It’s natural to expect that last year’s winners will continue to do well. Watching LeBron James dominate the court this year, we expect him to do so next year too. And he probably will.

Many expect similar performance patterns in the investment world. Unfortunately investing is not nearly so predictable.

Walking randomly

We saw this a couple weeks ago when we looked at the track record of major asset classes over the last five years. What we found was a seemingly random pattern where gold led the pack for two years, then went straight to the back of the bus.  Emerging markets did just the opposite a few years earlier, moving from worst to first in one big leap. The rankings of other asset classes jumped around in a pattern that could only be called random.

Anyone picking asset classes based on what did well in the previous year would be in for lots of frustration.

It turns out that it’s just as tough to predict performance of individual mutual funds using past performance as a guide.

At the end of 2011, Bloomberg assembled a list of 10 top performing actively managed mutual funds for 2011 – the funds that produced the greatest return for the year. In a generally flat market that year, the top 10 averaged almost a 10 percent return for the year.

Did outperformance continue?

In a burst of curiosity, we checked to see how well those funds performed in 2012 and beyond. Did the good return in 2011 lead to more of the same in later periods?

Well, yes and no. In the past year (ended May 15, 2013), the average return of those ten funds jumped up to nearly 24 percent. That is a nice increase. But it’s a significant shortfall to the S&P 500 index, which produced 28 percent.

Furthermore, these so-called ten top funds fell far short of the ten funds that Bloomberg listed as the worst of 2011. In the past year, these prior weaklings generated a nearly 30 percent return.

Wait, what was that again? If you read about the top funds of 2011 and bought them a year ago, in May 2012, you would have not only earned less than the S&P 500 in the past year, but also significantly less than the ten funds that Bloomberg ranked as the worst of 2011. It makes you wonder.

Ignore the rankings

It’s numbers like these that make us so content to own indexes for the long term instead of trying to predict next year’s big winner. Not to mention that all of the funds in both of Bloomberg’s best and worst categories have expense ratios far higher than the typical index ETF. And some charge front-end loads of more than five percent. That’s a nifty “sales fee” paid for the privilege of buying a fund, even if it ranks in the bottom one percent of performance.

We encourage all investors to ignore lists of bests and worsts, star ratings, manager rankings and all other historical data. There’s just no reason to expect they’ll lead you better performance than you’ll experience with low expense, tax-efficient index investments.

For our most popular posts, click here.

This article may include forward-looking statements. All statements other than statements of historical fact are forward-looking statements (including words such as “believe,” “estimate,” “anticipate,” “may,” “will,” “should,” and “expect”). Although we believe that the expectations reflected in such forward-looking statements are reasonable, we can give no assurance that such expectations will prove to be correct. Various factors could cause actual results or performance to differ materially from those discussed in such forward-looking statements.

Nothing in this article is intended to be or should be construed as individualized investment advice. All content is of a general nature. Individual investors should consult their investment adviser, accountant, and/or attorney for specifically tailored advice.

Any references to third-party data or opinions are listed for informational purposes only and have not been verified for accuracy by the Adviser. Adviser does not endorse the statements, services or performance of any third-party vendor without specifically assessing the suitability of a third-party to a client’s or a prospective client’s needs and objectives.

Performance is not indicative of any specific investment or future results.  Mutual fund returns are shown for illustrative purposes only.  There is no guarantee that these or other mutual funds will continue to perform at the historical levels described. Securities mentioned may or may not be held in client accounts.  

Bloomberg’s 2011 rankings based on Jan 1 to Dec 12, 2011.  Subsequent performance data based on May 18, 2012 to May 17, 2013.

Nobody (well almost nobody) would fall for those scams. But they are just the tip of a giant, despicable, and surprisingly sophisticated iceberg.

What’s really going on?

The real threat today is the growth of wire fraud – the compromise of identity and login credentials to move money out of an account into criminal hands.

The fantastic emails (inheritance, confirm package delivery, bank credential update, IRS inquiry, and so on) are in many cases simply covers to get an unwitting victim to reveal a tiny piece of information (like an email, first name, last name, login ID, etc.) or open a door for malicious software (“click here”) that can compromise your information.

Like all of you, I don’t knowingly respond in any way to any of these email ploys, although some of them look very realistic.

But email is not the only tool for fraud. I recently started getting random calls to my home and my office from very pleasant sounding people, posh English accent in one case, asking such simple, innocuous questions (“Is your first name John?”) and apologizing for bothering me as they tried to verify my last name, my address, my phone number, anything.  Are these people idiots, I thought?  No, it was cyberfraud in practice, and it’s organized, persistent and relentless.

Once enough pieces of the puzzle have been acquired, the fraudsters can request bogus wire transfers, take over control of your accounts, and basically turn your life into a nightmare.

Once gone, the money is virtually impossible to recover

Meet Tobey, or better yet, don’t…

Cyberfraud may seem primitive and naïve, until you understand that there are literally global phone and email banks of people at work. Like Tobey’s organization.

Tobechi Onwuhara, aka Tobey, an accused master scammer long wanted by the FBI, is a prime example of a successful scam artist. Educated, well-spoken, with no accent, Tobey and his organization will takes months to collect enough information on a single person to execute online wire transfers.  Alleged to have defrauded the financial industry of tens of millions of dollars, Tobey has just been arrested overseas and extradited.

What Fidelity is doing

I refreshed my cyberfraud knowledge by recently attending an online presentation by Fidelity (primary custodian for Osbon Capital clients) on “The Evolving Cyber Fraud Threat.” I must say I was pretty surprised by what I learned, but also reassured that there is a lot of help available.

Fidelity would be an obvious target for criminals, and has invested proactively in building formidable defenses to protect accountholder funds. So, not to worry, just be aware.

I like Fidelity for many reasons, but chief among many is its redundant rules-based systems for money movement.  Unless instructions are absolutely PERFECT and within the rules, money will not move in Fidelity. It’s almost comical, but I have had to resubmit wire requests for missing punctuation.  What may seem like an annoying, small-minded obsession with detail is actually Fidelity’s protection system at work.

Furthermore, as a boutique advisor, I know all of my clients and their financial habits.  So if something out of the ordinary happens (“send $25,000 to London this weekend”) my radar activates immediately.

Don’t worry, don’t respond, just stop…

There is no reason for undue worry about being a victim of cyberfraud. Substantial protection is built in to Fidelity and Osbon Capital systems on your behalf.

However we are all responsible to be alert, aware, inquisitive and cautious. If you ever have any question or doubt about any combination of online, phone and financial activity, it’s worth just stopping, not acting, thinking, waiting, and asking questions. Erring on the side of caution can only help to thwart the next Tobey.

For our most popular posts, click here.

Although Adviser has a reasonable belief in Fidelity’s ability to safeguard client assets and identify suspicious transactions, Adviser has not independently verified all aspects of Fidelity’s anti-fraud program or associated internal controls.

Now he’s 25, a former Bloomberg salesman covering Goldman Sachs, and writer and world traveler. 

No layups

What will Max be doing at Osbon Capital?  Not the easy stuff. His focus will be on operations and finance, assuring that we maintain best-in-class standards with our providers, vendors, independent contractors and clients. That’s COO work. He’ll also be responsible the inflow and outflow of revenue and payments at Osbon Capital, which in a larger firm would make him a CFO.  Both acronyms are too big for a small firm like ours but the tasks remain the same. Max will continue as an analyst, researching and addressing specific questions with the goal of providing insight from information.

With Max focusing on analysis and operational efficiency, I have more time to dedicate to client service and individual investment strategy.

Why now?

Max is moving to Boston in May. It’s an ideal time for him to be helping out at Osbon Capital, although he has been contributing to the family firm for some time.   You would have already seen his work in several recent articles, including Four Flavors of Risk, Getting Ahead by Not Falling Behind, and last week’s piece, It’s Always Something, but Rarely Everything.

The NexGen advantage

There are significant advantages to involving a next generation family member in our business.  Simply stated the advantages are: continuity, clarity and skin-in-the-game.  Max owns a small portion of Osbon Capital, as does his younger sister.  Ownership keeps you focused.  Owners have a lot at stake.  With Max joining the firm I am simply expanding on what I outlined in What’s Best For the Client, starting with the owner-operator culture.

Also, as I have seen firsthand, younger people have a different perspective, and multiple viewpoints are valuable in staying humble and curious in the investment management business.  It’s very funny to witness your own son, for example, get smarter and faster than you in certain ways, and I think it is a big positive all around.

What to expect

As I said before in Lifetime Employment, I plan to operate Osbon Capital for as long as I can, so I don’t anticipate any material changes anytime soon.  Sole discretion for investment management stays in my hands.  You may not even notice much of a difference at Osbon Capital. On the other hand, I hope you do.  I hope Max gets a chance to meet you, or perhaps you will get a telephone call or email from him.  I hope you are, as I am, impressed with Max.  He’s a good guy to have on the team.

For our most popular posts, click here.

My view is less dramatic: there’s always something that’s down, but rarely are all asset classes down at the same time. Right now stocks are strong and gold is weak.  But the reverse has often been true, and will likely be true again.

Let’s take a short trip down memory lane and put things in perspective.

The graphic above shows how the returns of seven different asset classes have ranked over the last few years.  The asset classes, represented by widely held ETFs, are color-coded on the left.  The gold ETF, GLD, is shown as gold. International stocks are white, etc.

Gold’s poor recent performance is represented by its position at the bottom of the right hand column. Its negative return is surely a disappointment to gold holders today, but in 2010 and 2011 it topped the chart, and over the last decade or so, the return on gold has been enviable.

By the same token, the lavender-colored emerging markets box was dead last in 2008 but first by a wide margin in 2009 (with a remarkable +75 percent return). Go figure.

Predictably unpredictable

If you’re looking for the pattern in this checkerboard, I wish you luck. Between 2008 and 2009, the rankings basically reversed order, and since then it looks like random hopscotch.

Index investors like ourselves accept and embrace this apparent randomness. We don’t try to explain performance in the past or predict it in the future. We know in any given year there will be winners and losers and we expect to own some of both.

We’ve seen the poor track record of active managers who try to pick hot securities and time the market based on hunch, hope and what they see as patterns in charts like this one. (See “Charts look ominous, but can we trust them”.)

That’s not our approach. We’d rather own a diverse portfolio of low-expense, tax-efficient ETFs representing many asset classes. That way we know we’ll own the winners every year, and just as importantly, never have all our eggs in the worst-performing basket.

For our most popular posts, click here.

This article may include forward-looking statements. All statements other than statements of historical fact are forward-looking statements (including words such as “believe,” “estimate,” “anticipate,” “may,” “will,” “should,” and “expect”). Although we believe that the expectations reflected in such forward-looking statements are reasonable, we can give no assurance that such expectations will prove to be correct. Various factors could cause actual results or performance to differ materially from those discussed in such forward-looking statements.

Nothing in this article is intended to be or should be construed as individualized investment advice. All content is of a general nature. Individual investors should consult their investment adviser, accountant, and/or attorney for specifically tailored advice.

Any references to third-party data or opinions are listed for informational purposes only and have not been verified for accuracy by the Adviser. Adviser does not endorse the statements, services or performance of any third-party vendor without specifically assessing the suitability of a third-party to a client’s or a prospective client’s needs and objectives.

Performance is not indicative of any specific investment or future results.  ETF returns are shown for illustrative purposes only.  There is no guarantee that these or other ETFs will continue to perform at the historical levels described. Securities mentioned may or may not be held in client accounts.  

2013 year-to-date results are through March 31, 2013.

With its exceptional representation of long-term market trends, I consider the Andex chart one of my most important reference tools.  In fact, I keep an oversized version pinned to the wall right behind my desk, so I can easily consult it. And I frequently do.

Have your very own

I’d be pleased to send you your own Andex chart if you like. Just send me an email with your postal mailing address and I’ll put it in the mail to you right away.

For our most popular posts, click here.

Nothing in this article is intended to be or should be construed as individualized investment advice. 

The annual Andex chart is a Morningstar product.  As with any third-party data, Adviser has not verified it independently for accuracy and uses it for informational purposes only.

An investment cannot be made directly in an index. 87-year investment returns are hypothetical as index-based investments were not available in 1926. There is no guarantee that indices or asset classes will continue to perform at the historical levels described.

No doubt about it, risk is a big word in investing.  Too big, in my view, to have much meaning unless one looks deeper and gets more specific.

Max Osbon recently pointed out four different flavors of investment risk. When you recognize which type(s) you identify with, you’ll have a better understanding of what kind of investor you are and how to approach your investments.

The Four Flavors

In order of increasing optimism, the four flavors of risk are:

• Liability
• Uncertainty
• Possibility
• Opportunity

Liability risk, or the possibility of losing more money than you actually have, is directly related to leverage, also called margin, in which you borrow money or securities to amplify your returns.  More leverage, more risk.  Too much leverage in the wrong direction or at the wrong time and you end up like Lehman Brothers, AIG, Bear Stearns, Fannie Mae or Freddie Mac to name spectacular examples – out of money, out of business, or bankrupt and probably at the wrong end of a lawsuit.

Investment liability risk is completely avoidable, and in my view, entirely unnecessary.  My only advice here is just don’t borrow investment money. Period.  That way, you cannot lose more than you already have.

Uncertainty risk is everywhere, quite common, and unavoidable.  It is simply the risk of the unknown, which in general describes…life.  Uncertainty risk in investing can be uncomfortable, such as when headlines are dire or securities prices seem to be in an unstoppable downward spiral (fueled by more dire headlines, of course).

How to deal with it?  Relax, turn off the TV, enjoy your family, take the long view, let your money work for you, and stay disciplined. Easy to say and hard to do. Your investment advisor can help, by keeping you focused on long-term goals and long-term performance of different asset classes. Ultimately it is uncertainty that creates the possibility for positive returns; it is an essential long-term ally, even if it makes you anxious it in the short term.

Possibility risk is an optimistic viewpoint on the tradeoff between risk and return and how to use the former to get the latter.  Investing more in stocks – generally riskier and higher returning securities – and less in bonds is a prime example of possibility risk in action.

Accepting more risk may improve your long-term rate of return, and have a huge impact over time. (See our post comparing a 5 percent and a 9 percent annual return over a generation.)

Possibility risk gets you thinking more specifically about your goals: How much money is enough? Am I getting the return I should? Will there be enough money when I need it most?  Those are the really interesting and useful questions upon which your investment advisor builds your portfolio if you practice goal-based asset management, as we do.

Opportunity risk is the most positive and open-ended way to look at risk and use it to your advantage.  This is an old philosophy, typified by the Chinese word for crisis, composed of the characters for “danger” and “opportunity.”  Those who see risk this way not only accept risk, they embrace it – not for the thrill, but for the rewards it enables.

With opportunity risk we look at the link between risk and return to determine if we are getting enough return for the risk we are taking. (We use Windham optimization software to do this at Osbon Capital.)  Opportunity risk is the mirror into which you gaze to determine what your risk tolerance is.

Risk is a matter of taste

It’s worth spending some introspective time as you mull these four flavors and savor what they mean to you as an investor. There is no right or wrong perspective on risk: a risk-averse investor is neither better nor worse than a risk-preferent one – just different.  But self-awareness is important; the better you understand your risk palate, the better you can avoid some common pitfalls, which we discussed in another recent risk article – The Risk of Being Human.

For our most popular posts, click here.

This article may include forward-looking statements. All statements other than statements of historical fact are forward-looking statements (including words such as “believe,” “estimate,” “anticipate,” “may,” “will,” “should,” and “expect”). Although we believe that the expectations reflected in such forward-looking statements are reasonable, we can give no assurance that such expectations will prove to be correct. Various factors could cause actual results or performance to differ materially from those discussed in such forward-looking statements.

Nothing in this article is intended to be or should be construed as individualized investment advice. All content is of a general nature. Individual investors should consult their investment adviser, accountant, and/or attorney for specifically tailored advice.

Any references to third-party data or opinions are listed for informational purposes only and have not been verified for accuracy by the Adviser. Adviser does not endorse the statements, services or performance of any third-party vendor without specifically assessing the suitability of a third-party to a client’s or a prospective client’s needs and objectives.

Predicting winners and losers is a great way to entertain yourself every March, but it’s no way to invest.

Of the 12 highest seeded teams in the NCAA tournament, only one – Louisville – made the Final Four. The other eleven got bumped off in early rounds by surprise teams like Harvard and Florida Gulf Coast University, or by their own mistakes.

No matter how much you know about basketball, your bracket was probably full of losers by the Elite Eight, if not before.  Teams that you counted on for easy points were long gone, and teams you never would have picked were flying high.  If you watched the games, you probably wanted to kick the TV at least once or twice.

By the way, in ESPN’s bracket game, 47 of 8.1 million entrants correctly picked the Final Four.

Sure things don’t always pan out

Predicting college basketball is tough, especially in a one-and-done tournament format. And like it or not, picking winning investments is just as difficult. Sure winners often lose and sure losers sometimes win. Even the most celebrated money managers, supported by analysts, economists and elaborate pricing models, make serious gaffes, guessing wrong on the direction of individual securities and of the market as a whole.

The result is the phenomenon we have frequently referenced – active managers failing, on average, to keep up with simple benchmark indexes.

If your bracket featured talented teams like Kansas, Indiana, Miami or Ohio State in the finals, you understand what I’m talking about. Good teams don’t always advance. And good stocks don’t always deliver the return you’d expect.

Own the whole field

As we discussed last week, passive investors don’t try to beat the market with longshot picks. In essence, we bet on the whole field, assured of owning all the winners and avoiding the possibility of getting stuck with a portfolio of nothing but underperformers. By allocating a very small portion of one’s assets to thousands of different stocks, you are basically investing in the force of capitalism as a whole rather than pinning your hopes to the fortunes of any individual company.

You can’t really own the whole field in the NCAA tournament. And you wouldn’t want to. Half the fun is pulling for your teams as the clock ticks down. But investing for your retirement and the security of your family is another matter. You can own the whole field, or a close approximation, via index ETFs. We believe that is the right approach.

Congratulations to the Louisville Cardinals, 2013 champs!

For our most popular posts, click here.

This article may include forward-looking statements. All statements other than statements of historical fact are forward-looking statements (including words such as “believe,” “estimate,” “anticipate,” “may,” “will,” “should,” and “expect”). Although we believe that the expectations reflected in such forward-looking statements are reasonable, we can give no assurance that such expectations will prove to be correct. Various factors could cause actual results or performance to differ materially from those discussed in such forward-looking statements.

Nothing in this article is intended to be or should be construed as individualized investment advice. All content is of a general nature. Individual investors should consult their investment adviser, accountant, and/or attorney for specifically tailored advice.

Any references to third-party data or opinions are listed for informational purposes only and have not been verified for accuracy by the Adviser. Adviser does not endorse the statements, services or performance of any third-party vendor without specifically assessing the suitability of a third-party to a client’s or a prospective client’s needs and objectives.

Index based investing, using ETFs (exchange traded funds) to invest in diverse markets, earns its p-word moniker. Index ETFs simply duplicate asset classes –stocks, bonds, real estate, and so on. Almost no daily activity is required to operate an ETF, in contrast to active investment. Active managers, forever hoping to time the market or find hot securities that will beat the market, typically make many more trades than passive managers.

Most passive moves are meant only to keep an ETF in line with the index it tracks.

Invest like Mother Nature

Passive investing is simpler, but does that make it weak? I’d look to nature for the answer. The wind, tides, and sun are passive – they exert huge forces without anyone doing anything.

Index investing is the same idea – lots of power with little effort. With minimal trading and no forecasting of unknowable future events index investors simply reap index returns over time.

What kind of returns?  Index returns!  As the 2013 Andex chart points out (send me an email for your own copy), large US stocks have compounded annually at 9.8% since 1925.  Small US stocks have done ever better at 11.9 percent.  Long term government bonds come in at 5.7 percent, and 30 day T-Bills at 3.5 percent. Inflation, by comparison, has averaged about 3 percent.

Yes, returns can be far higher or lower over shorter periods, (for instance, the Dow Jones Industrial Average produced a total return of 11.93 percent in the first quarter of 2013; hedge funds averaged 3 percent) but over long time periods, we generally see what mathematicians call “convergence to the mean,” – returns cluster around long-term averages. For investors, I’d call convergence a force of nature in itself.

But can’t we do better?

Some critics of passive investing would argue that earning market returns with indexes is mediocre. I guess I would agree if most mutual fund managers beat the benchmarks. But they don’t.

The SPIVA Scorecard from S&P shows that benchmarks beat 66 percent of domestic equity funds in 2012, 74 percent of funds over the last 3 years, and 69 percent of funds over five years. Empirical data shows more clearly each year that active managers, on average, underperform benchmark indexes – the same kind of indexes that ETFs track.

Of course index funds have a big advantage. With few trades, no analysts picking hot stocks, and no economists and forecasters to pay, ETF expenses are far lower than actively managed funds. That means more money goes into the investor’s pocket. See “Cost is boss when it comes to performance.”

The performance and cost results have been good news for passive for some time as we pointed out in our recent post on Vanguard: “Play to win”.

Passive and proud of it

To put passive power to work, I established Osbon Capital in 2005.  As a compounding machine for individual clients we have grown like an oak – sturdy, strong and steady.  I attribute our success to goal-based asset management via diversified, tax-efficient index investments, without the cost burden and wild goose chases of active management. That’s passive power at work.

For our most popular posts, click here.

This article may include forward-looking statements. All statements other than statements of historical fact are forward-looking statements (including words such as “believe,” “estimate,” “anticipate,” “may,” “will,” “should,” and “expect”). Although we believe that the expectations reflected in such forward-looking statements are reasonable, we can give no assurance that such expectations will prove to be correct. Various factors could cause actual results or performance to differ materially from those discussed in such forward-looking statements.

Nothing in this article is intended to be or should be construed as individualized investment advice. All content is of a general nature. Individual investors should consult their investment adviser, accountant, and/or attorney for specifically tailored advice.

Any references to third-party data or opinions are listed for informational purposes only and have not been verified for accuracy by the Adviser. Adviser does not endorse the statements, services or performance of any third-party vendor without specifically assessing the suitability of a third-party to a client’s or a prospective client’s needs and objectives.

Performance is not indicative of any specific investment or future results.  Index returns are shown for illustrative purposes only.  There is no guarantee that indices will continue to perform at the historical levels described.

An investment cannot be made directly in an index. Securities mentioned may or may not be held in client accounts.  

Over time unforeseen risks can and will accumulate in a portfolio. Interest rate risks, market risks, inflation risks, default risks, and the risk of improper diversification are examples of potential pitfalls that must be persistently monitored.

Some of these risks are welcome – they bring the opportunity for greater returns. But others bring too much downside, with little or no opportunity for additional gain. Managing a well-diversified investment portfolio comes with the responsibility to identify and correct the accumulation of those unwanted risks (often called “uncompensated risks”).

Here’s a recent example of accumulated risk causing problems in “set it and forget it” portfolios:
Mid to long term duration bonds.

Remember that bond prices move in the opposite direction of interest rates. When interest rates were falling, as they have fairly consistently over the last generation, the market prices of existing bonds rose considerably. But now with interest rates at historic lows and very little room to fall any further, an allocation to mid-long term bonds simply has a very limited upside. However, with no limit on how high rates could go in the future, there’s boundless downside risk.

Holding these bonds means locking in to rates that can leave the investor losing ground if interest rates or inflation rise. It’s a danger affecting set it and forget investors who fail to monitor for unwanted risks.

Take risks that provide potential return

Isn’t a move out of mid-long bonds a speculative “active management” decision? No. We don’t recommend re-allocating assets to chase the best performing sectors, as active managers do. But we do recommend reducing or eliminating those risks that have become unnecessary. Again, this is not to be risk averse; we like risky assets because they provide the opportunity for returns. What we don’t want is to continue to hold assets that don’t balance risk and return.

As we mentioned in our recent article Why Do Allocations Change, the reason we make changes in asset allocations is to keep things unchanged. We rebalance to put portfolios back in line with client goals and to protect the relationship between risk and return. Modifications may be small, but attention to detail is important. Small repairs can make big impacts – especially when compounded over a generation.

Just as CEO’s constantly look for opportunities to increase their bottom line by cutting unnecessary costs, investors can boost potential performance by eliminating these unnecessary risks. That means monitoring for imbalances in all market conditions.

Max Osbon worked at Bloomberg for two and half years after graduating from Santa Clara University in 2010 with degrees in Mathematics and Finance. Max is currently traveling the world and submitted this article from Maputo, Mozambique. Follow his travels at www.neverinamerica.com.

For our most popular posts, click here.

This article may include forward-looking statements. All statements other than statements of historical fact are forward-looking statements (including words such as “believe,” “estimate,” “anticipate,” “may,” “will,” “should,” and “expect”). Although we believe that the expectations reflected in such forward-looking statements are reasonable, we can give no assurance that such expectations will prove to be correct. Various factors could cause actual results or performance to differ materially from those discussed in such forward-looking statements.

Nothing in this article is intended to be or should be construed as individualized investment advice. All content is of a general nature. Individual investors should consult their investment adviser, accountant, and/or attorney for specifically tailored advice.

Any references to third-party data or opinions are listed for informational purposes only and have not been verified for accuracy by the Adviser. Adviser does not endorse the statements, services or performance of any third-party vendor without specifically assessing the suitability of a third-party to a client’s or a prospective client’s needs and objectives.

They make it look easy

Every year thousands of fund managers toil over decisions of what to buy and when to sell. Some get it right and some make a mess. In 2012, with all the major markets doing well, making a nice return should have been pretty easy. It clearly was for Vanguard, based on its results, summarized by this chart.

Click on image for full Vanguard report

For the year, 73 percent of Vanguard funds beat their Lipper group averages.  And if you look back 3, 5 or 10 years, the outperformance is even stronger at up to 90 percent of funds outperforming their asset classes. (See results in more detail)

Vanguard must have the best forecasters and stock pickers in the business, right? No, to the contrary.  As an index fund provider, Vanguard doesn’t pick stocks, it simply creates funds that track different kinds of stocks…and does the same with its bond funds too, with similar results.

The company’s biggest advantage is generally agreed to be its low management costs, consistently among the lowest in the business. With less of the pie going to management expenses, more return stays in the funds and flows through to shareholders.

I’ve singled out Vanguard because they reported their results so clearly and graphically, but I expect we’d see similar numbers for State Street and BlackRock, two other giant providers of index funds.

This is not meant as an endorsement for any specific fund or provider, but the numbers tell a strong story about the index approach. By simply seeking to match the performance of various asset classes, indexers have consistently beat group averages.

Yes, some active managers also beat the averages in any given year, but doing so year after year is very rare. And I’m not sure how anyone could accurately predict – before the fact – which active manager was going to outperform over a five- or ten-year period. There are no guarantees in investing, but in my view, sticking with well managed indexes provides the most reliable chance of beating benchmarks over the long term.

A first step only

Of course performance game is only one element of your long-term investment success. As we described in a previous article, we see index ETFs as great building blocks for low-cost, tax-efficient, diversified portfolios. When you build your portfolio with strong materials, you can then focus on your goals instead of being distracted by the active management performance derby.

For our most popular posts, click here.

This article may include forward-looking statements. All statements other than statements of historical fact are forward-looking statements (including words such as “believe,” “estimate,” “anticipate,” “may,” “will,” “should,” and “expect”). Although we believe that the expectations reflected in such forward-looking statements are reasonable, we can give no assurance that such expectations will prove to be correct. Various factors could cause actual results or performance to differ materially from those discussed in such forward-looking statements.

Nothing in this article is intended to be or should be construed as individualized investment advice. All content is of a general nature. Individual investors should consult their investment adviser, accountant, and/or attorney for specifically tailored advice.

Any references to third-party data or opinions are listed for informational purposes only and have not been verified for accuracy by the Adviser. Adviser does not endorse the statements, services or performance of any third-party vendor without specifically assessing the suitability of a third-party to a client’s or a prospective client’s needs and objectives.

Performance is not indicative of any specific investment or future results.  

An investment cannot be made directly in an index. Securities mentioned may or may not be held in client accounts.