Larry the Index Investor - A Super Story

Was feeling a bit bored today so put together the below just to jot down some thoughts...

Larry was sick of having a poorly performing super fund, this money was supposed to see you through your twilight years wasn't it, that was going to be a hard task with everyone who's hands the money passed through, taking a piece of his retirement pie. The only winners it seemed were the fund managers

Larry resented the fact that he was paying someone else to lose his hard-earned and wanted more control of his future, a SMSF offered this option providing flexibility in investment choice and asset selection and still at a lower cost than his last years total payments to a professional manager

A Money Management article stated:

“Research conducted by CoreData shows that Australian financial planners have lost approximately 215,000 clients over the past 12 months. Even more disturbing, 28 percent of respondents who currently have a relationship with a planner are ‘very likely’ to consider not using a planner in the future – up from only 4% last November.”​

Larry had been told you need $200,000 to make having your own SMSF worthwhile. However the $200,000 figure was based on the average cost of running a SMSF, which the ATO had worked out to be $5,100 per year in 2011. There were certainly cheaper options than that at the time, so he took the plunge

Larry had invested into the stock market previously and whilst he'd had some wins he'd also had some losses, not unlike a night at the casino. He realised that when he bought a stock there was an ownership bias, he placed a higher value on it now that he owned it, he didn’t want to sell it as he thought it would go up in value. If it went down in value he didn’t want to sell it and take a loss, he hoped that it would go back up in value. Human emotions can sabotage the best laid plans and the enemy in the mirror is real

Westpoint, Fincorp, ACR, Bridgepoint, Storm Financial, Timbercorp, Opes Prime, Great Southern are all corporate examples of woe that have benched investors retirement plans

If Larry was going to do this he needed a rational investing system that wouldn't light up his amygdala like a Christmas Tree. Warren Buffett said that “investing is simple, but not easy” and Wazza know's a thing or two about the market, Larry needed simple and his research led him to index funds and the financial wisdom of Nobel Laureate winners, Professors, Academics, Economists, Endowment Fund Managers and Investment professionals

Smarter people than Larry had been recommending these types of funds for years

Paul Samuelson, the first American to win a Nobel prize in Economics said:

“The most efficient way to diversify a stock portfolio is with a low fee index fund”​

William F. Sharpe, Nobel Laureate in Economics (1990) said:

“More often (alas), the conclusions [supporting active mutual fund management] can only be justified by assuming that the laws of arithmetic have been suspended for the convenience of those who choose to pursue careers as active managers”
​

Prof. Eugene Fama, Nobel Laureate:

" For most people, the market portfolio is the most sensible decision."
​

Maybe the above is all theory though and they know nothing about real money management, Larry looked at several investing rock star professionals who reiterated the above.

Legg Mason's Bill Miller had spent his career trying to beat the market and he had done so for 15 years straight at one point, from 1991 to 2005 the Legg Mason Value Trust fund trounced the market, an outstanding record, he was the Usain Bolt of the Financial World. The fund subsequently tanked in following years though and whilst the fees of 1.19% of assets a year on its “A” class shares, in addition to the 5.75% sales commission levy didn't hurt in the good times, they certainly took of some of the shine in the bad

Bill once stated a great case for index funds

"If somebody said, I've got a fund here with a really low cost, thats tax efficient, with a 15-20 year record of beating almost everybody, why wouldn't you own it".

"With the market beating 91% of surviving managers since the beginning of 1982, it looks pretty efficient to me."​

In 2014 Buffett revealed he didn’t trust anyone to pick winning stocks after he was gone. Instead, he said that on his passing, 90% of his estate for his wife would be put into a low cost S&P 500 index tracker, and the remaining 10% to be held in bonds. To be fair though with his asset base, I would say the returns on the 10% alone would see Larry through

Buffett said:

“I believe the trust’s long-term results from this policy will be superior to those attained by most investors — whether pension funds, institutions, or individuals — who employ high-fee managers.”​

Peter Lynch is a mutual fund manager whose Fidelity Magellan fund averaged a 29.2% annual return,consistently more than doubling the S&P 500 market index between 1977 and 1990 and making it the best performing mutual fund in the world. During his tenure, assets under management increased from $18 million to $14 billion. Since those heady days, his fund has been easily surpassed by the U.S. index, and he has this to say:

“The public would be better off in an index fund”​

Ted Aronson actively manages more than $7 billion for retirement portfolios, endowments and corporate pension fund accounts. But as for his own his own taxable money

“..all our [his family’s] taxable money is in Vanguard’s no-load index funds”​

Lars Kroijer was a Hedge Fund Manager who had A Change of Heart in 2006.

He founded the hedge fund firm Holte Capital Limited in 2002, starting with a fund of $3.5 million. By 2008, his fund reached about $1 billion in invested capital, before the global financial crisis led him to close the hedge fund business.

Kroijer then created and was an author of two books: The first, Money Mavericks: Confessions of a Hedge Fund Manager in 2010 was about his own life as a hedge fund manager. The second, Investing Demystified, a book saluting passive investing in index funds as the most logical choice for almost any investor.was published in 2013.​

If a hedge fund earned 10 percent in a year, only 3 percent would end up in investors’ pockets. The other 7 percent would be eaten up by dozens of layers of fees.

When Wall Street veteran Gordon Murray told his good friend and financial advisor, Dan Goldie, that he had only six months to live, Dan responded, “Do you want to write that book you’ve always wanted to do?”

The result was "The Investment Answer: Learn to Manage Your Money & Protect Your Financial Future."

A Dying Bankers Last Instructions​

Jack Bogle:

"The beauty of owning the market is that you eliminate individual stock risk, you eliminate market sector risk, and you eliminate manager risk. -- In my view, owning the market and holding it forever is the ultimate strategy for winners."​

 

Larry's market cap weighted index investing is a momentum strategy. Components and weightings are constantly in motion in response to market and business cycles. As investor sentiment bids up prices in a sector, those stocks become increasingly expensive and represent a larger portion of the index and subsequently with a decline in share value, the stock’s share of the index is reduced. With a survivorship bias, poor performers are removed as the index self-cleanses

Active mgrs vs the index (Australia). Latest SPIVA Report. Pay attention to the long term data ie 10 years (borrowed from @Nodrog post)



Indexing shines because it's cheap, As Bogle said 'In Investing, you get what you don't pay for'. Money you lose to fees compounds over time

Based on an initial investment of $50,000, the average investment management fee paid by Australian individual small investors for multi-sector balanced managed funds is just a under 1 per cent, but can be as high as 2.5 per cent. That is nosebleed high by international standards. Those high fees on managed funds are often not justified by the funds returns, according to analysis by comparison website Canstar. Most ETFs have fees of between 0.2 and 0.5 per cent, a fraction of those charged by managed funds.

Vanguards VAS (ASX 300) charges just 0.14%

Imagine you have $100,000 invested. If the account earned 6% a year for the next 25 years and had no costs or fees, you'd end up with about $430,000.

If, on the other hand, you paid 2% a year in costs, after 25 years you'd only have about $260,000.

That's right: The 2% you paid every year would wipe out almost 40% of your final account value. 2% doesn't sound so small anymore, does it?​

​

This hypothetical illustration doesn't represent any particular investment nor does it account for inflation. "What you lose to costs" represents both the amount paid in expenses as well as the "opportunity costs"—the amount you lose because the costs you paid are no longer invested. There may be other material differences between investment products that must be considered prior to investing. Numbers are rounded.

If you'd invested $10,000 10 years ago and you now had $12,500 you would have underperformed your groceries due to inflation (2007-2017)

 

Excellent articles Redwing, you should get bored more often!!

 

Bogle's tenets

1) Chose a sound financial lifestyle
2) Start investing early and often
3) Know what your buying
4) Preserve your buying power
5) Keep costs and taxes low
6) Diversify your stock portfolio​

Note though Larry is a fan of the LIC thread and strategy also thanks to PC members

1. Spend less than you earn,
2. Borrow less than you can,
3. Select your chosen LIC/s of choice,
4. Buy what you can when you can,
5. Reinvest all the dividends,
6. Participate in SPP where offered,
7. Pin the ears back buying when the market collapses,
8. Never sell

And

No 1 - Just save and invest.
No 2 - Collect dividends, buy more.
No 3 - Back to step one

 

According to Sharesight, Larry's SMSF portfolio has achieved the following

• Total Return 14.13% p.a.
• Capital Gain 9.56% p.a.
• Income Gain 4.57% p.a.

 

@Redwing what does Larry's SMSF portfolio comprise?

 

@Ynot

It's a very simple and lazy broad based and cheap portfolio for Larry that requires little maintenance, purchase decisions are dependent on asset goal allocation, in a nutshell it's...

25% Australian Index (Home Country bias)
25% Australian Bond Index
25% US Index
25% World (ex US) Index

So 75% Stocks and 25% Bond's, the Bonds are about as exciting as waiting in line at the post office, but they are coveted for their dry powder appeal in times of market volatility. The best purchasing times to deploy these during the past decade or so have been after 9/11, the start of the Iraq war, the GFC, the European debt crisis, the flash crash..

 

Thanks @Redwing. The proportion of shares to bonds in Larry's portfolio of 75%/25% is very close to that of an article I was reading over the weekend by Jim Collins in US (The Simple Path to Wealth). Jim Collins' normal investment stance seems very similar to Peter Thornhill's for 100% invested in share index funds such as VTSAX, however Jim mentioned that studies show that the optimal portfolio breakup is 80% shares funds (perhaps VTSAX) / 20% bond fund (perhaps VBTLX). I like the idea of this apportionment for my super in retirement mode where the 20% in bonds/cash can provide the necessary safety funds to give 4 to 5 years of pension payments in case of a significant market downturn.

 

@Redwing or others do you have any suggestions for low cost ETFs for the 25% US Index and 25% World (ex US) index that are domiciled in Australia and do not require special taxation arrangements such as completing the W-8Ben form?

 

Vanguard offer VGS for World ex Aus which is Aus domiciled. Not as broad as some others, is broad, all in one international and cheap.

Not aware of another that's as simple and Aus domiciled.

 

@Ynot

There's this from the Propertychat ETF thread

As per Hodor, Vanguard has also added new funds since

ETF watch also has some good info prior to going direct to the funds sites

 

Problem is that VGS doesn’t go anywhere near the breadth of VTS + VEU. But, they have some drawbacks as well.....if you wanted to go Oz domiciled you’d go VGS + VGE, 90/10 weight or similar.

 

I do understand the value of Index Investing.
But, I have been 'experimenting' this financial year. So far I have done about 90 trades (buy & sell together). It is about 15% return (after taking out fees) on investment before tax.
That is similar to Larry's Return.
I don't sell anything at a loss. So what I"m holding now has a high paper loss. When/If they become green then I will sell them which will increase the return figure.

 

Is there a chance you've sold off all the good stocks but left yourself with all the non performers?

 

That is a possiblity. My worst performers are Telstra, PLS (I think they will fly high) and MYR. Mostly due to the size of them. They make up about 75% of the paper loss.
I can hold them for a long time though.

 

@Redwing, @The Falcon and other asset allocators a question please?

A number of major risks can be reduced by investing outside your own country. Typically equities are split between Australia and Overseas. Vanguard’s own diversified ETFs also have significant exposure to Overseas bonds relative to local bonds. Why is it that most here who invest in Bonds generally only invest in Australian Bonds? Just like equities our local bond market is tiny relative to overseas. Wouldn’t protecting against Home Country Risk in Bonds be just as important as Equities?

 

This is a really well known behavioural bias.

"Cut your losses and let your winners run" or alternatively "don't pluck the flowers and water the weeds"

 

The Falcon will likely give a better explanation than I, Larry's portfolio is simple and lazy

The Paradox of Choice - Why More Is Less is a 2004 book by American psychologist Barry Schwartz. In the book, Schwartz makes the counter-intuitive case that reducing choices can greatly reduce stress, anxiety, and the frenzy of daily life

Researchers Kalok Chan, Vicentiu Covrig and Lillian Ng say most investors–no matter where they’re from– usually tilt their portfolios towards home country stocks. After all that's the currency Larry will be spending his retirement dollars in

 

Thanks @Redwing.

Adding International Bonds is still simple and cheap:

https://api.vanguard.com/rs/gre/gls/stable/documents/11608/au

In regard to simplicity I suppose just buying one of Vanguards diversified ETFs is as simple as it gets.

As for spending in local currency that’s why Overseas Bonds are Hedged.

A lot of indexing / asset allocation ala Boglehead is often based on US literature. Of course there tends to be a home bias but the US bond and share markets are huge. Australia is tiny in comparison. I would have thought adding one extra holding (Overseas Bonds) might be worthwhile given the significant risk mitigation against Home Country Risk.

Mind you I’m not an investor in Bonds but was just curious.