Recently I got this question from a client. He probably read that index funds are cheap (true) and passively managed index funds probably beat most actively managed funds over the long-run (also true).
Most people have probably heard about the colossal index fund manufacturer Vanguard Funds and its founder John Bogle. To his credit index funds were unheard of when Bogle founded Vanguard. To this day Bogle rails against the excessive fees and lack of transparency of the actively managed mutual fund universe. Clearly investors have gotten the message. Most of the new money going into the mutual fund world is headed toward index funds.
Recently Bogle was asked about his prediction for the stock markets over the next 10 years. He responded that the US market will have at least two 50% downturns over the next 10 years. And what should people do when that happens? His response was pure Bogle: “Keep a stiff upper lip.” In other words, do nothing.
At our firm we no longer employ actively managed mutual funds in our client portfolios. We use independent, boutique money managers (Advisory Alpha and Portformulas). AA uses Exchange Traded Funds and Portformulas picks stocks. Because our clients are either already retired or close they cannot afford to “wait for the market to come back” especially if they are taking money out to live on instead of putting money in. Keeping a “stiff upper lip” might be the right thing to do for a 40-year old who is more than 10 years from retirement. For a 60-year-old who has more paychecks behind him than in front of him? Not a good idea!
The money managers we use therefore must be skilled risk managers for all kinds of markets, not just the kind of bull market we are currently in. In the case of our money managers one uses extreme diversification (Advisory Alpha) while the other uses trend analysis (Portformulas), two different methods with the same objective: minimize the damage during the inevitable downturn. For that skill we pay them a fee in the range of 1.5-2.5%. The fee may seem high in the context of a bull market. However, it’s when the market goes the other way or sideways where they really earn their keep.
Recently I spoke to two couples who attended one of our retirement classes. In each case they were managing their own investments through Vanguard. They were scared out of the market and went to cash when Trump was elected over a year ago. Their poor decision led to “losing” 20% or so which is what the markets have gained since the election. We call that lost opportunity cost. Had they used a professional money manager who charged a fee they likely would have stayed the course and received most of those gains. And that’s just one of the reasons why we pay them to manage our money for a fee, myself included.