

Instead, Eimer and his wife saved half of his salary and invested heavily in their retirement and college savings funds. They paid off a mortgage on their two-bedroom condo in 2003 and bought a new Toyota Corolla for just $15,000. Later they "splurged" on a Honda Element for $18,000.

"Frugality was grounded into me from a young age," said Eimer, whose grandfather lost everything in the Great Depression. "If we had not prepared for the worst, we would be faced with financial disaster."

Eimer said he converted his wife from a "spendthrift" when they first met to a frugal manager of the household budget. "Without her, we wouldn't have been able to do any of it," he said, noting the family gets by on just a single prepaid cell phone.

Beating the odds: Disaster struck in 2005 when Eimer was diagnosed with an extremely rare and terminal form of thyroid cancer. That forced him to give up his lucrative side career making up to $200 an hour writing textbooks for McGraw-Hill, Prentice Hall and other publishers.

There was one doctor on the whole planet who was researching this form of cancer, Eimer said, and she developed an experimental chemotherapy drug that helped save his life.

While the drugs extended his life considerably, he still deals with chronic pain, fatigue, abdominal pain and loss of his hair, which has since returned. But Eimer has been able to continue teaching middle school science at Phil-Mont Christian Academy in Springfield, Pa.

Almost a decade after receiving his grim diagnosis, Eimer has beaten the odds and is currently in stable condition. He's also beaten most retail investors by actually participating in the bull market that has left many everyday Americans behind.

"I went through the dotcom bubble, but this seemed worse," Eimer said about the 2008 crash after Lehman Brothers collapsed in September of that year. He said friends who were financial advisers told him to "ditch all stocks and buy silver."

Buying at the bottom: But Eimer did the exact opposite of those dark warnings: He scooped up beaten down stocks and bonds at what turned out to be historically-low prices.

Eimer said he felt confident enough to do this because he had no debt and a ton of fresh powder: 25% of his portfolio had been in cash when the market cratered. At that point, he had bigger problems as he braced for cancer to take his life.

Rather than risk trying to find individual stock winners, Eimer continued a strategy that he's implemented since the 1990s: Buy a diversified variety of index and mutual funds.

Bad luck while investing in individual stocks led Eimer to conclude: "It was only my broker who was getting wealthy."

One mutual fund that's been particularly kind to him is the Vanguard PRIMECAP Fund(VPMAX), which invests mostly in technology and biotech stocks like Google (GOOGL,Tech30) and Amgen (AMGN). The fund has soared 133% since the start of 2009, besting the S&P 500's 123% gain.

"Today, our portfolio is up about 2-1/2 fold from the recession lows. We have zero debt, we're on target to become millionaires in about three years and I'm still alive," Eimer said. "We count ourselves blessed!"

(I share this article for two points: 1) he *risked* his money because at that rate, the collapse of the dollar was the only thing to fear (exact reason I had), and 2) his spin on financial advisers.

The Full Motley -- 2Q, 2014

After a slow start that allowed the "gloomers & doomers" (as Moe Ansari loves to call them) to start crowing that a major market retreat was near, the Dow set new all-time highs earlier this quarter.  Right now, the market has given up those earnings, but it is at 16,575, which is almost exactly where it started the year.  I cannot say that it is showing no signs of slowing down, because the honest truth is that there were no signs that it would increase this year so far, or not decline.  Either is possible, especially in the short run, and a 10% market correct may be the most feasible.

Regardless, my stock-heavy retirement account is doing fine and, most surprisingly, I moved money from my stock index fund, my active stock fund, my international index fund, AND my bond index fund.  The sum taken from all those funds was almost exactly 1% of the account, and most of the funds to be rebalanced (>80%) came from the Vanguard Total Stock Market Index Fund and Vanguard PRIMECAP Fund.  My only fund under-performing its peers over the past three months was my most aggressive active stock fund, which was initially unexpected, but if small- and mid-cap stocks slow down first, then the large-cap funds may just be recognizing the residual benefits from last year's massive increases, and a correction is ahead.

In other news, maintaining this blog has been getting slightly more complex as my employer has started to monitor what I post (hence, the new disclaimer on the main page, which I had always wanted but I never had an incentive to find out how to add it).  Their oversight should not affect the content (as stated in the disclaimer, every moves that I discuss is tailored exclusively to my personal goals and risk tolerance) but it may skew the frequency with which entries are posted.  With a ridiculously low readership, however, I do not anticipate it becoming an inconvenience for anyone.


Move $1144 to Explorer.
Move $25 from Hi-Yield.
Move $545 from Stock Index.
Move $340 from PRIMECAP.
Move $103 from Bond Index.
Move $131 from Int'l Index.

Haunting Words

Very early in my career, I was a financial adviser.  Straight out of college and still working as a cashier at Schlotzsky’s Deli, I was the quintessential financial adviser off the street: A know-nothing mouthpiece who memorized a presentation to recite to as many people as I could find who were willing to listen. See, there are no actual qualifications to call yourself a financial adviser. Conversely, Certified Financial Planners are qualified.

Meanwhile, I was 23, and this career choice was a lot tougher than I had imagined.  Who knew that no one eating at a fast food restaurant wanted to listen to their friendly cashier for financial advice?  Just like the greener grass in other yards, other people had more success getting people to listen to them, mostly older people (in reference to both my colleagues and to their clients – albeit, I was only 23, so virtually everyone in the work force was older).

It was May 2000, and I was just starting out in finance. I knew nothing. Well, almost nothing! I remember my mentor telling me the story of his clients who were nearing retirement, but they had not saved a large enough nest egg. These bullrageous market conditions were a blessing, and he said that, although those clients were hesitant to put a lot of their money in the market, when they saw how quickly and how high the amounts that they put in had grown, they finally agreed to follow his advice and put a lot more of their money in these fast-rising technology mutual funds. Remember, this was May 2000. As we know now, putting more money in the tech bubble at that stage was the modern equivalence to 1912 contemporaries buying non-refundable tickets on the Titanic’s next voyage.

Unfortunately, I did not know any better then. It is humbling to think how I got from there to here, except that it was a day-by-day process. I got here because I lived each moment in between the two. I remember after the 2009 recovery saying I felt far more confident in my investing knowledge because I had experienced a full cycle for myself. Truly, I had.

My first investment was on March 11, 2003, an insignificant day in history to investors but a truly ideal day to start investing because it was the absolutely lowest point of the stock market that calendar year (the markets were recovering from their 2002 lows, but the incline hit a minor correction in February and March). My investment was the Vanguard 500 Index. I still have that investment in my portfolio, and I have never added another penny of my own money into the fund, but I have let dividends reinvest. It allows me to see how large a little amount can grow in the course of 10 years. Likewise, I can see firsthand how quickly a setback can wipe out numerous years of that growth.

CNNFN: Top Incomes Can Be Fleeting

Top incomes can be fleeting
By Jeanne Sahadi
http://money.cnn.com/2014/03/26/pf/taxes/high-income-taxpayers/index.html

There are few lifetime memberships in the exclusive club of high-income taxpayers.

In fact, there's a lot of turnover in the top 1%, entry into which took at least $389,000 of adjusted gross income in 2011 -- a threshold met by nearly 1.37 million returns that year.

Membership can be fleeting because many people are temporarily catapulted into the top 1% or even top 0.5% of tax filers due to a windfall of some kind.

Two examples: proceeds from the sale of a business or from one-time capital gains.

In fact, nearly 60% of those in the top 1% of taxpayers at the start of any 10-year period between 1987 and 2010 had dropped out by the 10th year. That's from a study by the U.S. Treasury Department.

And the Tax Foundation found this: Of those who reported income of more than $1 million between 1999 and 2007, about half only reported income that high for one year.

Make no mistake: They still may be rich. But their incomes fluctuate greatly.

"There are a lot of people who are [at the top] only once in any given period," said Roberton Williams, a fellow at the Tax Policy Center.

Transience is also a characteristic of those at the very tippy top. Among the top 400 taxpayers between 1992 and 2008, nearly three quarters appeared only once during those 17 years, according to IRS data.

There are many reasons why tax filers drop out of the highest income groups:
--They may start to bring in less taxable income once they retire.
--They may have a bad year on their investments and claim losses, which can offset their capital gains.
--They may change the composition of their income, so that more of it is coming from tax-exempt investments, which don't have to be reported on one's 1040.

Indeed, the federal tax return offers no clue to a person's net worth.

For example, the size of retirement accounts and the value of property that has not been sold are not reported on tax returns. While those assets may throw off some taxable income, such as rent, their underlying value is a better measure of wealth.

That's why there's a lot less fluctuation in the top ranks of the wealthy than there is among the highest income households.

Bill Gates' income in any given year may be topped by that of a hedge fund manager, Williams noted. But his wealth remains vast enough to keep him among the world's richest for a very long time.

Aesop Investing

The legendary tale of the tortoise and the hare has forever provided a cautionary warning that slow & steady can win the race.  Recently, I heard this fable applied to finance as well, and, at first, it rubbed me the wrong way.  I was not sure how apropos the metaphor was for investing, despite my own personal preference for “slow & steady” investments like index mutual funds.

For starters, the tortoise and the hare were in a race against each other, and personal investing should not be comparable to direct competition.  In a race as with most forms of competition, there would be a clear beginning and a definitive end.  Additionally, the goal of both competitors would be perfectly aligned, but there would only be one winner.  Immediately, those disconnects triggered a realization of the most applicable lesson to be taken from the same fable for investing.  Looking at what others are doing will lead to a pitfall!

Listening to the success stories (or financial failures) of others is fine, but never take their words as pure fact.  People have numerous ways to perceive the same set of circumstances.  It stretches beyond the basic half-empty/half-full conflicting viewpoints.

Pretend I put $10,000 in a single stock for five years, and that investment went as high as $15,000 at one point, and then as low as $7,500 at a later point, but, at the end of five years, that initial investment was worth $11,000 (ignore dividends and assume no additional money was commingled into the stock during the interim).

In this scenario, I would most likely say my investment made $1,000.  But I could say my investment lost $2,500 or I could say my investment lost $7,500.  Truthfully, I could even say that this investment made $8,500, i.e. $5,000 when it went from $10K to $15, plus another $3,500 when it went from $7.5K to $11.  People invest with blinders, and everybody's blinder is different.  These “blinders” are a conglomerate of our individual perceptions, intentions, and expectations.  Without seeing detailed balance sheets or an audited track record, the facts may or may not be interpreted in the same way.

Therefore, hearing that a turtle has earned $8,500 in an investment when your money only earned $1,000 in an identical investment may be troubling or, at least, perplexing.  But making changes based on only those facts in an attempt to outpace the “competition” will likely send your portfolio into a destructive pitfall.  While many people accept that slow & steady won the proverbial race, the reality is that the bunny shifted focus from what he was doing to where his opponent was.  Investing is not a competition.  Turning it into one is instantly problematic.

The Haves & The Have-Tos

I was listening to a radio program by Bill Tatro on Money Radio 1510 at the end of last year, and he shifted his financial analysis into a psychological commentary on the set of people who had unrealistic monetary expectations.  He noted a number of his clients have a mental block about living below their means.  He said that they live under the guise that the next big raise was right around the corner or that their debt would work itself out.  The concept of living on $25,000/year was impossible for these clients that he described as "having a $75,000 lifestyle on a $50,000 income."  He said that these people suffer from a "have-to" curse, e.g. they have to drive a new car, they have to get the latest technology gadget, and they have to eat out more often than not.  It made me realize that the most troubling gap in our country is not between "the haves and have-nots," but rather those who have and those who have-to.

Speaking from personal experience, I have to live below my means.  Quitting my job to start a new career was extremely stressful, even though I had enough to live on.  Originally, I built up a substantial amount of savings to live on, but even then, I was not psychologically prepared to watch it deplete so quickly.  I got a part-time job in retail.  Once I graduated school and got a job, I started living at that income level.  It wasn't comfortable, in fact, it was very stressful as those closest to me knew.  It felt as though I was spending almost everything that I earned (in reality, I made money during these 2 1/2 years of a reduced income, thanks to the exceptional market conditions in 2013).  But I had scaled back my spending to the point that I was no longer pulling money from savings after I got my first full-time job, although my annual income was under $25K.  Living that way left me unsatisfied.  It was not the lifestyle to which I was accustomed.

Later in the show, Bill Tatro wondered aloud whether people were still familiar with the financial cliche "money doesn't grow on trees."  Immediately, I thought of an episode of Keeping Up With The Kardashians, a show that I criticize more often than I watch, where Kendall Jenner asked her father for money, and he fed her that saying.  She flippantly replied, "yes it does.  Money is paper, and paper is made from trees."  It was cute for 16-year-old Kendall to say, but I groaned instantly out of pity for knowing too many grown adults who feel the same way.  They are the same people who have-to be "keeping up with the Kardashians," because I guess the Joneses aren't impressing anyone these days.

Financial advisers often speculate where their message is getting lost.  The AICPA created a solid campaign around Benjamin Bankes, reminding people to "feed the pig," i.e. their piggy bank, and providing numerous examples of how to cut expenses.  I believe the message is heard, but it is actively ignored by the have-tos in favor of the lingering effects from the message-less Occupy movement.

In short, I believe there is a certain resonating fear of income among my peer groups.  When I was in high school, there were budding concerns of the youngest generation appearing to embrace (and to celebrate) failures while having an unspoken fear of success.  It came to define the generation socially, especially those under the influence of the grunge music that dominated airwaves in the early 90s.  Why ever try if there's nothing wrong with being a loser?  The attainable goal of building productive members of society took a backseat to teaching every child to hold on to dreams.

On March 27, 2008, John Mayer posted a deeply thoughtful blog that he wrote "to shed a little light on why we're all in the same boat, no matter the shape of the life we lead: because every one of us were told since birth that we were special.  We were spoken to by name through a television.  We were promised we could be anything that we wanted to be, if only we believed it and then, faster than we saw coming, we were set loose into the world to shake hands with the millions of other people who were told the exact same thing."

The expectation of living a life to rival fantasy was abruptly halted by universal realities that our world failed to prepare us for because it was too busy pampering everyone equally.  Last month, Oxfam released a report that 50% of the world's poorest people have the same combined wealth as the richest 85 individuals in the world.  That same week, Pope Francis challenged the world's richest "to ensure humanity is served by wealth and not ruled by it."

Unfortunately, all the media coverage vilifying the rich continues to coddle an underachieving generation and seemingly to smoke screen individuals from aspiring towards a better life.  Money cannot buy happiness, but life is a lot better without the endless stress cycle of not having enough money day-in and day-out.  The only way to get ahead, though, is a matter of effort and determination.  I hope to expand on that thought later.  For now, I will just conclude that the have-tos find it easier to dream the life than live the dream.

myRA or the hiRA?

"Let's do more to help Americans save for retirement.  Today, most workers don't have a pension.  A Social Security check often isn't enough on its own.  And while the stock market has doubled over the last five years, that doesn't help folks who don't have 401(k)s.  That's why (...) I will direct the Treasury to create a new way for working Americans to start their own retirement savings: myRA." -- President Barack Obama, January 28, 2014 (SOTU)


Personally I have mixed thoughts about the myRA, which is apparently a more positive stance than the vocal majority out of the financial industry.  The pros/cons of myRA are quite transparent.

On paper, the myRA program just makes great sense to me.  The White House released the first Fact Sheet on the accounts this week.  The most obvious point of contention from the financial industry is the forced investments into Treasury securities, but I have no issue with that restriction.  It prevents myRA investments from higher risk equities as to not discourage novice investors by starting off on the wrong foot, e.g. buying at the peak of the market, or by fostering more distrust where participants could have less in their myRA after putting money into it.

The problem is that most dissenters from the investment industry cannot turn off their own minds and view things from the mindset of a non-investor.  Professionals know what is best to prepare for retirement, because they know how the business works, but the problem is that large percent of the population who do not know how investments work or, even worse, where to start.  This investment is exclusively for their benefit.

Fortunately, I am in a rare situation where I spent 10 years in the financial industry, and then spent the past three years under-employed while I tried to start a new career in the legal field.  Having a couple jobs making less than the proposed minimum wage during that time enables me to appreciate things like this myRA proposal differently.  I did not have access to a 401(k) in my past two jobs.  In my case, I opted to hold off on retirement contributions because I was still pulling money out of my investments for living expenses, but my experience was a temporary situation with a visible end in sight.  If this opportunity existed, I most likely would have put $5 (or more, knowing me) to this type of retirement account just to continue active contributions to my retirement.

Obviously, I could have set money aside each paycheck to contribute into my Roth IRA once the accumulated balance reached the minimum additional investment amounts, but the reality is that I did not think to do so because it was not a visible option.  Therein lies the problem: saving for retirement, outside of employer retirement plans, must be a priority.  Conversely, myRA investing should capture participation rates that exceed individual retirement plans and inch closer to the participation rates that employer retirement plans have.

My initial concern on the myRA project is how it seems the more popular myRAs are, the more expensive the program will become.  Won't the accounting of these millions of myRAs at balances under $100 be a tremendous expense?  There is a valid reason why the finance industry has set minimum initial investment amounts.  Unless they are waiving the accounting requirements to give them an advantage over what the financial industry can offer, I do not understand why the reporting expenses would be lower for a myRA than for the current IRA options.

That said, the pros and cons of any situation are not mutually exclusive, but considering them separately is necessary to move toward a conclusion.  And just like investing, personal emotion holds the least amount of weight.  The dissent from investment professionals is valid, but they should consider those concerns on par with clients who delay investing because of their own personal emotion; in each case, it is best to think of personal opinions as an obstacle and not a valid reason for dismissal.

For additional information available on the proposed myRA program, please visit http://www.whitehouse.gov/blog/2014/02/11/myra-helping-millions-americans-save-retirement

The Full Motley: 1Q, 2014

It is hard to believe that we are almost halfway through the first quarter of 2014.  Because, personally, it feels as though we should be further along than that!  Regardless, there have been a couple years in which the first quarter of the year has been so strong that there was not a day in the remaining 9 months that was lower than where the year started.  Obviously, this is not one of those years!

Market fluctuations are part of the game.  The market does not always rise and never falls anymore than people do expect to always be happy and never be sad.  The point, much like life, is to expect things will be better in multiple years to come based on the choices we make now.  Few people are expecting the market to be up 10% by the end of the year (like I predicted it would be in my annual preview) but if the market falls 10%-15% in the first half of the year, then it would have another six full months to gain another 25% when the bears hibernate.  That is not to insure a strong probability, but merely assessing possibility.

Overall, my account is down from where it started this year, as expected, but I was intrigued to see which fund had been performing best so far this quarter (which is to say, it had lost the least).  It turned out to be my actively managed large cap fund.  None of the moves to rebalance equaled 1% of my overall portfolio, but I performed the rebalance in my former-employer's account.

Perhaps the more interesting situation nowadays is that my former-employer's 401(k) account is not my only active 401(k) account these days.  Having been on the job for two full months now, my new employer's 401(k) account is going to grow exponentially.  My hope is that it will grow higher than the markets fall, but when buying into the market, having a depressed market is hardly a bad thing.  Additionally, I would be able to revisit past investment strategies, such as directing all new money into one fund or sector and then rebalance quarterly.  It would make more sense to rebalance that account quarterly and then only rebalance this former-employer's 401(k) twice a year.

In future years, I may need to revisit my rebalancing methodology entirely.  The option to roll my old 401(k) account into my new account exists, but the investment options are superior in my old account, so it is an option that does not appeal to me at this point.  Additionally, I could roll my old 401(k) account into my Roth IRA.  But, as for right now, I prefer having it separated.

It will be more interesting in May to see how my new 401(k) looks since I will have been contributing to that account for six months by that point.  And, of course, it is anyone's guess where the major indexes will be at that time!

Guilt-Free Investing

I apologize in advance that the complexity of this entry is a bit backwards.  It will start with the most complex information first and then simplify into more attainable concepts.  There are countless measures to the market, but one commonly quoted is CNNFN's own "Fear and Greed Index."  According to Investopedia, it measures those two primary emotions that drive investors as generated by seven indicators:

1. Stock Price Momentum - as measured by the S&P 500 versus its 125-day moving average.

2. Stock Price Strength - based on the number of stocks hitting 52-week highs versus those hitting 52-week lows on the NYSE.

3. Stock Price Breadth - as measured by trading volumes in rising stocks against declining stocks.

4. Put and Call Options - based on the Put/Call ratio.

5. Junk Bond Demand - as measured by the spread between yields on investment grade bonds and junk bonds.

6. Market Volatility - as measured by the CBOE Volatility Index or VIX.

7. Safe Haven Demand - based on the difference in returns for stocks versus Treasuries.

Each of these seven indicators is measured on a single scale from 0 to 100 with 50 denoting a neutral reading, and a higher reading signaling more greed.  The index is then computed by taking an equal-weighted average of the seven indicators.

Furthermore, "Investopedia explains the Fear and Greed Index is a contrarian index of sorts, which is based on the premise that excessive fear can result in stocks trading well below their intrinsic values while unbridled greed can result in stocks being bid up far above what they should be worth.

"The index can therefore be used to signal potential turning points in the equity markets.  For example, the index sank to a low of 12 on Sept. 17, 2008, when the S&P 500 fell to a three-year low in the aftermath of the Lehman Brothers bankruptcy and the near-demise of insurance giant AIG.  It traded over 90 in September 2012 as global equities rallied following the Federal Reserve's third round of quantitative easing (QE3)."

Accordingly, the nature of investing itself is based on fear and greed, both of which are commonly identified as sinful emotions.  Is there any way to achieve guilt-free investing?  Fortunately, the answer is yes.

John Bogle, best known for as the creator of index funds, has rallied against the sinful actions leading up to the incidents like the collapse of the Lehman Brothers, and Enron before it, as an irrational exuberance of greed in a way.  His 2009 book Enough opened with a tale of accomplished authors Kurt Vonnegut and Joseph Heller attending a party by a billionaire hedge fund manager in Shelter Island.  Vonnegut noted how that gentleman "(has) made more money in a single day than Heller had earned from his wildly popular novel Catch-22 over its whole history.  Heller responds, 'Yes, but I have something he will never have ... enough'."

The temptation to reach for more is equally balanced by the fear of losing too much, which is why the Fear and Greed Index is relevant to daily market watchers.  However, those emotions are controllable.  Ignoring them and deciding that they will have no power are both successful methods for keeping them in check (the success of either of them most likely varies by each person).  The fact is that no one started investing to lose money, and long-term investors are far more likely than not to gain, which is a success.  Comparing it to other fields of greener grass is the first mistake.  Concepts like "opportunity costs" truly exist and worthwhile factors for decision making, but they should stay in proportion to higher drivers that are more important.

The success of the index fund is a win against fear and greed.  One of the most telling descriptions Bogle has given about index funds is that it enables every American to participate in the economy, effectively giving the average Americans access to "their fair share" of the American economy.  When the market rises, the index fund increases.  If the market retreats, the index fund will lose value.  If investors create a simple portfolio by selecting index funds, then there should be no opportunity for greed (and likewise, if their intentions are pure, then there should be little concern for fear), and the profits realized are not a matter of wanting more, but simply partaking in the American economy.  Setting aside any displaced intentions, pure index fund investors can enjoy guilt-free investing.

Betting on a Losing Fund

Question: if it is so difficult to compile a portfolio of winning stocks that most professional advisers cannot consistently outperform the market itself, then is it easier to find a losing fund that happens to become a winner later?  I found myself testing that thesis last week, just to see what happens in the coming years.  Not surprisingly, my projected loser is the Vanguard Precious Metals & Mining Fund.

I invested the minimum into the Fund; expecting it to spend the duration of its time in my portfolio at a significant loss considering, after increases of 75% and 40% increase in 2009 and 2010, respectively, it went down 20% in 2011, 13% in 2012, and another 35% in 2013.  However, I suspect it may be substantially undervalued now, or at least ready for some upward recovery.  Therefore, I made the minimum initial investment and I plan to move any earnings (potentially, including reinvested dividends) into a better fund, letting the investment stay at its minimum or fall where the market takes it.  Effectively, I am betting on a losing fund.  In the best case scenario, I would be wrong about the fund's abysmal future.  In the worst case scenario, I would prove myself correct about the gold market.

Often investing is so backwards from our human nature that reverse psychology may be the best guide, just like putting more money into a falling market (which paid off huge for me in 2009).  Relying on human instincts or applying what has been learned from other experiences to the stock market is not a successful strategy for investing.

Additionally, I put the minimum initial investment into Vanguard Health Care Fund on Wednesday evening, and I am strongly considering Vanguard Small-Cap Value Index Fund in the near future.  All of these moves are inspired from the same fact that, although I believe the markets may set a few more record highs, I expect that the top of the market has been reached for all intents and purposes, so there is nowhere to go but down.  In fact, the market has been down ever since my first move(s) on Wednesday.  It would be beneficial to position my portfolio to hedge against market risk, but unfortunately, where the sharpest market declines will be are difficult to ascertain.  In other words, if I expect to lose a lot of money soon, then shifting unrealized earnings into a losing fund is not a big risk.  After all, I do not expect to have this money a year from now as it is.

The benefits of diversification are easy to understand.  Personally, I think most investors latch onto the concept far too early.  But if all your money were housed in a couple funds, then eventually (regardless how broad the funds are), it would be foolish not to diversify into specialized assets (specifically, sector funds) when the warning signs of a market decline are seen.

Case in point, I ran the numbers on my move this evening, and my new sector funds are down a combined $112 since I moved into them.  However, if I had not pulled the money that day, then I would be down another $60, so clearly I made the right choice!

CNBC: Want better returns? Hire a good-looking CEO

Want better returns? Hire a good-looking CEO
http://www.cnbc.com/id/101292577#!
—By CNBC's Kiran Moodley

Attractive chief executives receive higher total compensation, better returns on their first days on the job and boost stock performance when they appear on television, according to the preliminary findings of a new study.

Joseph Halford and Hung-Chia Hsu, two economists at the University of Wisconsin, released a working paper called "Beauty is wealth: CEO appearance and shareholder value." In the paper, they rated the attractiveness of 677 CEOs from S&P 500 companies based on "facial geometry."

The study wanted to find out whether there was a positive relation between the attractiveness of a company's CEO and a return on investment in that company, something argued by John Graham, R.Campbell and Manju Puri in a 2010 paper from Duke University. These three authors said that good looks made CEOs appear more competent and gave them better negotiating skills, enabling them to extract better deals for shareholders.

When looking at the relationship between CEO attractiveness and stock returns around their first day in the job, Halford and Hsu concluded: "We find that FAI (facial attractiveness index) has a positive and significant impact on stock returns surrounding the first day when the CEO is on the job, indicating that shareholders seem to perceive more attractive CEOs to be more valuable."

Halford and Hsu told CNBC that Marissa Mayer, the president and CEO of Yahoo, was a good example, based on their report. "She scored 8.45 (out of 10) in our facial attractiveness index and is among the top 5 percent (best-looking) in our sample," they wrote. "Yahoo has been doing well since she became the CEO (about 158 percent increase in stock price).

"Of course, we don't mean that all the increase in stock price is from her appearance. We just find that there might be some positive correlation between the two."

The economists conducted a variety of tests, for example, analyzing 1,830 merger and acquisition deals between 1985 and 2012. They discovered that: "The evidence...suggests that more attractive CEOs receive more surpluses for their firms from M&A transactions, a finding consistent with the hypothesis that more attractive CEOs improve shareholder value through superior negotiating prowess."

Furthermore, the paper looked into CEO television appearances—which they restricted to those shown on CNBC.com between 2008 and 2012—and whether there was any correlation between the appearance of an attractive CEO and stock returns. Halford and Hsu concluded that shareholders responded positively to viewing more attractive CEOs on television.

Does this mean that Halford and Hsu would suggest that companies hire stunning CEOs to ensure a more profitable existence?

"Our results do not suggest that, when searching for CEOs, firms should only look at appearance without considering other abilities," they wrote in an email to CNBC. "On the other hand, for firms that rely more on the negotiation and visibility aspects, maybe they should place more weight on appearance when searching for CEOs."

This is not the first time the interaction between beauty and business has been investigated.

In 1994, University of Texas economist Daniel Hamermesh coined the term "pulchrinomics," or the economic study of beauty. He wrote about the topic in the American Economic Review, commenting on a study conducted by himself and his colleague, Jeff Biddle, where interviewers in the 1970s had had ranked the attractiveness of U.S. and Canadian workers, as well as noted their earnings. More attractive workers were found to earn a 5 percent premium over those of average appearance.

"Wages of people with below-average looks are lower than those of average-looking workers; and there is a premium in wages for good-looking people that is slightly smaller than this penalty," the report noted.

Commenting on Halford and Hsu's report, Robert Williams, principal and director at recruitment firm Asia Media Search, said first impressions were important.

"A commanding presence will add credibility either consciously or subconsciously, rightly or wrongly," he told CNBC via email. "My guess would be that Wall Street, like Washington, will always put stock in good looks as a measure of ability.

"I wonder if in today's instant media world, whether Abraham Lincoln, with his acne scarred face, lanky body and high pitched voice, would ever have been elected, or FDR for that matter. Would the television media focus just on his wheelchair?"

He concluded: "As a recruiter, I feel the focus should be a candidate's abilities and accomplishments, not the smile. But human nature is what it is."

CNNFN: Fundamental index funds: Great players, wrong game

Fundamental index funds: Great players, wrong game
http://money.cnn.com/2013/12/01/investing/fundamental-index-funds.moneymag/index.html?iid=H_M_News
By Paul J. Lim

Several years ago a group of investing heavyweights, led by Robert Arnott of Research Affiliates and Jeremy Siegel of WisdomTree, claimed to have built a better index fund.

Ever since, these "fundamental indexers" have waged a public debate with Vanguard founder Jack Bogle and other passive-investing purists over what an index fund is.

That argument distracts from the true advantages of fundamental index funds. Like traditional indexes, fundamental indexing calls for owning most of the stocks in the market, instead of picking individual issues. But rather than holding shares in proportion to a company's total market value, the new funds weight them based on attributes such as earnings, dividends, or valuations.

As a result, their portfolios tilt toward value stocks, or shares that are cheap relative to profits or assets.

"And all the evidence we have seen is that there is a value premium" -- that is, an extra return for value stocks -- says Paul Kaplan of the fund research group Morningstar.

They also skew to smaller stocks, which likewise outperform over long periods. (Says who? Eugene Fama, for one; he just won the Nobel in economics.)

Purists cry foul. "Anytime you depart from the market, you're an active manager," says Bogle.

Here's the thing, though: Even if you think this is another form of active stock picking, it turns out fundamental funds may be the best possible way to do that. Arnott now argues that "we're more of a threat to active management than to cap-weighted indexing, because investors are more likely to be deeply disappointed with their active managers."

For example, PowerShares FTSE RAFI U.S. 1000 ETF, which tracks Arnott's strategy, gained an annualized 18.7% over five years, beating the S&P 500 and 91% of all active large-cap funds. Similarly, WisdomTree Earnings 500 and WisdomTree SmallCap Earnings beat more than 60% and 90% of their respective active peers.

How? In addition to their tilts, these funds enjoy a cost edge. WisdomTree Earnings 500 charges 0.28% of assets, a percentage point less than the average active fund. It also trades infrequently, cutting transaction costs.

So if you want to dabble in active funds for a shot at out-performance, consider using a fundamental fund instead.

A portfolio half in an S&P 500 indexer and half in an average active large-cap fund would have returned 15% annualized over the past five years. Had that active stake been in the PowerShares fund, you'd have earned about two points better a year. That's a fundamentally sound result.

Send a letter to the editor about this story to money_letters@moneymail.com.


MY OPINION: Jack Bogle has described Index funds as providing the average investors with “their fair share” of the American economy.  In essence, it’s protection against greed.  Bogle has waged war against greed, as evident in his book Enough.  I am not surprised that he would dismiss these funds from his design of "index funds."