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DFA vs. Vanguard

Systematic wrote:

In the nicest way possible…

….and I mean NICEST….

No offense taken, bro.  I’m asking for constructive criticism, and you’re giving it.  I appreciate it.  I still don’t  necessarily agree with you, but I like the dialogue. 

@Sys - If you want more exposure to small-cap and less to large-cap, then….(wait for it)…sell LC and buy SC.  You don’t need to call the fund manager.  That’s what the “buy” and “sell” buttons are for. 

And in the world of private wealth, I don’t know that I’d ever calculate what duration I would need.  I might use some generalities, like “I want long-term corporate” or “short-term government” depending on the situation, but to say “I need a duration of 3.825” in a private wealth situation seems to be overkill. 

And you said that you know people with 234 stocks in one asset class.  I think we can both agree that more =/= better.  Yes, you need a sufficient number to achieve basic unsystematic diversification, but 234 stocks (presumably scattered across the economical/geographical spectrum) should most certainly do the job. 

@STL - When I said “four-fund max”, that’s the holding for any client’s portfolio.  That doesn’t mean those four specific funds.  Yes–you would need muni bond funds, government bond funds, emerging market funds, REIT funds, etc.  But any given person only needs to own four funds.  It’s far easier to own one large-cap global fund than to own a LC domestic value, a LC domestic growth, a LC foreign value, and a LC foreign growth.  And it should perform just as well. 

By the way–I’ll probably have very few, if any, clients with $10m or more in investable assets.  The clients have that much net worth, but most of it is tied up in their businesses (which is why they’re wealthy to begin with).  And if I did get somebody with $50m in investable assets, they’d have to understand the model and it simplicity.  If they didn’t accept it, then I’d send them to my buddy at US Trust. 

82 > 87
Simple math.

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Serious question, why even bother with four funds? Why not a single target date or target risk fund? If you’re really going for low fees and simplicity that would be the way to go.

Edit: What would you recommend for a 35 year old with $250k to invest in an 80/20 portfolio? I’m really curious how you could cover everything with four funds. 

Never heard of a “target risk fund”.  Can you give me an example? 

I stated in another thread–I don’t like target date funds because I don’t have any control over the allocation.  If, for example, I wanted to be 50-50 stocks/bonds, and the fund is 80-20 stocks/bonds, then I can’t control it.  If I hold two funds, I can just sell some of the stocks and buy bonds. 

Plus, like Sys said, if I see a real buying opportunity some area of the market (say the Euro is at an all-time low and I expect it to appreciate) then I can buy European stocks.  Can’t do that with a target date fund. 

Yeah, that would be low fee and simple, but a little too simple, even for a simple-minded guy like me. 

EDIT - How would I allocate $250k to four funds, trying to get 80/20?  50k to Dodge and Cox Income, 125k to Dodge and Cox Global, 50k to Royce Premier (or another small/mid cap blend, with some foreign exposure), and 25k to some diversified emerging markets stock fund. 

To note–I don’t really know all the fees associated with buying into the funds.  If they charge a 1% redemption fee every time you sell, that might change my thinking.  Then I’d have to go with ETFs, and I don’t know if there is such a thing as a “global mid/small ETF”. 

82 > 87
Simple math.

Greenman72 wrote:

Systematic wrote:

In the nicest way possible…

….and I mean NICEST….

No offense taken, bro.  I’m asking for constructive criticism, and you’re giving it.  I appreciate it.  I still don’t  necessarily agree with you, but I like the dialogue. 

@Sys - If you want more exposure to small-cap and less to large-cap, then….(wait for it)…sell LC and buy SC.  You don’t need to call the fund manager.  That’s what the “buy” and “sell” buttons are for. 

And in the world of private wealth, I don’t know that I’d ever calculate what duration I would need.  I might use some generalities, like “I want long-term corporate” or “short-term government” depending on the situation, but to say “I need a duration of 3.825” in a private wealth situation seems to be overkill. 

And you said that you know people with 234 stocks in one asset class.  I think we can both agree that more =/= better.  Yes, you need a sufficient number to achieve basic unsystematic diversification, but 234 stocks (presumably scattered across the economical/geographical spectrum) should most certainly do the job. 

@STL - When I said “four-fund max”, that’s the holding for any client’s portfolio.  That doesn’t mean those four specific funds.  Yes–you would need muni bond funds, government bond funds, emerging market funds, REIT funds, etc.  But any given person only needs to own four funds.  It’s far easier to own one large-cap global fund than to own a LC domestic value, a LC domestic growth, a LC foreign value, and a LC foreign growth.  And it should perform just as well. 

By the way–I’ll probably have very few, if any, clients with $10m or more in investable assets.  The clients have that much net worth, but most of it is tied up in their businesses (which is why they’re wealthy to begin with).  And if I did get somebody with $50m in investable assets, they’d have to understand the model and it simplicity.  If they didn’t accept it, then I’d send them to my buddy at US Trust. 

Seriously, you should’ve been a lil offended… I was kinda being a d!ck, sorry about that, haha. 

My point was if you have 1 US equity manager, you have no control over small vs large and you can’t hit the buy and sell buttons. The fund companies don’t make asset allocation decisions for you, the just give you the ingredients… you should be artfully crafting a meal that your clients couldn’t cook for themselves. They either need to get value from you, or perceive value. In the best interest of your children, I strongly suggest you give them as much of both as possible.  And you are going to want to manage duration just like you did on your example above. The fund manners are going to manage around the Barclays, or WGBI, and you need to manage them to meet your clients needs. 

I guess what sweep and I are telling you, is buy 10+ damn funds. Also, there’s no way your turning down a guy with $50mm because he doesn’t understand your business model. That’s several years of net flows for most advisors… if that guy says jump, you say “how high”

I think sweep is an external wholesaler. I used to work an RIA with a few billion in assets. Also, start reading riabiz.com to learn about the industry. Also, I’ve never heard of your weird custodian you posted above. DFA won’t be on their platform, they’re on very few. Your best bet is tda they’re kind of the up and comer for custodians and have reasonable trading costs. 


Systematic wrote:

I think sweep is an external wholesaler.

I’m not on the retail side anymore. I work on the key account/institutional sales.

Thanks for the feedback, Sys.  I appreciate the ideas from both you and STL. 

82 > 87
Simple math.

Greenman72 wrote:

Never heard of a “target risk fund”.  Can you give me an example? 

They’re similar to target date funds, but they have a static allocation to stocks and bonds providing the investor with a target risk allocation. Generally people with small account balances use them. For example, if you’re working with a client and their kid has $10,000 to invest you might put it in an “Aggressive” target risk fund, instead of buying several mutual funds.  See the link for Vanguard’s example:

https://personal.vanguard.com/us/funds/vanguard/LifeStrategyList

Greenman72 wrote:

I stated in another thread–I don’t like target date funds because I don’t have any control over the allocation.  If, for example, I wanted to be 50-50 stocks/bonds, and the fund is 80-20 stocks/bonds, then I can’t control it.  If I hold two funds, I can just sell some of the stocks and buy bonds. 

Plus, like Sys said, if I see a real buying opportunity some area of the market (say the Euro is at an all-time low and I expect it to appreciate) then I can buy European stocks.  Can’t do that with a target date fund. 

Yeah, that would be low fee and simple, but a little too simple, even for a simple-minded guy like me. 

My main problem with this is you’re basically market timing, which is nearly universally agreed to be impossible. Instead of maintaining a strategic weight to all the various asset classes by purchasing a dozen or so mutual funds/ETFs, you’re waiting to make very sizable shifts among a few funds based on your outlook (which is likely wrong {nothing personal, just a good bet}). There’s nothing wrong with making tactical moves by overweighting/underweighting asset classes, but every advisor I’ve ever worked with maintains some sort of strategic weight so they don’t miss the initial move - which is normally the biggest. 

Greenman72 wrote:

EDIT - How would I allocate $250k to four funds, trying to get 80/20?  50k to Dodge and Cox Income, 125k to Dodge and Cox Global, 50k to Royce Premier (or another small/mid cap blend, with some foreign exposure), and 25k to some diversified emerging markets stock fund. 

If you brought this to me, I’d have serious reservations about manager risk (70% of my funds being in D&C) and I don’t think you’re covering all the asset classes adequately. No TIPS or really any inflation hedge what so ever, very little emerging market equities, basically no small/mid international stock, no emerging market debt, no international debt outside of the UK, no alternatives, very little REIT exposure, (Royce is closed to new investors); and a single small/mid domestic can’t adequately cover small value and mid growth at the same time (historically two of the best performing asset classes). And, after 2008 I would never put all my fixed income money in a single bond fund. Much too much manager risk.

This is what Sys and I are talking about. You can’t cover everything with four funds. All it takes is one other advisor to point out all these holes and you’ll lose your clients. 

Greenman72 wrote:

To note–I don’t really know all the fees associated with buying into the funds.  If they charge a 1% redemption fee every time you sell, that might change my thinking.  Then I’d have to go with ETFs, and I don’t know if there is such a thing as a “global mid/small ETF”. 

For RIAs there really aren’t any fees to buy into mutual funds. There’s no load - either front or back-end - and you’ll normally only find redemption fees on relatively illiquid asset classes like emerging markets. But, you do have to hold mutual funds for at least 30 days. You’re not supposed to actively trade them. We flag RIAs/advisors all the time for making “round-trips” in and out of our funds. Every fund company does this. That’s another reason to have a strategic weighting across a dozen or so funds and then tactically manage around them.

All of the above said, I’m not bashing your choices or your possible return profile. Looking backwards this would have been a very successful portoflio over the last 10 years. But, that’s not the way it works. Ask yourself this, if this is a good strategy how come it’s not already popular among advisors? 

^Okay, I have heard of “target risk” funds.  I’ve just never heard them called that. 

About market timing - I’m not saying I would sell all of my other assets and shift into 100% European stocks.  But instead of being 50/50 US/International, I might shave off 10% of US, so I’m 40/60.  The “core” is still fundamentally the same, so I’m only changing on the margin.  I’m not sure how this is fundamentally different than tactical asset allocation. 

Sweep the Leg wrote:

I’d have serious reservations about manager risk (70% of my funds being in D&C).

And, after 2008 I would never put all my fixed income money in a single bond fund. Much too much manager risk.

Why do you say these?  

Sweep the Leg wrote:

 I don’t think you’re covering all the asset classes adequately. No TIPS or really any inflation hedge what so ever, very little emerging market equities, basically no small/mid international stock, no emerging market debt, no international debt outside of the UK, no alternatives, very little REIT exposure, (Royce is closed to new investors); and a single small/mid domestic can’t adequately cover small value and mid growth at the same time (historically two of the best performing asset classes). .

Again, I’m not sure that you have to fill up each “asset bucket”.  If I had 40 different funds that included a fund for each part of the US stylebox, the International developed stylebox, the emerging markets (both large and small), the Frontier markets, growth REITs, income REITS, commodities, managed futures, MLP’s, and all the million different types of bonds out there, I’m not sure that this extremely complex and difficult-to-manage portfolio would perform any better than the simple four-fund one. 

If I really thought that there were a benefit (either to myself or to the client) for complicating their portfolio to include 40 different funds, then I would consider it (and consider whether I could actually run the shop, in addition to the tax and valuation practice).  But I think it’s just added complexity with no benefit.  And just saying, “Well, this is how UBS and Morgan do it” isn’t enough to convince me. 

Sweep the Leg wrote:

Ask yourself this, if this is a good strategy how come it’s not already popular among advisors? 

Because the industry is really really really good at selling crap to unaware clients.  And people are taught that “you get what you pay for” (which I believe to be untrue in investing) and “practice makes perfect” (which I also believe to be untrue in investing).  And it’s human nature to want to come up with complicated answers to simple problems. 

EG - if you manage John Doe’s portfolio, you might charge 1% of assets and put him in 80 different funds and ETF’s, and monitor his portfolio on a daily basis.  I would charge .5%, and put him in four funds and check it once a year.  And everything John Doe has ever been taught tells him that he’ll get more “bang for his buck” by going to STL, when I think the empirical evidence says otherwise. 



82 > 87
Simple math.

Again, I don’t want to be argumentative or intransigent.  I’m really trying to get input, so I can decide whether I need to change the way I think, or whether I should abandon the idea of adding investment management to the accounting practice. 

And I don’t want to sell a bunch of **** just to line my own pockets with gold.  I’ve seen too many dodgy advisors who do that.  I’ve actually been told (by my manager at Morgan Stanley) that we couldn’t sell index funds or ETF’s, because it would be hard to justify a 1% fee on them.  He acknowledged the fact that they outperformed most actively-managed funds, but told me that my job was to sell financial products, and index funds just weren’t “hot” enough for clients. 

82 > 87
Simple math.

Greenman72 wrote:

Sweep the Leg wrote:

I’d have serious reservations about manager risk (70% of my funds being in D&C).

And, after 2008 I would never put all my fixed income money in a single bond fund. Much too much manager risk.

Why do you say these?  

Manager risk is a very real risk. The 5.75% front end load isn’t the reason the industry is shifting away from A Shares. It’s because you had to use one fund company to hit your breakpoints and, in the process, expose yourself to manager risk. For example, when American Funds does poorly, all their funds tend to do poorly because they have centralized research and the same macro themes play out across all their funds. To hedge against this the industry moved to the fee-based model where using more than two managers in a given asset allocation model is fairly uncommon. Having 70% of your money with one firm is very rare. That’s the knock on DFA (hey! we came full circle).

The part about the single bond fund is a very real, but fairly new risk. In 2008, bond funds that were supposed to be safe and protect investors in times of crisis completely imploded. Many multi-sector bond funds were down well over 10%. Imagine the pain a person near retirement felt as they not only witnessed their equities getting cut in half, but their “safe” bond portfolio getting crushed by 20%. To make matters worse, the Barclays Aggregate Bond Index was up 6% in 2008 so it just goes to show how much risk these bond funds were taking and their clients (and advisors) had no idea. Dodge & Cox held up fine, only down about 60 bps, but that still sucks compared to the index being up 6%. Having a well diversified bond portfolio has been one of the key takeaways from the financial crisis. 

Greenman72 wrote:

Sweep the Leg wrote:

 I don’t think you’re covering all the asset classes adequately. No TIPS or really any inflation hedge what so ever, very little emerging market equities, basically no small/mid international stock, no emerging market debt, no international debt outside of the UK, no alternatives, very little REIT exposure, (Royce is closed to new investors); and a single small/mid domestic can’t adequately cover small value and mid growth at the same time (historically two of the best performing asset classes). .

Again, I’m not sure that you have to fill up each “asset bucket”.  If I had 40 different funds that included a fund for each part of the US stylebox, the International developed stylebox, the emerging markets (both large and small), the Frontier markets, growth REITs, income REITS, commodities, managed futures, MLP’s, and all the million different types of bonds out there, I’m not sure that this extremely complex and difficult-to-manage portfolio would perform any better than the simple four-fund one. 

If I really thought that there were a benefit (either to myself or to the client) for complicating their portfolio to include 40 different funds, then I would consider it (and consider whether I could actually run the shop, in addition to the tax and valuation practice).  But I think it’s just added complexity with no benefit.  And just saying, “Well, this is how UBS and Morgan do it” isn’t enough to convince me. 

You don’t need 40 funds to cover everything I listed. And, by the way, those asset classes I mentioned are the bare minimum for what’s considered a well diversified portfolio. You can reach all of them with 5 domestic funds, 2-3 international funds, 3 fixed income funds, and 1-2 alternative funds. 13 total funds isn’t so bad. Most models I see are between 12-18.

There most certainly is a benefit. This could be an entirely separate discussion…not even sure where to begin. We could talk about the benefits of using domestic and international funds vs global; why you always need some exposure to TIPS; why have about 10% in uncorrelated assets really makes sense…all this stuff is pretty straightforward. But the short answer is, no one manager can effectively allocate across all domestic equites (for example) and especially not on a global scale; nor do you (or me) offer the ability to make timely tactical shifts. You need exposure to the asset classes because it lowers risk without lowering your return. REITs, for example, are correlated to the S&P to the tune of about .6. So, it makes sense from a diversification standpoint to hold them. This is really portfolio construction 101. All this is really just scratching the surface though. There are tons of reasons to own a well diversified portfolio, and simply owning four funds that have a thousands securities does not guarantee diversification.

Greenman72 wrote:

Sweep the Leg wrote:

Ask yourself this, if this is a good strategy how come it’s not already popular among advisors? 

Because the industry is really really really good at selling crap to unaware clients.  And people are taught that “you get what you pay for” (which I believe to be untrue in investing) and “practice makes perfect” (which I also believe to be untrue in investing).  And it’s human nature to want to come up with complicated answers to simple problems. 

EG - if you manage John Doe’s portfolio, you might charge 1% of assets and put him in 80 different funds and ETF’s, and monitor his portfolio on a daily basis.  I would charge .5%, and put him in four funds and check it once a year.  And everything John Doe has ever been taught tells him that he’ll get more “bang for his buck” by going to STL, when I think the empirical evidence says otherwise. 

I don’t buy this at all. If your strategy could effectively gather assets guys would be all over it. Today’s advisors get paid on AUM and like to play golf. If there was a winning formula that could simplify their business while attracting clients they’d do it in a second. No one is going to pay you a fee, even a low one, to check their portfolio once a year. The major drawback of the fee-based model is investors expect their advisor to actually do something for their fee. If you want to buy something and forget it, go back to the A Share model.

Sweep the Leg wrote:

The major drawback of the fee-based model is investors expect their advisor to actually do something for their fee. If you want to buy something and forget it, go back to the A Share model.

I think the flip side of this is also equally true–the major advantage of the fee-based model is that advisors get to absolutely nothing and still get paid. 

In theory, I think a lot of advisors are “continually monitor your portfolio, and using the very latest cutting-edge research, we are constantly shifting into different sectors and asset classes which we expect to outperform while simultaneously reducing your systematic risk.” 

In practice, I think a lot of advisors are playing golf and charging 1% of $100m per year. 

82 > 87
Simple math.

sharksfan wrote:
DFA = enhanced indexing … .

Enhanced, or optimized?

Simplify the complicated side; don't complify the simplicated side.

Financial Exam Help 123: The place to get help for the CFA® exams
http://financialexamhelp123.com/

As I recall, enhanced just means that they’ll try to generate a little alpha but not if it results in more than just a tiny bit of tracking error.  Presumably it is also optimized, but you can have optimized portfolios that are more than enhanced.

You want a quote?  Haven’t I written enough already???

Greenman why not go 100% passive with I shares? The way I see it your job isn’t to pick managers unless your running a fof, you’re really selling a service that’s trying to preserve capital more than anything else.

^Certainly could, although (getting back to the original discussion) I’m not sure that using DFA funds wouldn’t be preferable to ETF’s that track a commercial index. 

Of course, using iShares would be the ultimate in “capture beta not alpha”, but I do think there’s a little alpha to be generated by smart managers.  That’s why I chose the funds that I did.  Maybe I should rethink that strategy. 

Also, (and I don’t spend all my time reading Barron’s or Morningstar, or else I would probably know more,) I don’t know if there are “global” ETF’s.  That is, I used the example of the D&C Global fund earlier to gain exposure to all large caps, foreign and domestic.  If there is no such thing as a “global” ETF, then I’d have to abandon my “four-fund” rule, which actually might not be a bad idea, after listening to Sys and STL. 

82 > 87
Simple math.

^Yes, but is your job to “capture alpha”?

Not really.  Your job is to invest client assets according to their needs and wants.  Capturing alpha isn’t part of it.  But if you knew you could get a positive alpha with a lower stdev, you’d be a fool not to grab it.  I think a few (emphasis on the “few”) managers are able to do that. 

Do you disagree?  I’m not sure what your point is. 

82 > 87
Simple math.

If you’re trying to capture beta of US stocks, why can’t you just put your entire investment in SPY? I understand the need for different asset classes (bonds, real estate) but trying to capture beta by allocating between US growth/value, momentum/defense–does that really work?

Jorn Lande wrote:

…trying to capture beta by allocating between US growth/value, momentum/defense–does that really work?

IMHO, no.  Some others would say that you need “systematic exposure to growth and value in order to achieve the desired asset diversification…”  I think that’s baloney.  There’s an ongoing debate about whether value or growth will win, and there’s no way to tell what will work in the future. 

Yes, investing 100% into an S&P 500 index fund or ETF would be the ultimate in “capture beta”, and would also be the ultimate in simplicity.  But that’s a little too simplistic, even for a simple guy like me.  While I don’t think you necessarily need exposure to every single asset class in the world (like emerging market floating rate collared debt), just having one asset class is surely a recipe for disaster. 

82 > 87
Simple math.

Fuark Sweep, we’re making negative progress in this thread…

The whole debate on passive versus active never gets old…and I suspect it is because of all the vested interests. Keep in mind I am in the active management part of the industry as I say this – I have never understood how the search for an extra 50bps per year keeps an entire portion of the industry afloat, teeming with researchers, analysts and PMs. It seems to me that you pay some lowly people to construct an index, and that does a pretty good job at capturing a large chunk of the return stream flowing to assets (i.e., the beta) – why go crazy with selection and complex schemes to piece together something that can add, maybe, (a volatile) 50-75bps per year?

Now I realize that this will open me up to criticism by some, but again, keep in mind, my own livelihood is in the belief of active management. I’m simply pointing out that if you have a blended portfolio delivering 7-8% per annum on average, the additional uncertainty introduced in seeking the advantage of an additional few basis points a year, I wonder sometimes, is it worth it? We’re not talking about a magnitude of alterning your return stream by a factor of 2x or 3x here, we’re talking about a very low percent of your total return that is involved in the active management differential.

As an analog, imagine that 99% of the resources of the agricultural industry were focused on extracting the last 1% of the crop yield…we wouldn’t think twice about criticizing this and suggesting that these resources be deployed elsewhere in society to achieve a greater benefit. 

"When what I'm doing isn't working, that's when I'll take your criticisms." -- Me, some time ago

Greenman, go mess around etfdb.com. You can find a lot of ETFs in there, and it’s easy to navigate. I think you may change your preferences that way. There are cheap MSCI World ETFs, for instance: http://etfdb.com/index/msci-world-index/. They even have some portfolio suggestions (I really don’t like those, but reading them may help you think about what you can do with ETFs)

ETFs are not a guaranteed best bet for stocks (tracking error, transaction costs and stuff), but they do OK. For other classes you must know what you’re doing. For instance, contango will eat you up in many commodity ETFs.

The hardest part to do with low fees/low AUM is to get a good grip of different/smart/exotic betas. HF replication funds may have very little in common with the real risk factors that may affect HFs. You’ll also hardly have access to top managers when trying to get exposure to some Alternative Investments.

Also, always remember you will be dealing with people. If your portfolio falls too hard, even on a single year, they’ll fire you.

STL has been hitting the nail on the head. On an intuitive level, I think the best way to look at diversification is to get away from any single risk crushing your portfolio. If you’re all above equities and HY, for instance, you may get badly burned if your optimistic way to look at things does badly.

Diversification is a good thing. Dalio’s All Weather approach has some interesting insights, and CFA’s curriculum L3 IPS section is pretty standard and it tends to work well. I mention the IPS stuff because I think it’s more important to first thing qualitatively about risk factors and client’s needs before throwing a lot of assumptions into Monte Carlo simulations and the like.

As DoW above has wisely shown, playing defense may be much more rewarding than reaching for more bps (that gets clear when things go bad). 

Any type of concentration, like buying only equity or trusting on just a few managers, is better for things that represent part of somebody’s portfolio. In your case, maybe the best idea would be to have a Strategic Asset Allocation based on Time Horizon, Liquidity Needs, yadda yadda (textbook L3) + some minor tactical shifts so your clients will have stuff to talk about at parties.

In my opinion, you may have an easy time beating a fewPrivate Wealth shops because some of them seem more interested in selling sucky structured notes to naïve clients or getting rebates from high-fee funds than actually helping people. If you build a low fee diversified portfolio you can probably deliver better results without unnecessary risk.



Destroyer of Worlds wrote:

The whole debate on passive versus active never gets old…and I suspect it is because of all the vested interests. Keep in mind I am in the active management part of the industry as I say this – I have never understood how the search for an extra 50bps per year keeps an entire portion of the industry afloat, teeming with researchers, analysts and PMs. It seems to me that you pay some lowly people to construct an index, and that does a pretty good job at capturing a large chunk of the return stream flowing to assets (i.e., the beta) – why go crazy with selection and complex schemes to piece together something that can add, maybe, (a volatile) 50-75bps per year? 

I think both clients and practitioners think or want to think they are not only above average, but way above average. In the some way entrepreneurs like to think they may be be building the next Google, investors like to think they may be investing with the next Buffet, or buying the next MSFT. And some will succeed, so hope is always around.

Destroyer of Worlds wrote:
The whole debate on passive versus active never gets old…and I suspect it is because of all the vested interests. Keep in mind I am in the active management part of the industry as I say this – I have never understood how the search for an extra 50bps per year keeps an entire portion of the industry afloat, teeming with researchers, analysts and PMs. It seems to me that you pay some lowly people to construct an index, and that does a pretty good job at capturing a large chunk of the return stream flowing to assets (i.e., the beta) – why go crazy with selection and complex schemes to piece together something that can add, maybe, (a volatile) 50-75bps per year?

The efficency of markets/suitability of passive investing relies heavily on how much active management/research is out there. If everyone stopped research and just indexed, security prices would be complete nonsense. I’ve always found the debate interesting as someone largely outside of of the asset management industry… “security prices reflect all known public information.” Well yes, because some analyst did the work and made that info known.

If there was less research, there would be more to gain by doing research. It’s an equillibrium sort of thing, no?

Passive investors are really just freeloaders on the active side, getting a free lunch.

“I can no longer obey. I have tasted command, and I cannot give it up.”

^Charles Ellis suggested the same thing in “Winning the Loser’s Game”.  He says that the reason that active managers can’t beat the market is because they’re so good at research.  The only way that active management will ever beat passive management is if enough analysts drop out of ER that it actually becomes profitable to do ER again. 

Anyway, thanks for the suggestion, Crazyman.  Never heard of that site. 

@DoW - can you point to any empirical evidence that suggests that my “four-fund rule” is right on?  Or is there some that shows that it is bunk?  (BTW–saying “all the advisors do it this way, so it must be the right way” is not what I would consider empirical evidence.  That might be a commercial for limiting liability or marketing yourself, though.)

82 > 87
Simple math.

Greenman72 wrote:

Not really.  Your job is to invest client assets according to their needs and wants.  Capturing alpha isn’t part of it.  But if you knew you could get a positive alpha with a lower stdev, you’d be a fool not to grab it.  I think a few (emphasis on the “few”) managers are able to do that. 

Do you disagree?  I’m not sure what your point is. 

How do you know your clients even want alpha? The 35 yo self made millionaire may not care about alpha, but may be more interested in tax avoidance, a 65 yo retired doctor might be more concerned with charitable giving etc. The way I see it, you’re performing a service of “I’m looking after your investments so you don’t have to”, and your primary goal is “don’t lose money”. From time to time, some investors may be interested in alpha and you can invest in certain assets based on that, but not as a general business plan. But this is solely my opinion.

^That’s a good point.  And your other points are well taken too. 

That’s where I think the real synergy of tax accountant + investment advisor will reall really come into play.  Being both, there’s nothing “lost in translation” between the tax advisor and the wealth advisor. 

And IMHO, too many tax practicioners focus on “We need to reduce your income taxes right now.  Today.  That is the only value we add.”  And too many investment advisors are focused on “We need to increase your investable assets right now.  Today.  That is the only value we add.”  Unfortunately, neither one is working with the other, and neither one is asking all the right questions. 

82 > 87
Simple math.

Greenman72 wrote:

That’s where I think the real synergy of tax accountant + investment advisor will reall really come into play.  Being both, there’s nothing “lost in translation” between the tax advisor and the wealth advisor. 

Here in KC we have one of the largest RIAs in the country, Creative Planning, that does what (I think) you’re getting at. They only use ETFs…won’t even take calls from guys like me. They’re one of the best - if not the best in the country - at what they do. Check out their site and the services they offer. Keep in mind, the reason they can do all this and charge less than your average mutual fund, is because they have extremely high minimums and they reached scale a long time ago. Having nearly $10B in AUM allows you to do nice things.

^Took a look at it, and yes, that’s extremely similar to what I want to do, except that I’m not an attorney (which they have on staff), and they don’t seem to do business taxes–only personal.  (It’s hard to be a CPA firm and not do business taxes.) 

And of course, I’d be doing it on a much smaller scale.  $100m AUM is a good goal.  If I ever got to $250, I’d feel like the king of the world. 

82 > 87
Simple math.

Here’s an interesting discussion on DFA’s alpha:

http://www.bogleheads.org/forum/viewtopic.php?f=10&t=125633&sid=a8e631e2...

Simplify the complicated side; don't complify the simplicated side.

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