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Are Index Funds Lagging?



Yes, according to research by Thomas Howard and Jason Voss.[1] The index fund has had its day, but that day may be over, at least for the time being. If you are invested in index funds you may want to consider a change.


I spent over 18 years working for large and regional brokerage firms. They taught the advisors to “sell the relationship, not the performance”. The idea was to get clients to like you enough that your returns were not the concern. I remember talking to a prospective client whose account was up over the years just a little over 5% compounded annually. While that is not a bad return, it was a number of percentage points below the S&P 500 TR. I asked if the prospect was happy with that return, and her response was that she really liked her advisor. The advisor had convinced her that higher returns meant higher risk and the advisor was diversifying the portfolio to reduce risk. That is not atypical of my industry, this focus on relationships over returns. In fact, many of the prospects we talk to during our presentations have little or no information on how their investments are actually performing. The clients have a financial plan that shows they have a 98% or 95% chance of having enough money for the remainder of their life, and that is enough. What is missing and why clients should care is that those projections are based on past historical averages and use statistical analysis which is flawed. The stock market is not a ladder than moves up one step at a time. It is more like a roller coaster, where those slow climbs are followed by the sudden peak and plunge downward. Of course, the ride does bottom out and begins to climb again. But that is not how the computer programs running your financial plan work. The financial plans assume that the ride will be nice and easy and up all the way. There is the old joke about the drunk who is wandering around under a streetlight when a cop approaches him and asks what he is doing. The inebriated guy says he dropped his house keys and cannot find them. The cop volunteers to help him look, but after a few minutes gives up and asks, “Are you sure you dropped the keys here?” “No,” says the drunk. “I dropped them in the alley.” “Why aren’t you looking for them in the alley?” “Because the light over here is better.” Financial Plans use the Monte Carlo Simulation to determine the probability that the client will have enough money to live out their life. The problem is this: the Monte Carol Simulation is based on the bell shaped curve, the Normal Distribution. But stock market returns do not form the bell shaped curve. For mathematicians and statisticians, the bell-shaped curve is easy to work with. It is, however, like the drunk looking for his house keys under the streetlight, not finding the real probabilities or running out of money. That point came home for a number of people during the Great Recession when they saw their investment portfolios plunge and leave them short of the retirement funds they hoped for or the income anticipated. The difference between $100,000 growing at 5%, 10%, and 15% over 25 years is the difference between

$338,635

$1,083,471

$3,291,895

That is why performance matters. It may be in the advisor’s best interest to sell the relationship, but is it in yours? Is the relationship worth almost $3,000,000 on a $100,000 investment? And I realize there is no guarantee that the higher returns can be achieved, but math says there is a high probability that asset allocation, based on historical averages, cannot reach higher performance. That is why it should be concerning if you are in an index fund. Active fund managers of the best idea funds have been doing better than the index for the last decade. Since 2009, active managers have been doing much better than index funds and better than those managers who try to mimic index funds (the so-called “closet indexers”).


Graph Used with permission from AthenaInvest.


Past performance is no guarantee of future results.

For Adams Financial Concepts we have a passion from creating and maintaining wealth for our clients. We try very hard to deliver superior results. We know there will be times of periodic loss, setbacks, and unexpected occurrences. Those do not scare us out of the market. We remain fully invested all the time because we do not want to miss the best trading days. As Peter Lynch once said, “It’s a great feeling to get caught with your pants up.” We have a passion for creating and maintaining wealth.


Article Written by:

Mike Adams, President & Principal Adams Financial Concepts LTD.

206-903-1019

https://adamsfinancialconcepts.com/

1001 Fourth Ave, Suite 4330, Seattle WA 98011


[1] Jason Apollo Voss CFA & C. Thomas Howard, Return of the Active Manager, Harriman House; 1st edition (October 29, 2019).


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