Millionaire Teacher (17 page)

The fund you choose will depend on your tolerance for risk. If you're interested in an allocation of bonds that's close to your age, then you could choose from the following respective funds.

Another word about risk

Investors with a corporate or government pension might not feel the need to invest so conservatively. For example, a 50-year-old school teacher with a pension might prefer to buy the Growth Fund instead of the Conservative Fund. Over time, the Growth Fund will likely do better, but the volatility will be higher. If someone has a strong alternative source of retirement income, then they might want to take a higher risk/higher return option.

Neerav might be right when suggesting that most Australians are unaware of Vanguard. But one thing's for sure, there is economy in numbers. The more Australians who catch onto Vanguard, the cheaper its products will become.

The Next Step

Once you learn how to build indexed accounts, the time commitment you will spend on making investment decisions and transactions will be minimal. You could end up spending less than one hour a year on your investments.

Nobody is going to know how the stock and bond markets will perform over the next 5, 10, 20 or 30 years. But one thing is certain: if you build a diversified account of index funds, you'll beat 90 percent of professional investors. In a taxable account, you'll do even better.

There's only one risk standing in the way of your investment success, and it's an ironic one. If you speak to an adviser at a financial institution, they will do their best to convince you to follow a higher-cost, less-effective option. In my next chapter, I'll reveal some of the tricks they use to keep investors away from index funds.

Notes

1.
Morningstar.com, Rebalanced fund returns for Vanguard's U.S. total stock market index (VTSMX), Vanguard's international stock market index (VGTSX), and Vanguard's total bond market index (VBMFX) (2006–2011).

2.
Morningstar.com, Fund returns for Fidelity Balanced (FBALX), T Rowe Price Balanced (RPBAX), and American Funds Balanced (ABALX) (2006–2011).

3.
Morningstar.com, fund turnover rates.

4.
Morningstar.com, fund turnover rates for Vanguard's Target Retirement Funds.

5.
“Global Couch Potato Performance,” accessed January 10, 2011,
http://www.canadianbusiness.com/my_money/investing/article.jsp?content=20070123_122259_5192&ref=related
.

6.
Globeinvestor.com
Fund Performances.

7.
Toronto Dominion Bank, e-Series index funds, accessed April 15, 2011,
http://www.tdcanadatrust.com/mutualfunds/tdeseriesfunds/index.jsp
.

8.
Ibid.

9.
Ajay Khorana, Henri Servaes, and Peter Tufano, “Mutual Fund Fees Around the World,”
The Review of Financial Studies
2008 Vol. 22, No. 3 (Oxford University Press) accessed April 15, 2011,
http://faculty.london.edu/hservaes/rfs2009.pdf
.

10.
Toronto Dominion Bank, e-Series index funds, accessed April 15, 2011,
http://www.tdcanadatrust.com/mutualfunds/tdeseriesfunds/index.jsp
.

11.
Infinity S&P 500 Index Fund Costs, accessed January 10, 2011,
http://www.fundsupermart.com/main/fundinfo/viewFund.svdo?sedolnumber=370283#charge
.

12.
Vanguard S&P 500 Exchange Traded Fund Cost, accessed January 10, 2011,
http://finance.yahoo.com/q/pr?s=SPY+Profile
.

13.
Personal Interview with Gordon Cyr, October 18, 2010, in Singapore.

14.
Fundsupermart.com for actively managed Singapore market unit trust performances, accessed May 2009,
http://www.fundsupermart.com/main/home/index.svdo
; Singapore exchange traded fund historical prices, accessed May 2009,
www.sgx.com
; Historical dividends for Singapore market ETF: Streetracks .com, accessed May 2009,
http://www.streettracks.com.sg/ssga/jsp/en/AnnualReport.jsp
.

15.
Vanguard Australia, Life Strategy Funds and Fees, accessed November 1, 2010,
http://www.vanguard.com.au/personal_investors/investment/managed-funds-up-to-$500000/diversified/diversified_home.cfm
.

16.
Ibid.

17.
Ibid.

RULE 7

Peek Inside A Pilferer's Playbook

If you've read what I've written so far about indexed investing, I hope that you're planning to open your own indexed account. Or perhaps you'll want to find a fee-only adviser who can set it up for you.

Either way, if you currently have a financial adviser buying you actively managed mutual funds, you're probably thinking of making the split.

That might be easier said than done. I like to think that the majority of investors who have attended my seminars have decided to index their investments—to save costs and taxes—while building larger accounts than they would have done with baskets of less-efficient products. But not all have. I know many would-be indexers spoke to their financial advisers, fully intending to break free, but the advisers' sales pitch froze them in their tracks.

Many financial advisers have mental playbooks designed to deter would-be index investors and they initiate their strategies with remarkable success, metaphorically ensuring that their clients continue climbing Mount Kilimanjaro with 50-pound packs on their backs.

How Will Most Financial Advisers Fight You?

Often, when a friend or family member wants to open an investment account, he or she asks me to come along. Beforehand, I briefly talk to the new investor about the markets, how they work, and the merits of index investing. I tell the person that every single academic study done on mutual fund investing points to the same conclusion: to give yourself the best possible odds in the stock market, low-cost index funds are key.

Walking into a bank or financial service company, we're then settled into plush chairs across from a financial adviser selling us on the merits of his ability to choose actively managed mutual funds. When my friend brings up the merits of index funds, the salesperson has an arsenal of anti-index sales talk.

Here are some of the rebuttals the advisers will give you—desperate, of course, to keep money flowing into their pockets and the firm's. If you're prepared for what they might say, you'll have a better chance of standing your ground. Don't forget. It's your money, not theirs.

Index funds are dangerous when stock markets fall. Active fund managers never keep all their eggs in the stock market in case it drops. A stock market index is linked 100 percent to the stock market's return.

This is where a salesperson pushes a client's fear button—suggesting that active managers have the ability to quickly sell stock market assets before the markets drop, saving your mutual fund assets from falling too far during a crash. And then, when the markets are looking “safer” (or so the pitch goes), a mutual fund manager will then buy stocks again, allowing you to ride the wave of profits back as the stock market recovers.

It all sounds good in sales theory, but they can't time the market like that—and hidden fees still take their toll. Ask your adviser to tell you which calendar year in recent memory saw the biggest decline. He should say 2008. Ask him if most actively managed funds beat the total stock market index during 2008. If he says yes, then you've caught him talking out the side of his head. A Standard & Poor's study cited in
The
Wall Street Journal
in 2009, detailed the truth: The vast majority of actively managed funds still lost to their counterpart stock market indexes during 2008—the worst market drop in recent memory.
1
Clearly, actively managed fund managers weren't able to dive out of the markets on time.

What's more, a single stock market index is just part of a portfolio. Don't let an adviser fool you with data comparing a single index fund with the actively managed products they're selling. As you read in Chapter 5, smart investors balance their portfolios with bond indexes as well.

You can't beat the market with an index fund, they'll say. An index fund will give you just an average return. Why saddle yourself with mediocrity when we have teams of people to select the best funds for you?

I've heard this from a number of advisers. And it makes me smile. If the average mutual fund had no costs associated with it—no 12B1 fee, no expense ratio, no taxable liability, no sales commissions or adviser trailer fees, and no operational costs—then the salesperson would be right. A total stock market index fund's return would be pretty close to “average.” Long term, roughly half of the world's actively managed funds would beat the world stock market index, and roughly half of the world's funds would be beaten by it. But for that to happen, you would have to live in the following fantasy world:

If the fantasy scenario above were correct, then yes, a total stock market index fund would generate very close to an average return.

But in the real world, advisers suggesting that a total stock market index gives an average return are proving to be well-dressed Pinocchios or post-Columbus sailors with a “Flat Earth” complex.

But a tough salesperson wouldn't give up there. Next, you might hear something like this:

I can show you plenty of mutual funds that have beaten the indexes. We'd only buy you the very best funds.

It's pretty easy to look in the rearview mirror at the last 15 winners of Golf's British Open Championship and say: “See, here are the champions who won the British Open over the past 15 years. These are people who can win. This knowledge qualifies me to pick the next 15 years' worth of champions—and we'll bet your money on my selections.”

Studies prove that high-performing funds of the past rarely continue their outperforming ways.

Just look at the system used by Morningstar's mutual fund rating system. No one in the world has more mutual fund data than Morningstar. Certainly, your local financial adviser doesn't. But as detailed in Chapter 3, the funds given “top scores” by Morningstar for their superb, consistent performance usually go on to lose to the market indexes in the following years.

Even Morningstar recognizes the incongruity. John Rekenthaler, director of research, said in the fall 2000 edition of
In The Vanguard
: “To be fair, I don't think that you'd want to pay much attention to Morningstar's ratings either.”
2

So if Morningstar can't pick the top mutual funds of the future, what odds does your financial planner have—especially when trying to dazzle you with a fund's historical track record?

If you're the kind of person who enjoys winding people up, try this comeback out the next time an adviser tries selling you (or one of your friends) on a bunch of funds that he claims have beaten the index over the past 15 years.

Hey, that's great. They all beat the index over the past 15 years. Now show me your personal investment account statements from 15 years ago. If you can show me that you owned all of these funds back then, I'll invest every penny I have with you.

OK—maybe that's a bit mean. You aren't likely to see any of those funds in his 15-year-old portfolio reports.

If the salesperson deserves an “A” for tenacity, you'll get this as the next response:

But I'm a professional. I can bounce your money around from fund to fund, taking advantage of global economic swings and hot fund manager streaks and easily beat a portfolio of diversified indexes.

Just thinking about that kind of love gives me goose bumps. Many advisers will lead you to believe that they have their pulse on the economy—that they can foresee opportunities and pending disasters. Their sagacity, they will suggest, will enable you to beat a portfolio of indexes.

But in terms of financial acumen, brokers and financial advisers are at the bottom of the totem pole. At the top, you have pension fund managers, mutual fund managers, and hedge fund managers. Most financial advisers, as U.S. personal finance commentator Suze Orman points out, are “just pin-striped suited salespeople.”

Your financial planner could have just a two-week course under her belt. At best, a certified financial planner needs just one year of sales experience at a brokerage firm, and fewer than six months of full-time academic training (on investment products, insurance, and financial planning), before receiving his or her certification. With some regular nightly reading, it wouldn't take long before you knew more about personal finance than most financial planners. They have to sell. They have to build trust. They have to make you feel good about yourself. These skills are the biggest part of their jobs.

When arbitration lawyer Daniel Solin was writing his book,
Does Your Broker Owe You Money?
, a broker told him:

Training for a new broker goes something like this: Study and take the Series 7, 63, 65 and insurance exams. I spent three weeks learning to sell. If a broker wants to learn about (asset allocation and diversification) it has to be done on the broker's own time.
3

This might explain why it's often common to find investors of all ages without any bonds in their portfolios. Predominantly trained as salespeople, it's possible that many financial representatives aren't schooled in the practice of diversifying investment accounts with stocks and bonds.

Noted U.S. finance writer William Bernstein echoes the gaps in most financial adviser training, suggesting in his superb 2002 book,
The Four Pillars of Investing,
that anyone who invests money should read the two classic texts:

“After you're finished with these two books, you will know more about finance than 99 percent of all stockbrokers and most other finance professionals,” he said.
4

From what I've seen, he's right.

When my good friend Dave Alfawicki and I went into a bank in White Rock, British Columbia, in 2004, we met a young woman selling mutual funds. Dave wanted to set up an indexed account, and I went along for the ride. The adviser's knowledge gaps were extraordinary, so I asked the question: What kinds of certification do you have and how long did it take? She received her license to sell mutual funds through a course called Investment Funds in Canada (IFIC). It's supposed to take three weeks of full-time studying to complete the course, but she and her classmates finished it in just two intensive weeks.
5
Before the two-week course, she knew nothing about investing.

A year later, I went into another Canadian bank with my mom to help her open an investment account. We wanted the account to have roughly 50 percent in a stock index and 50 percent in a bond index. Of course, the adviser, as usual, tried talking us out of it.

But once the adviser recognized that I knew more about investing than she did, she came clean. To paraphrase the discussion, she shocked us with this:

First, we get a feel for the client. The bank suggests that if the client doesn't know much about investing, we should put them in a fund of funds, for example, a mutual fund that would have a series of funds within it. It tends to be a bit more expensive than regular mutual funds. This sales job only works with investors who really don't know what they're doing.

If the investor seems a little smarter, we offer them, individually, our in-house brand of actively managed mutual funds. We don't make as much money with these, so we push for the other products first.

Under no circumstances do we offer the bank's index funds to clients. If an investor requests them and we can't talk them out of the indexes, only then will we buy them for the client.

I appreciated her candor. By the end of the conversation, the adviser was asking me for book suggestions about indexed investing and she gratefully wrote down a number of titles. At least she was willing to take care of her personal portfolio.

Three years later, a different representative from the same bank phoned my mom. “Your account is too risky,” he said. “Come on down to the bank so we can move some things around for you.”

Thankfully, my mom was able to stand her ground. With 50 percent of her investment in bond indexes, the account wasn't risky at all—but it wasn't profitable for the bank.

If you notice a financial adviser has a university degree in finance, commerce, or business, hang tight for a moment. Find someone else with one of these degrees and ask this: During your studies at university, did you study mutual funds, index funds, or learn how to build a personal investment portfolio for wealth building or retirement? The answer will paradoxically be no. So don't be fooled by an additional, irrelevant title.