Mo’ Money!

May 22, 2006

What index investors really want to know.

It's fine to think 1) save my money 2) get my asset allocation right and 3) stick to my plan w/ optimal diversification and lowest possible cost.  But be honest, isn't that a little boring?  TELL me you're not looking at how to squeeze higher returns out of your portfolio.  All but the most diehard indexers are.

Don't get me wrong, index investors are not like that mindless active crowd, often running uneducated and willy-nilly to whichever marketing pitch sounds best.  Oh no, with us index investors, it's a bit more subtle.  Based on the email we get from readers and my own experience, I'm going to outline some of the top issues that index investors look at.  And they're not always so…passive.

We'll lay them out…and then provide you with answers that will make you filthy stinking rich…in no time at all[1].

  1. Is now a good time to get into the market?  Mr. Bogle would say anytime is a good time to get into the market.  B-O-R-I-N-G. And obviously wrong.  How does January of 2000 look to you now?  Sly index investors who think (like most investors) that they're clever and can "see" the market in the moment look at momentum and trends.  So are we in or out now?  Overall, both in the U.S. and abroad, after a very nice run, it would seem that we're primed for a fall. On the other hand there are some areas that look appealing. In particular, large U.S. must be due any day.  Conventional wisdom says "equitize on the down swing" You know, buy low, sell high.  The S&P and the Dow have fallen back a bit…so if you've got cash burning a whole in your pocket, it may not be a bad time to get in.  EM frightens me, as do gold/commodities, real estate and really, most of the rest of it, including (still) fixed income, which at least shouldn't lose you much money.
  2. What is the easy money I'm missing out on/ where should I tilt? As alluded to above, there are a couple of views on this:  one is that markets have had a nice run - and it's due to continue.  Up up and away…and the faster the better.  No reason to be nervous about Emerging Markets. Look at them go!  And gold too - why not?  Who says 25 year highs can't become all-time highs?   The other view, for the contrarians among us, is that you've got to love U.S. mega-cap & large value, and if, god forbid, you do look at sectors, pharmaceuticals, biotech and that ilk, they seem like they may again be ready to gain some lost ground.  ANY DAY NOW, right?  And if you want momentum, you've got to like oil still (we're running out, right?) and those hot water & alternative energy slivers put out by Powershares.  China's been on a run, as well (though they've got frightening market structure issues).  Of course the contrarian disagrees with the momentum player and says if you're not already in EM, EAFE, gold or other commodities, the odds are good that you've missed those trains.
  3. Do I own enough "asset classes"?  The index industry itself has helped us again become believers in ourselves, following some of our woeful experiences in the great tech bust of 2000. Slyly moving into the realm of active (and higher margin) management with "enhanced indexing" "fundamental indexing" "intelligent indexing" etc., index providers have provided increasingly, almost farcically thinly sliced indexes that are all about bang for your buck.  The question is, "Should I be in the Red Fizzy Beverages sector ETF?  I do think that Redpop and Cherry Cream Soda are poised for a rebirth.  The reality is that outside of these sectors, many index investors have looked for portfolio ballast in recent years in alternative new "asset classes" such as commodities, real estate, and (please god, no) hedge funds.  Strangely, the dubbing of a new "asset class" also tends to correspond with the coronation of the investment area that most looks like rocket fuel on fire.
  4. Should I just disregard market cap altogether?  There's been a determined drive in the index industry to pursue "state of the art".  The wholesale move to free float weighting kicked this off.  However, remember that what free float weighting attempted to do was more accurately reflect capitalization weighting, that is, to include in capitalization, the actual market cap that is market available.  The new methodologies are attempting to improve on market cap weighting…and well, to beat it.  That's fine, as long as you're aware of where your money is and understand that there's no free money.  Indeed, there are many fairly religious index investors who have long tilted against straight cap weighting, and overweighted, for example, small cap and value.  This makes perfect sense, as there are times when it makes sense to have more equity risk and potential gain in a portfolio.  Again, get your plan and then stick to it.  That's the key.  Otherwise the odds are you'll end up buying high and selling low, which is not what you want to do.
  5. Which specific index should I buy for my asset?  The truth is that most investors are really running blind on this one.  For perspective's sake, you should know that the overwhelmingly most important issue is the asset allocation.  The choice of index is really just working on the margin in comparison.  That said, there are huge differences among indexes, particularly in the size and style areas.  Know what you're buying.  Do you want to be smaller or larger, more purely or moderately growth or value?  It also makes sense to consider that being within one methodology (index family) might be ideal to minimize overlap, but it's not absolutely necessary.  Again, study what is in each index, and decide from there.
  6. Which specific index fund or ETF should I buy to cover my index?  To be honest, in the index realm, the answer to this question is even more at the margin than your choice of index.  Generally speaking, 150 basis point Attica index funds excepted, there's little difference among the index funds.  Vanguard, iShares, SSgA and Fidelity are all in the same ballpark in terms of broad index offerings, and DFA is certainly not a bad choice if you have access to their funds.  The things I look at in choosing an index fund or ETF are expenses, tracking error/management and tax efficiency, roughly in that order.  This, as I said is after I've selected my underlying target index.  
  7. Do I really want to stick with my plan?  Um, yes.  You'd be amazed at some of the emails we receive questioning asset allocation decisions made years ago and wondering whether a portfolio might be missing the boat in this investment area or that.  Make no mistakes about it.  This is where many investors get crushed…running with the crowd.  If you've made your target investment, and gotten where you need to be, why on earth would you think of messing around with your carefully laid plans?  On the flip side, if you're a bit short late, desperation, like greed, generally does not work for you. Plowing all of your life savings into tech 5 years from retirement so that they could buy the 60-foot boat did not pan out well for many investors.  It's amazing how short memories become, though, when piles of money are being formed all around.
  8. How do I actually figure out my asset allocation?  This seems like a pretty basic question to be all the way down at number 8, but we do hear it a lot.  We need to put up a nice tool on our site (there are some of them out there).  This, like how much money you need to be saving, is one of the most basic questions.  The very rough guideline that many people use for a rule of thumb is that you should have roughly your age in cash and fixed-income, and the rest in equities.  So if I'm 35, I ought to have 65% in equities and the rest in cash or fixed income, depending on my risk tolerance.  In reality, many investors, myself included, are slightly more equity-heavy than that. On the backside, if you're retired and have all the cash you need, it may not make sense to own equities, even if you're only 70.  It depends on your targets, returns assumptions, and what you're comfortable with.  But the age guideline is a good one.
  9. When is that China alternative water microtech ETF coming out?  (Insert your fund of choice here)  Because we report on new product developments, we do receive a lot of this type of question relating to specific products.  And if it's an ETF, an index or an index fund, we're pretty tapped in to what's going on.  So lets briefly summarize a few of the most popular fund questions.  Wisdom Tree ETFs are coming out SOON.  They'll have a whole lineup covering some interesting asset classes with a unique methodology.  ProFunds also (really) we understand are almost here with leveraged ETFs.  iShares GSCI fund - we don't know where this is one is, but it must be on the horizon.  Expect more microsectors from iShares & maybe more fixed income, international and possibly even activish methodology-driven funds from 45 Fremont.  SSgA is working fiercely to build out a complete lineup of international and fixed-income ETFs, in addition to doing more in the sector space, and with the SPDRs family.  Look for Vanguard to similarly respond to intermediary demand with more in the sector realm.  No word on fixed income or more international.  Rydex is coming out with a full lineup of currency ETFs, and Deutsche Bank will very actively be in that space as well.  No word on how near Macro Securities is to either the Oil ETF launch or to figuring out the puzzle for the Macro real estate ETFs. But they're in an extremely interesting space. Van Eck got their first ETF off the ground, a gold equities ETF, that fills a nice nitch.  Look for more from them.  First Trust is another comer in the ETF space with more products brewing.  There are a LOT of smaller players out there working on all sorts of things, and with the above mentioned group, I think you can continue to see more innovation in the area of ETFs built around underlying derivatives.
  10. How do I save myself from myself? a) get a plan that calculates how much you need to be saving to reach your goals. b) figure out your asset allocation c) choose funds that are as broadly diversified and low cost as possible within your asset allocation d) stick to your plan e) if you MUST speculate, restrict yourself to some tiny percentage of your overall portfolio, say 5% or less.    So that really is it.  Attn: index industry - lets start refocusing on the basics.  And attention index investor: keep your eye on the ball, and don't get distracted by all of those shiny things the index industry has been throwing at you lately.  Make them work for you, not work you.  It's a shame that the index industry is coming out with more volatile and expensive products (neither of these traits will generally serve most investors well), as the actively managed fund industry seems to be heading the other way. 

Well, there you have it.  If you've made your way here, you're sure to find yourself fabulously wealthy in no time at all[2].  Gold chains, big boats, a palace in the Hamptons…you know, mo' money.  It's what indexing is all about.

 


 

[1] This is a JOKE.  Do NOT sue us with sad tales of us costing you the family fortune.  This is tongue in cheek.  Get it? Go to Morningstar to get filthy stinking rich using ETFs (see Matt Hougan's article here  http://www.indexuniverse.com/sections/features/12/669.html

[2] See footnote 1 above.

 

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