Ferri: Mistakes Teach Value Of Indexing

The school of hard knocks can teach anyone about the superiority of indexing.

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Reviewed by: Richard Ferri
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Edited by: Richard Ferri

I’d have a lot more money today if all I had ever done was buy index funds and hold onto them. Instead, early in my investing years, I bought “gems” like penny stocks before they went bankrupt, options on banks falsely rumored to be ripe for buy-outs, a vacation timeshare because I thought it had appreciation value, and Salvador Dali prints from a dealer who went to prison for selling fakes. If I had known Bernie Madoff, I probably would have begged him to take my money.

 

I find I’m not alone in having made dumb investment mistakes. The School of Hard Knocks has been well-attended. It seems everyone has a story, and many people lost a lot more than the superficial shellacking I took. I feel particular empathy for people who lost their entire savings to scammers and frauds. Their lives and dreams are shattered. It’s not only the Bernie Madoffs doing this, it happens in large, publicly traded companies with familiar household names like Enron.

 

Who is to blame for the carnage?

 

My mission early in life was to find the secret to making a lot of money and do it fast. I was smart, I was determined, and I was shark bait. Overconfident in my knowledge and ability, I was often on the wrong side of the trade. Even when I was right, emotions like fear and greed caused me to change my mind. They saw me coming a mile away.

 

We are our own worst enemies when it comes to investing, even though sane and sensible advice has always been available. People like Vanguard Group founder, John Bogle, and institutional consultant and author of Winning the Loser’s Game, Charles Ellis, have been telling us for decades not to concentrate our savings in speculative ideas. They preached diversification and low cost. I heard these words; I didn’t listen. I was the loser in Ellis’ loser’s game.

 

Luckily for me, one day in 1996, I picked up a copy of Bogle’s first book, Bogle on Mutual Funds. I had no particular reason for selecting this book, except that I had read every beat-the-market investment book in the store.

 

'Win By Not Losing'

Bogle’s message was different. He said most people did not earn the return of the market, and that getting my fair share of the market’s return using index funds was superior to trying to beat it. Win by not losing, to paraphrase Ellis. This simple piece of advice created an “Aha!” moment in my life and it changed my career.

 

Trying to get people to see the benefit of index funds wasn’t easy in 1996. It was a wildly booming market with an expanding tech stock bubble. People were quitting their jobs to day-trade stocks over the Internet. My barber told me he made more money trading AOL stock between haircuts than he ever made cutting hair. He viewed index funds as a crutch for people who didn’t know how to invest.

 

Unfortunately, like most stock traders who jumped on the Internet lottery, my barber’s luck didn’t last. He lost almost everything when the bubble burst. I tried again to convert him to index funds with the little retirement money he had left. He listened patiently, and then asked me what I knew about covered-call stock options.

 

The landscape is different today. There’s a much greater acceptance of index investing. According to the Investment Company Institute’s 2015 Investment Company Factbook, domestic equity index funds and exchange-traded funds (ETFs) received $1 trillion in net new cash and reinvested dividends from 2007 through 2014, while actively managed domestic equity funds experienced net outflows of $659 billion during the same time frame.

 

I like to think I played a part in the growing acceptance of low-cost indexing. I’ve written profusely on the topic for almost 20 years including several books and hundreds of articles. My firm, Portfolio Solutions®, was one of the first companies to offer a low advisor fee service to construct portfolios using index funds, ETFs, and Dimensional Fund Advisor funds. We now have $1.4 billion* under management for hundreds of clients nationwide.

 

Investor awareness about index investing recently received a boost from do-it-yourself automatic investment programs. So-called robo-advisor firms such as Betterment and Wealthfront have adopted the low-advisor-fee model and are casting a bigger net using technology to market their services.

 

Educating the masses isn’t cheap or easy, and I commend the robos’ efforts to put young people on the right track early in their lives. The cost savings should be a huge benefit to future generations and to society.

 

In the spirit of education (and business development), my firm intends to launch a robo-advisor platform in the coming months. This service will be automated, with low management fees, small account minimums, and proprietary portfolios composed of select passively managed mutual funds and ETFs based on our many years of research and experience in the industry.

 

Today’s young investors have a much greater chance to learn about index funds earlier in life. I hope this prevents many from making the dumb (and costly) mistakes I made when I was their age. With today’s online tools and greater information dissemination, young investors should be better positioned to benefit from the knowledge and a higher level of personalized service as their wealth builds. This should speed their journey even further. It’s a win-win for everyone.

 

*As of 02/27/2015


For a full list of relevant disclosures, click here. Rick Ferri, founder of Michigan-based Portfolio Solutions, is a widely recognized index investor and the author of several books on index investing.

 

 

Richard Ferri, CFA, is founder and managing partner of Portfolio Solutions. He directs the firm's research and education, and is head of the Investment Committee. Ferri writes regularly for the Wall Street Journal, Forbes, the Journal of Financial Planning and his own blog at www.RickFerri.com.

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