Nevada Does Not Gamble With Their Public Pension

The Wall Street Journal recently ran an article about the Nevada Public Employee Retirement System pension investments.  The entire pension investments are managed by one single person who invests 100% in passive index funds.  The entire investment process costs a paltry $18 million per year.  Compare that to North Carolina's annual costs of $595 million per year (see page 10).

Now compare the investment results ending June 30, 2016:

	NV	NC
1-year	2.3%	0.8%
3-year	7.8%	6.1%
5-year	7.7%	6.0%
10-year	6.2%	5.5%

Click here to view the actual investment return reports for Nevada and North Carolina.

Now consider this, the difference between 7.7% and 6.0% returns amounts to $10 Billion in lower returns over just the past 5 years for North Carolina's $90 Billion pension fund.  That $10 Billion shortfall will need to be made up by North Carolina tax payers and lower payouts to retirees.  The result is, taxes will need to be higher and less money will be available for services such as education and healthcare. Considering North Carolina's entire state budget is just $22 Billion each year, the $10 Billion in lower pension returns is a silent fiscal catastrophe the burden of which will be felt for generations.

It is brutally clear, that the North Carolina pension should aim to emulate Nevada.  North Carolina needs to quit investing in expensive investment strategies that do not work.  North Carolina needs to follow Nevada's example and invest 100% in passive indexed strategies and quit squandering money on private equity, real estate, hedge funds, commodity funds, and other expensive actively managed investments.        

 

How to Win at Investing

Below are links to short clips of a fantastic documentary called "How to Win the Losers Game." The documentary, produced by Sensible Investing, basically tells you the nasty truths about investing, but also tells you the very best way to go about investing.  Much of the documentary is focused on the United Kingdom, but most of the data and statistics hold true here in the United States as well the rest of the world.  

Regardless of where you live and invest, regardless of your age, EVERYONE should watch these video clips.  
In a nutshell, the lowest cost investment strategy will always beat a more expensive strategy.  So, you should index everything and ignore the so-called "experts" that chatter endlessly about the ups and downs of the markets, and always stay the course.  

Part 1  (6:02)
Part 2  (7:38)
Part 3 (10:41)
Part 4 (12:08)
Part 5  (8:37)
Part 6 (13:16)
Part 7  (8:14)
Part 8  (9:49)
Part 9  (8:55)
Part 10 (10.01)

If you are on Twitter, @InvestSensibly is well worth following.  (I'm on Twitter too @relmbo). 

More evidence you will be better off if you index your investments

Click here for an article from Bloomberg news that suggests college endowment investment returns fail to beat simple index funds.

(Hat Tip to the Real McCoy)

Ben Graham and Warren Buffett both Advocate Index Investing

Perhaps shocking to some folks, but even the great Benjamin Graham (the father of value investing and Warren Buffett's mentor) became an advocate of indexing as the best investment strategy (click here to listen to this Jack Bogle speech at about the 55 minute mark).

The Retirement Gamble

If you have a 401(k) or IRA or any investments at all, click here for a must-see video "The Retirement Gamble" from last night's FRONTLINE on PBS.  The moral of the story:  When it comes to investing, expenses are your enemy, and index funds are your friends.

During the video, Jack Bogle, the founder of Vanguard and the inventor of the first low-cost index mutual fund, stated that over a lifetime many investors keep roughly one third (1/3) of their investment gains while Wall Street takes two thirds (2/3).  As shocking as it may seem, I wanted to reiterate that Jack Bogle's figures are correct.

Take the following example

Hedge Fund Futility: Why bother?

A recent study by Goldman Sachs highlights the futility of hedge funds.  

Returns through November:
S&P 500 Index 14%
Average Large Cap Mutual Fund 13%
Average Hedge Fund 6%

In other words, index funds have beaten most mutual funds and crushed most hedge funds.  One of the reasons for poor performance from hedge funds is their fee structures.  Many hedge fund fees are 2% per year plus 20% of all profits.  

Consider this example:
A lucky hedge fund manager beats the S&P 500 Index by 3% this year for a return of 17% BEFORE fees (Given the efficiency of the stock market, this would be a monumental achievement).  2% would come off the top leaving a 15% return.  But, the 20% take of the remaining profits would eat another 3%.  This would leave the investor with a net return of 12%, which would have trailed most mutual funds and all S&P 500 Index funds.  

My advice:

Why Everyone Should Buy Index Funds

Question: What are your odds of picking a mutual fund that beats a low-cost index fund? 


Answer: Zero


Proof: Watch this video of University of Chicago Finance Professor Gene Fama.


Want more proof?: Here's the research behind the video.


Quick Summary:
Famous finance professors Gene Fama (Univ. of Chicago) and Ken French (Dartmouth) analyzed all actively-managed US stock mutual fund data from 1984-2006.  They found

College Endowment and Public Pension Fund Returns Are Not Good

Most college endowments and public pension funds are plowing more and more money into complicated and expensive "alternative investments" such as hedge funds and private equity in a failed effort to boost returns.  However, my analysis, combined with a recent study of college endowment fund returns and a study of public pension returns, proves most would  be better off if they simply indexed all their money.  In fact, my simulation of index fund returns would have placed easily in the top 25% of all college endowments.

	1-year	5-year	10-year
Median Public Pension Fund	21.6%	4.7%	5.7%
Median College Endowment	19.8%	4.6%	5.5%
Simulated Index Fund Returns*	22.3%	5.8%	6.2%

Perhaps a difference of 0.5% may not seem like much, but it is HUGE when one considers the dollar amounts involved.  A difference of just 0.5% per year over 10 years amounts to:

Vanguard Finds Picking Active Managers is Hard – Duh?!

Vanguard fired Mellon Capital Management.  Vanguard had previously hired Mellon to manage the Vanguard Growth and Income Fund(VQNPX).  VQNPX is a large cap blend mutual fund whose stated goal is to beat the S&P 500 Index.  Mellon didn’t get the job done so Vanguard has hired two new managers to try to beat the S&P 500 Index. 

The fact that Vanguard even attempts to have actively managed funds perplexes me since the Vanguard Group was built on the theory that active managers won’t beat index funds over the long-term.  The performance of VQNPX below once again proves this:

VQNPX                      S&P 500

3-year             -0.6%                          +1.2%

5-year             -2.6%                          -1.2%

10-year           +2.2%                         +2.8%

I love Vanguard, but this makes no sense to me. Personally, I think the VQNPX investors would have been better served if Vanguard had merged the fund into the Vanguard 500 Index Fund (VFINX) – but time will tell.

Avoid Hell's Kitchen and Beat 90% of All Investors

There ought to be a new entry in Wikipedia’s definition of “mean reversion” – See Bill Miller. 

I hate to kick a guy while he is down, but the Bill Miller example is just too good an opportunity for a teaching moment.  Princeton professor Burton Malkiel is famous for his book, “A Random Walk Down WallStreet.”  One of my favorite Malkiel quotes:

“if picking stocks is a random walk down Wall Street, picking funds is an obstacle course through Hell’s Kitchen.”

There is no better example of how difficult it is to not only pick stocks, but also to pick mutual funds than the Legg Mason CapitalManagement Value Fund (Ticker: LMVTX)  managed by famed investment manager Bill Miller.  Bill Miller’s face once graced the cover of virtually every investment magazine after producing one of the greatest streaks in investment history.  Miller became famous after managing to beat the S&P 500 Index 10 years in a row with his LMVTX mutual fund.

Unfortunately, as is usually the case, terrific investment returns are typically followed by dreadful investment performance.  This phenomenon has been seen time and time again, and makes picking mutual funds at least as difficult as picking winning stocks – maybe harder.  Bill Miller’s Legg Mason Capital Management Value Fund is unfortunately the poster child for this phenomenon.  After beating the S&P 500 Index 10 years in a row, the LMVTX has failed to beat the S&P 500 Index in 4 of the last 5 years, and is on pace to lose again in 2011.  What’s worse is the margin of failure. Consider the following performance figures in percentages:

2006    2007    2008    2009    2010    2011 YTD

LMVTX             5.9       -6.7     -55.1    40.6      6.7      -7.6

S&P 500         15.8       5.5     -37.0    26.5     15.1     -1.8

Difference       -9.9     -12.2    -18.1    14.2     -8.4      -5.8

Despite its name, the Legg Mason Capital Management Value Fund competes in the Large Cap Blend Morningstar category where its 5-year and 10-year performance track record is now so poor it is ranked in the bottom 1% of all mutual funds competing in that category. Don't get me wrong, Bill Miller is a very smart guy. He has done nothing "wrong."  He's just a guy who was very lucky for 10 years and he has been very unlucky more recently.  The fact is, most mutual funds fail to beat simple broad market index funds.  In that case, Bill Miller is in good company.

If this one example of how difficult it is to identify mutual funds that will outperform broad market indexes, consider the following information I gathered while perusing the Morningstar database of mutual fund returns.  Morningstar shows 1,890 mutual funds in the Domestic Large Cap Blend category (the same category in which the fund above competes).  Of these 1,890 funds only 823 have been in existence for 10 years.  Of those 823 funds with 10-year track records, only 209 or 25% have produced a 10-year return higher than their benchmark index.  So, there you go. It’s easy to find mutual funds that have beaten their index IN THE PAST.  I just found 209 of them.  But, the Bill Miller example shows you that while it is easy to find PAST WINNERS, it is impossible to predict future performance.

If that isn’t enough, consider the Morningstar database of 426 Mid Cap Blend mutual funds. 193 of these funds have a 10-year track record, but only 25 of these beat the relevant mid cap index over the 10-year period.  That’s right, only 13% of all mid cap blend mutual funds beat their benchmark index. Another way to look at it is 87% of the mid cap blend mutual funds failed to beat their benchmark index. 

And, the data on the funds above OVERSTATE the performance of mutual fund managers due to something called survivorship bias.  The Morningstar database only shows the funds in existence right now, and does not include the hundreds of funds that went out of business over the past 10 years due to poor performance. Thus, your odds of picking a fund that will outperform index mutual funds IN THE FUTURE is likely less than 10%.  (This will be the topic of another post, soon).

SUMMARY

The lesson here is that it is extremely tough to pick winning mutual funds since their historical track records provide no guide for the future whatsoever.  The funds with great track records rarely give a repeat performance.  So, how is an investor supposed to pick mutual funds that will beat stock market indexes IN THE FUTURE? You can’t, so just buy index funds and you will likely beat 90% of all investors. 

So, when your over-paid investment advisor shows you a list of 8-10 mutual funds with fantastic performance records that he/she recommends you buy, don’t be impressed.  Turn and walk away.  There are many good index funds out there, but I have always recommended Vanguard mutual funds to my friends, family, and in my books.

Jack Bogle one of the founding fathers of indexing

Here is a great video interview with Jack Bogle, the founder of the Vanguard Group of mutual funds and the inventor of the first index fund. Bogle has also written several books, the best of which is, "The Little Book of Common Sense Investing" (I highly recommend reading).  Many followers of Bogle call themselves Bogleheads and they have a website designed to help individual investors.

I agree with 99.9% of what Jack (John) Bogle says in the video. The one thing I don't quite agree with is his stance on foreign stock funds.  I've run the numbers several times utilizing statistical optimization software and I am convinced that a small position in a foreign stock index fund both REDUCES THE RISK of a diversified portfolio and INCREASES RETURNS over sufficiently long-run results.  The impact is somewhat small, but every bit helps.  Luckily, despite Bogle's views, Vanguard has the best foreign stock index fund in the business called the Vanguard Total International Stock Index Fund.

I have never worked for Vanguard, but I've always been a big fan.  I have the vast majority of my own money invested in Vanguard Mutual Funds and Exchange Traded Funds (ETFs).  I use only Vanguard Mutual Funds in my book "The Rollover IRA Cookbook" and use many Vanguard ETFs in "The ETF Cookbook."

As always, you can see all my books at www.InvestorCookbooks.com

YOU CAN’T SPELL “DUMBASS” WITHOUT MBA

Most of the world’s investment managers are highly educated individuals with MBA (Masters of Business Administration) degrees.  Yet, most of these educated, talented, and hard working folks still fail to beat simple passive indexing strategies.  Standard and Poor’s released a study that shows that the vast majority of mutual funds lost to the S&P indices over the past five years:

1. 61% of large cap managers failed to beat the S&P 500 (large cap index)
2. 79% of mid cap managers failed to beat the S&P 400 (mid cap index)
3. 61% of small cap managers failed to beat the S&P 600 (small cap index)

What’s more, the study did not point out that the minority of managers that did beat their respective benchmark indices (cough, LUCKY!) will most likely not do it again over the next five years.  But, numerous studies, some by Vanguard, show this also to be true.  Thus, don’t be fooled into thinking that you can pay an advisor, likely another MBA, who can pick the best mutual funds that will beat their benchmark indices.

I can tell you that this duMBAss invests his serious money only in index funds (and I suggest everyone else do the same).

Standard & Poor’s Indices Versus Active Funds Scorecard