On Monday, the UK implemented new rules banning embedded commissions on investment products. We’re still many years away from that in Canada, but it’s not for lack of effort on the part of John De Goey. For a decade now, the associate portfolio manager at Burgeonvest Bick Securities in Toronto has been a thorn in the side of the industry. Like almost all his contemporaries, De Goey started out selling mutual funds with deferred sales charges, but later become one of the early adopters of the fee-based, no-commission business model.
I chatted with John about his recently published book, The Professional Advisor III: Putting Transparency and Integrity First, a passionate plea for changes to the advice industry. Here’s an excerpt from our interview.
The first two editions of your book were published back in 2003 and 2006. A lot has changed in the investment industry since then.
JDG: When I wrote the first two editions, I knew more people in the advisor media—Advisor’s Edge, Advisor’s Edge Report, Investment Executive—and they were the ones writing about the book. So all I managed to do was piss off other advisors, and consumers didn’t hear the message. Now I am getting more interest from the Globe, the Financial Post, and people like you and Preet Banerjee, who are reaching ordinary investors. And the good news is, today they get it.
When I started in the business in 1993 the media were talking about the importance of cost, but in those days it was more like, “You can save money by investing with a company like Mawer or Beutel Goodman.” It was about low-cost actively managed funds that didn’t pay trailing commissions. When ETFs came along a little over a decade ago, they changed the game: advisors like me loved them because they allowed me to build portfolios using building blocks that were cheap, pure, broadly diversified and tax-effective. But when I first started talking about unbundling products and charging an asset-based fee in 2003, it was heretical. Today it’s mainstream.
I enjoyed the section where you talk about the deficiencies in the way advisors are educated. When I took the Canadian Securities Course, I too was amazed to find indexing gets only a few paragraphs. Is it any wonder so few advisors advocate passive strategies? Do they even know about the evidence?
JDG: The reason there’s so little discussion about passive strategies is that the industry has grown up with a culture of sales. The presumption, which is pretty much unsubstantiated, is that you can beat the market and therefore you should try to beat the market by using active products and strategies. As soon as you start from that premise, you’re going presumptively down one path, which is what I say about the Canadian Securities Institute textbooks. They teach people that active management is sensible management. But that’s putting the cart before the horse. You should stop and ask what the options are and what works—not only on an absolute basis, but on a balance of probabilities. Because neither option is unequivocally, 100% better all the time.
A lot of firms and advisors are advocating core and explore—even ETF providers themselves. Do you think adding an actively managed satellite component can ever add value?
JDG: I’m personally doubtful. Can it ever add value? I suppose there may be one or two instances. Can you ever win the lottery? Yes you can, but does that mean I’m going to run out and buy a ticket today? Just because it’s possible doesn’t mean it’s probable. And the next logical step is to conclude that because it’s not probable, it’s not advisable. For some people it might work, but I still believe whenever one pursues an active strategy, whether it is for 100% of their money or for a 10%, 20% or 30% satellite portion of their portfolio, the most likely reason for any outperformance is likely to be luck rather than skill.
You mention in the book that one of the reasons you gave up your column on Advisor.ca was you couldn’t get your compliance department to let you compare active management to gambling. What happened there?
JDG: Daniel Kahneman in his book Thinking Fast and Slow uses that exact same metaphor. Well, if it’s an unfair comparison, it ought to be unfair no matter who is making it. Yet a Nobel laureate can make it, because he doesn’t have a license, but an ordinary guy like me can’t make the comparison because I have a license and I’m regulated. It isn’t just my firm. At any firm they’re scared of regulators saying it’s detrimental to the public interest, and it’s portraying the industry in a negative light. I don’t think that’s the case: I think it is a full-truth, plain disclosure of material considerations.
The example I use is the packaging on cigarettes. That is now prescribed by law because the evidence is very clear there’s a linkage between cigarette smoke and cancer. Just because there might be exceptions—people who smoke all their lives and don’t get cancer, and people who never smoked and do get cancer—that doesn’t prove the linkage does not exist. It’s just a balance of probabilities. I’m not going to say you can’t frequent the casino or buy a lottery ticket. I’m just saying you need to understand the odds are against you. The same logic holds when pursuing active strategies: you might do better, but the odds are you will do worse.
Thanks for the interesting read, Dan and Mr. De Goey, particularly the section regarding Advisor.ca. It’s always fascinating to learn about the Sith-like culture at these organizations.
Great interview. I just reserved his book at the Toronto Public Library (hey it would cost me 1-1/2 $9.95 trades to buy it, lol). But, these comments in your interview just floor me:
‘you couldn’t get your compliance department to let you compare active management to gambling. What happened there?’
‘JDG: …a Nobel laureate can make it, because he doesn’t have a license, but an ordinary guy like me can’t make the comparison because I have a license and I’m regulated.’
I suggest JDG might have an over-zealous compliance department rather than his license and he being regulated prevent him from free speech, especially since there are a plethora of public sources that make the extremely valid and verifiable comparison.
@Noel: Actually John’s concerns about compliance are totally legit, and I doubt his firm is any more zealous than the norm. Any advisor licensed by the Investment Industry Regulatory Organization of Canada (IIROC) has to have blog posts, articles and client communications vetted by a compliance department. There are rules they must follow, and if they are broken, the firms and the advisors can face fines.
For those of us who are members of the media, or just the general public, IIROC has no jurisdiction, so we can say more or less whatever we want about the industry.
I do realize that they need to have what they write vetted. I am just surprised there is an actual rule that the compliance department can point to which prevents a member from comparing investing to gambling other than maybe some sort of general ‘one has to promote the interests of the industry’-type clause.
Ironic that the way around it is for him to point the reader to a source that says what he really wants to say, ie the book ‘Thinking Fast and Slow’.
Legal departments are paid to be risk averse. What benefit to the company is there in taking the risk? None? Then permission denied.
I always enjoy seeing JDG on Market Call on BNN. His presence is always a breath of fresh air in the midst of the stock picks and the technical alchemy… I mean analysis. Even an outlet like BNN that needs to feed the maw of the beast must be feeling some pressure to expose retail consumers to passive strategies.
I can just never figure out why I would pay him (or any other person) a fee to work with him to do something as simple as couch potato investing. It sort of confirms what I was told in doing my financial planning. All these guys are incredibly interesting and great to talk with. It just bears further consideration whether you should actually do business with them.
However, I greatly greatly appreciate the platform he has chosen to use promoting passive investing strategies.
@JAH: This is a common question, and I’ve addressed it before on the blog:
https://canadiancouchpotato.com/2011/05/09/do-indexers-need-an-advisor/
https://canadiancouchpotato.com/2011/09/30/when-should-you-use-an-advisor/
Many experienced DIY investors forget that most people find investing both intimidating and boring, and the last thing they want to do is manage their own portfolios. Most would have no idea where to begin, and they are more than happy to pay someone else to do it for them. Anyone inclined to read a blog like mine is already different from 9o% of the population, which thinks ETF stands for Emergency Task Force.
Another important point is that many of us suffer from overconfidence and are probably making mistakes without even knowing it. (“You don’t know what you don’t know.”) There are many examples of authors like William Bernstein who started out advocating for people to manage their own money, only to eventually realize that most people are simply not capable of doing so.
An article that I wrote for Investment Executive almost two years ago (linked here) addresses some of the points raised here – including the compliance issue.
Hi, I am a University Student looking to start a Couch Potato Portfolio to pay back OSAP in 4 years. I have had a TD Balanced Comfort Portfolio for about 6 months now and want to create my own portfolio with TD e-Series Funds. What Model do you recommend I use for low-moderate risk and investing $3000 to start with and small monthly contributions?
@Taran: I hope I’m not the only one who would discourage you from taking this particular path. You state a definite goal of paying off your OSAP (Ontario student loans for those outside of Ontario) debt in four years. A Couch Potato Portfolio should do well for you for beginning a *long term* investment strategy, but with your indicated time horizon, it is inappropriate. If you can squirrel away some extra cash in a “high-yield” savings account inside a TFSA, you are probably doing the best you can at this stage. For what it’s worth….
@Taran – If you don’t have a time horizon of at least 10-15 years you shouldn’t be investing in the stock market at all. Just in the last 12 years alone, the S&P/TSX Composite Total Return Index Value (‘TRIV’) alone has shown the same value in 2000, 2005 & 2009. It dropped over 40% in 2 years from the peak in 2000 and took 5 years to recover back to the previous value. Another drop of over 40% happened in 9 months from the peak in mid-2008 and took over 2 years to recover. What are you going to do if this kind of performance occurs in the next 4 years? With your time horizon I’d only go with a high-yield savings account or GIC in a TSFA and if that is maxed out then in a taxable account. Note: These are the TRIV values, not the Price values you see quoted in the press often.
Dan and John,
Great interview and thoughts.
I am on the same page, however, as I have discussed with both of you in the past, we don’t make it easy for someone to break into the industry as a fee-only planner (which I have been trying to do for the past year or so). As far as I know, there is no training program or MFDA equivalent for someone who wants to become a fee only planner or recommend index ETFs. On the flip side, there are lots of opportunities for salespeople, it is very easy to break into that side of the industry (I have had no less than five job offers) and the money is better.
To be able to recommend simple index ETFs, I would need an Investment Dealer’s licence, which not only costs $30 000 or $40 000 per year, but is only given to CFAs (and perhaps CIMs or others who have been in the industry a long time). To sell mutual funds- only a weekend course is required! Something is not right there.
Steve
@Noel & @Russ thanks for the info guys. Yea so I’m gonna stay away from the stock market but should I leave the money in the TD Comfort Balanced Portfolio or put that into my TFSA as well. It is 70% bonds and 30% equity. This is inside a TFSA.
@Taran: I would echo Russ and Noel’s advice, but I would be more blunt and say it makes no sense to invest at all when you have student loans. Why not just take whatever money you have saved and use it to pay down the debt, and then apply all of your planned monthly contributions to the debt as well? Or are you restricted from paying the loan ahead of schedule?
If you can’t start paying off the loan until four years from now, it still doesn’t make sense to invest. A portfolio of 70% bonds and 30% equity is pretty low risk, but it can still lose money over a period of a few years. Why not just use a savings account with a guaranteed 1.25% and eliminate that risk altogether?
@Dan H: Thanks for the link, which makes some important points. Most important, you correctly point out that is quite possible for advisors to deliver active management at a lower cost than passive management: the details matter a lot. Given the choice between prudent active management for 1.25% (individual securities + 1.25% advice fee) and passive management for 1.75% (0.50% for products + 1.25% advice fee) which is preferable? Once you eliminate the cost advantage, the passive argument falls apart pretty fast.
@Steve: MFDA-licensed advisors have a few options, one of which is to recommend index mutual funds or to get on board with a firm like Dimensional Fund Advisors. But they could not do this is they worked for a bank: their firm would have to support the idea, and few do.
@CCPDan: As long as Taran is recognized as a student, his OSAP loan does not accrue interest. I am aware of students who have managed to qualify for a loan, have not needed it, and have simply put the money in a savings account. Four years later, they pay back the loan and keep the interest earned.
@Taran: Is your TFSA with TD Mutual Funds or TD Waterhouse? How long have you been in the Comfort Portfolio? Are there any penalties for an early withdrawal? My initial thought is that if your account is at TD Waterhouse, you might be able to switch the position into the TD Investment Savings Account, fund code: TDB8150. I’m not sure if that is available in a “TD Mutual Funds” account, however.
Thanks, Russ, good advice.
@Russ yes the money is interest free till I am studying and I have about 4 years of study left. I had a bit of extra money from part-time job. The Mutual Fund is in a TFSA through TD Investment Services
@Taran I think you may have the “Balanced Income” Portfolio, which according to TD, is made up of 65% Canadian bonds with the remainder split evenly between Canadian and World equities. In any case, per the website, the Portfolios have a 2% redemption charge within 30 days. Since you started 6 months ago, you are fine in that regard, although they might charge you 2% on your most recent contribution if it is within the last 30 days. I don’t think you can get TDB8150, as I discussed above, in a TD Investment Services (TDIS) account. Your only choice within TDIS would be money market funds, which are yielding close to nothing. I would suggest you open a TD Waterhouse (TDW) TFSA account and transfer directly from TDIS to TDW. There shouldn’t be any fees to transfer within TD. TDW will have a transfer form for you to fill out along with your account app. In fact, you can go into the same branch where you likely opened the TDIS account and do all the paperwork there, too. Then, once the transfer is complete, you can switch out of your current Comfort Portfolio into the Investment Savings Account (TDB8150). By the way, TD Waterhouse Discount Brokerage is undergoing a name change to TD Direct Investing. Don’t be confused if you see the different name.
All the best in your studies, Taran. The youngest of my four children is now in 2nd year and enjoying university life a great deal (for the record the eldest is in law school, the 2nd child has graduated and is working, and the third in the final semester of her undergrad). Proud father!
@Steve: Thanks for the info. This explains why it is so difficult to find a fee-only (hourly rate) financial adviser/planner in Canada who can give recommendations to his clients abouts ETFs and passive index funds. While I was doing in research in my area, most fee only financial planners told me they didn’t have the license to give any specific investment advices but only general financial planning.
I think the best option for most ordinary people (those who will probably never read this blog) would be to find a Fee only financial planner for general planning and buy a low cost actively managed balanced mutual fund (ex Mawer’s) or a low cost balanced index fund (ex ING streetwise). Unfortunately, even this solution will still be too complicated for many of them who are used to a complete “hands off” experience with regular commission-based mutual fund seller/advisor.
@Steve – It’s possible to do what you want without such a big ‘nut’ by simply going to a firm that has a fee-based platform. Many dealers – which will license you as a salesperson – can facilitate fee based structure. But it’s finding the right dealer for you. Alternately, you can find boutique investment counseling firms that might also fit with what you want.
But you will need the requisite experience and credentials – no getting around that. And you need to connect with a firm to get the experience. But it’s tough because these firms are in the minority but it’s a growing minority.
@Jas – There is nothing stopping anyone from getting licensed to give investment advice and charging for this advice on an hourly or flat $ fee basis. I did it for 6.5 years through my own firm. But when new regulations came into place in 2009 and a constant ramping up of the enforcement/audit of firms – not the least of which is the evolving and ever vigilant FINTRAC – the costs of having your own firm (as I did) and truly being compliant (as I was) have snowballed.
I could have maintained my old model but the #s would have changed significantly. I was looking at a few options – i.e. hike my hourly rate, implement a more traditional % of fee model (which is what the whole industry uses) or require all clients to pay a minimum monthly retainer with excess time charged hourly. The sticker shock risk was too big for the hourly or retainer options so I decided that I was going to have to switch to % of assets if I was to continue. And that’s what we do today.
The more I did hourly consulting the more I realized that there were significant behavioural issues when it came to implementation. Plenty of clients were diligent about executing my advice. For instance, I had a few clients come back to me 6-12 months later asking if I’d change anything in my prior advice. And they asked because they’d done nothing with my advice. Others got talked into substitutes by brokers that I would never has suggested. Having discretion or at least being able to administer the assets is critical to proper and prompt execution.
@Dan – Did you mean to say ‘ Plenty of clients were diligent about executing my advice.’ or ” Plenty of clients were NOT diligent about executing my advice.’ because then you say ‘For instance’ and give examples of those who didn’t. Sorry, just trying to understand what you said.
Correct – plenty were NOT diligent about implementation. Sorry about the confusion – a hazard of my often lengthy posts.
@Dan Hallett: It’s amazing hearing of your professional experience how poorly compliant people are even after consulting for professional advice. I’ve just retired as a doctor, and I belonged to the old school, spend a lot of time getting to know patients and their habits, and giving them sound advice. The advice was largely common sense, something anyone could figure out on their own (apart from needing to ascertain there was nothing significantly physically wrong after a thorough investigation) and the implementation was straightforward: don’t smoke, get regular exercise, eat properly (nothing fancy!) and don’t be overweight. But compliance was very poor. I used to think it was because my advice was low-tech and not flashy latest fad stuff and largely not pharmaceutically related. Or because with the public health system they didn’t have to pay for the advice. But your experience confirms that even after paying for the advice they won’t take it. Maybe because the financial advice isn’t high tech and flashy? (Passive Index advice doesn’t sound very spectacular, I guess; after all we’re stating up front we don’t think we know much, and especially we can’t make accurate predictions about future financial events).
@Dan Hallet: I guess in a nutshell the Passive Index Investment principle doesn’t sound very sophisticated, although it is based upon very sophisticated research and analysis. This nutshell should become our mantra to explain to non-believers. But that’s the problem; fundamentally it comes down to belief (which depends largely upon the ability to abstract an underlying principle from the recurrent mathematical pattern derived from a large set of consistent data) or non-belief.
How frustrating it must be for a financial advisor to advise people to move from an active to a passive approach to find that clients don’t take the advice when the evidence overwhelmingly shows that the latter approach has an extremely high probability of outperforming the former over a time horizon of 10-15 years or more. Then, couple this with the fact that recommending a passive approach does not command anywhere near the fees that an active approach does, and sometimes not even ongoing fees at that. And, certainly it does not include any performance bonus as some actively managed funds do. So, work harder to make less?
Of course it goes without saying that active management has a ‘marketing department’ thousands of times larger than passive management does. In addition, some of the ‘financial speak’ contained in the marketing material of active managers sounds so sophisticated and involved that most people don’t understand it. They therefore conclude that the active managers must be really smart and must be great investors (especially with all those degree acronyms after their names). Lastly, the lack of proper reporting of investment returns, never mind against proper benchmarks (not in all cases but in enough to be concerned) the client is kept in the dark for quite some time on how they are really doing.
@Noel: You nailed it — gobbledegook you can’t understand sounds so impressive!! This was a recurrent theme in my medical practice — “Oh, I’m eating sea-salt now, because it’s harmless, not like regular salt, and this herbal doctor also told me to take extract of bee-pollen (for $$$!) because it boosts my xyz immune system modulators and modulates my energy channels”. Sounds suspiciously like “Political events in the Far East are creating a ripple effect that is impeding the formation of the recovery wave-front that is inevitable in the beta-index expansion predicted by the Matheson recovery model, resulting in a headwind in the cross-trend of the Renewable and Conventional Energy sector Mobilization. Therefore we are preferentially weighting our Commodities futures, but going short on Cash, but remain prepared to return to our underlying strategy of monitoring for events to justify reassessing our position.”
@ Oldie – Funny, a friend of mine is a doctor and is now in the process of converting his entire portfolio from active to passive. He said that when the financial professionals give presentations to him and his colleagues they often end with ‘We don’t practice medicine. We’re investment advisors. Your expertise isn’t ours and our expertise isn’t yours. So, each of us should do what we are qualified to do.’ In other words, we can invest your money better than you can. But, I think this is one area in which a non-professional can do as well as most professionals if one is willing to do a bit of work in the beginning and because a passive investment strategy is really quite simple and has proven long-term outperformance against active funds. Correspondingly, people can improve or help to ensure long term health by exercising the common sense lifestyle choices that you mention. There’s nothing fancy about either!
I’ll end with this, which was sent to me by a lawyer friend of mine who is being pitched by a wealth manager right now. This is one of the opening lines in the brochure:
‘Darwin asserted that it is not the strongest of the species that survives, nor the most
intelligent, but the ones most adaptable to change. Darwin Investment Strategies leverage a proprietary systematic formula based on Nobel Prize winning concepts to deliver strong, stable performance that is resilient to hostile markets.’
I’d be impressed if I knew it wasn’t true. Remember Long-Term Capital Management in the 1990’s? I think they had 40+ PhD’s executing proprietary formulas and delivered outstanding returns of 40% per annum. Their list of partners read like a Who’s Who of Wall Street and government finance. Hell, they even had the guy who co-authored the Black–Scholes model as a partner. Well, they did well until they didn’t and had to be bailed out to avert a collapse of some of the financial markets (a book was even written about it: When Genius Failed: The Rise and Fall of Long-Term Capital)
@Noel: Hey,
“Darwin Investment Strategies leverage a proprietary systematic formula based on Nobel Prize winning concepts to deliver strong, stable performance that is resilient to hostile markets.'”
Apart from the Darwin name, and the “proprietary” attribute (oh, to be able to skim off all the money saved by people using the Couch Potato Model), does this not accurately describe the Canadian Couch Potato method???
Regarding your Doctor friend, I don’t know who his Financial Professionals were, but the Canadian Medical Association has a couple of financial management subsidiaries, MD Management and MD Physicians Services, who hire financial advisors whose service is offered free to members. I have been impressed with the advice which is generally sound and prudent, except in the choice of investment vehicles. The MD Management in house Mutual Funds are of course actively managed. To be fair, the fee is very modest by Mutual Fund standards, and by my conservative allocation I thought I have been doing well over the past 38 years. I know now I could have done better with Passive Investing, but that’s water under the bridge. Passive Investing was never even offered. When I first broached the subject several months ago I felt like I was leaning up against an attitude of disapproval. However, what ever I asked got done, as long as they made sure I knew what I was doing. I am gradually transferring my funds to self managed accounts invested passively, and the professional assigned to this section of accounts, to his credit, has done the research whenever he encountered anything he was not familiar with in my approach. Even now, I am still not sure whether from their training they actually believe Active Management performs better, or whether they actually know Passive Management results in higher net returns, but it’s too hard to get these stupid doctors to stay the course on what can seem sometimes like a simplistic and foolhardy strategy, when all the experts are shouting “sell this” or “buy that”, so for ease of administration they recommend the Mutual Fund approach. I don’t even know which possibility I hope is the case — they both raise uncomfortable issues in my mind; it’s a real puzzle, but I’m not going there.
@Dan Hallet: When I was doling out my sad tale of woe to Noel, I suddenly had an inspiration, which would address the issue of proper compensation to well informed professionals laying out the benefits of Passive investing (in comparison with the obscene benefits received by advisors recommending actively managed mutual funds).
You have to believe that the client is prepared to pay a dollar per hour fee up front for the initial financial reviews and consultations, which can be priced modestly, and personally I would have no ethical problem with an advertised low hourly rate with the expectation that if they commit to portfolio change they will willingly pay you the same large amounts that their current managers are extracting. But for the clients with a large portfolio, beyond the initial interview and consultation, you undertake to do nothing further, unless they want you to implement a plan. Then the fee will be the equivalent to the net savings in management fees for, say, the next 4 months.
If you fail to convince the client, you are compensated for your labour and your expertise. If you are convincing, the client is inspired to change, but most clients will need some initial hand-holding, but the underlying assumption is that you will set them up and walk them through the initial nuts and bolts. So they hire you to set it up, and it costs them no further money, except 4 more months (or whatever) of the same fees they are paying anyway. Mind you, you must make it clear they will be saving the fee for themselves after that so that will be the Holy Grail to them. Whether the market suddenly improves or tanks during that time will be agreed by both to be irrelevant to the agreement, and if you have done your job, your client will be excited and by the prospect of huge benefits the further down the road he looks.
That’s just an idea off the top of my head. The professional Association of Mutual Fund Advisors will probably have negative views on it though. You know, though, if this had been presented to me 6 months ago, before I had done my own research and self education ( to do it myself), I might have accepted that offer. The price would have been right.
“Many experienced DIY investors forget that most people find investing both intimidating and boring, and the last thing they want to do is manage their own portfolios.”
Dan is quite right. In my circle trying to direct my colleagues to Dan’s useful site has been a failure largely due to Dan’s words above: disinterest and the belief that paying higher fees gets better results!!
@Oldie: Regarding your comment that ‘Apart from the Darwin name, and the “proprietary” attribute does this not accurately describe the Canadian Couch Potato method?’ the CCP method is not the concept of Nobel Prize winners, nor is it resilient to hostile markets. The S&P/TSX Composite Total Return Index dropped over 48% from a peak on June 17, 2008 to the low on March 9, 2009 and the S&P 500 Composite Total Return Index dropped 52% from a peak on May 19, 2008 to a low on March 9, 2009. Given such declines, if anyone has any meaningful holdings in equity markets in a passive portfolio their performance will be greatly affected over the short term. However, if one has a diversified passive portfolio, invests on a regular basis and rebalances as necessary one can certainly ‘weather the storm’ from these hostile markets over the long-term. What Darwin is trying to do is lessen volatility while producing strong returns, ie the holy grail of active management. Wishful thinking.
@Noel: Perhaps I suffer from an incomplete understanding of the CCP history and concept. But for what it is worth, this is my precis of the concept: Many highly regarded scholars in economics, including several eventual Nobel Prize winners, have, through the development over the years of economic and investment parameters, with the initial intent of identifying true indicators of superior profit resulting from shrewd judgement as opposed to sheer luck, in order to identify the mutual fund managers who were actually beating the market by good judgement rather than by inordinate risk-taking or luck, were surprised to find, after all their effort, that despite all the precise tools they had developed, they still failed to find a manager or a purported method that consistently or predictably beat the market for more than a continuous period of twenty years or so. In fact, the overwhelming majority failed to beat the market during measuring periods of far shorter duration than that.
In other words, they had failed to find a consistent alpha, to use the jargon of the economics-babblers. This was what I meant in my reference to Nobel Prize winners.
In the face of this negative finding, it followed that no active investment method or active advisor could be trusted to manage investments in a manner that would not lose to the market, or to put it another way, the investment that most closely matched the market was the most prudent long term investment one could make. There was no other choice. This was the thesis underlying the initial Couch Potato Portfolio proposal written by Scott Burns in an article in the Dallas Morning News in the early 1990’s, although he was not the first person to espouse this investing principle, i.e that passive investing in the index (which by that time was possible by virtue of index funds which had become available by then) was the only rational choice. The Canadian Couch Potato is modelled after this example.
I did not mean to imply that the Couch Potato Method is impervious to market losses. Understanding (or perhaps hoping) that this blog and the ensuing back and forth discussion was being read by those already converted to the faith, I was hoping to point out that the losses taken by a well designed Couch Potato Portfolio would be no less, but also no more than the equivalent mix of net losses/gains in the corresponding bond and equities markets. And further, that any hopeful-sounding tactical attempt by formula or seat-of-the-pants feel to pull out of equities in time to avoid loss has been shown by exhaustive statistical analysis to either fail in the attempt to consistently avoid losses proportional to market losses or to cause one to fail to consistently regain profit because of not being invested when the market surged again. Thus, the Couch Potato Strategy is to ignore the Economics-babble, don’t read stock market news or economic forecasts, and resolutely stick to the Bond:Equities investment ratio and diversified Asset Class mix that you have previously determined matches your risk/reward tolerance, and that is your greatest defence against loss, and your strongest offence to maximize profit. If you can correct me where I have strayed from the concept of Couch Potato Investing, the correction would be welcomed.
I did not intend to imply that the Couch Potato method offered a better ACTIVELY managed protection against loss or with a stronger expectation of profit. If I appeared to do so, it was a poor choice of words disguised as irony. I believe with passive investing you take your lumps just like the market does (although you mitigate the net effect by asset class diversification), then you rebound like the market does. And that’s the best you can do, and it’s not bad.
@Noel: Oh, perhaps my casual use of the “Holy Grail” phrase was confusing. I realize it is usually used in the context of the arcane secret known only to a precious select few that enables the keepers of the secret to cut through the mystery of the partially opaque market to capitalize on a sure-fire way of tactical buying and selling (i.e. Turbo-Active management) that will lead to a consistent profit denied to those not privy to the secret.
But my belief system, as a true Couch Potato believer is that this “Holy Grail” , i.e. “SECRET METHOD” actually does not exist. I was using this insight that the “SECRET” does not exist as my own very earth-shattering revelation, and calling this insight, perhaps with some irony, the real “Holy Grail”. Whatever we can agree to call it, I believe that this other “secret” (that there is no “secret”!!) is fundamental to our belief as committed Couch Potatoes.
It’s such a difficult concept to get over to non-believers as I’m finding out recently through discussion with friends, which is why I’m so interested in developing a method and vocabulary to explain the concept succinctly, and would welcome your feedback.
@Oldie – thanks for sharing so many of your thoughts, including your experience as a medical practitioner. To be clear, I’m not as big of a supporter of passive investing as DanB or those that comment here. While our firm’s business model – and our fee schedule – is separate from the choice of active or passive we probably have a tilt toward active management (but use some passive strategies).
I should also clarify that probably 3/4 of my former clients were diligent in promptly and accurately executing my advice. But it amazed it that even a number approaching 1/4 would delay things for so long after paying me a few thousand dollars for very explicit advice – e.g., “sell xyz…invest proceeds into…” for each account. I suspect that some were intimidated by the notion of actually taking execution into their own hands – even when armed with trading codes and instructions on how to trade. We take it for granted how scary that can be for people who’ve never done it before. The fear of making a costly mistake that can’t be blamed but anybody but him/her self is a tough hurdle for many.
But I also wanted to respond to your idea about a solution to the problem you see re: compensation of financial advisors. If I understand you, there is a fundamental problem with this otherwise good model.
Any firm or individual that wants to be able to recommend specific investments to any individual or non-individual based on specific goals, objectives and constraints needs a license. The cost of having that license – whether you use it or not – is prohibitive if there is a possibility that all you’ll get is a “low hourly fee” as you put it.
As I noted, I started a firm that I could build for any model. While advising people wasn’t my main focus, I did set up the advisory side of my business with a low cost infrastructure that would allow me to use an hourly fee model for advisory clients. Given the current regulations and the current state of enforcement/audit, I would say that the hourly model just won’t work.
It can on paper – and retainer is probably the only way to make it work – but it will scare too many people away because the numbers are big and they’re only expressed in dollar terms. It’s a lot easier to first see a fee in percentage terms – because that’s how the industry charges even when it’s fee only – and then show people what it works out to in $ terms. Otherwise, the advisor is getting compared to lawyers and accountants and most clients would expect their advisor to earn a lower hourly rate. But that lower hourly rate just doesn’t work economically.
Even when I was running my firm I never found another anywhere in Canada that offered my model. And I looked because I received inquiries from people in provinces where I had no license so was always trying to refer folks to other firms.
So a transparent % of assets model is the best people can hope for. Otherwise, spend the time to educate yourself on investing, maybe visit a fee-only planner (i.e. not licensed to give investment advice) and do the couch potato thing.
@Dan Hallett – Fees, execution and client behavioural issues aside, in a nutshell, what makes you not as big a supporter of passive investing for the long-term (say 15-20 yrs+) given the overwhelming evidence it beats almost all active strategies?
I ran a screen of all Canadian mutual funds that beat the S&P/TSX Total Return Index average annual return of 9.14% for the last 20 years. Only 37 of 435 funds with 20-year history beat the that index, or 8.3% of all funds, and that’s with survivorship bias. It also does not include the tax effect of portfolio turnover which would further reduce the return, but which is minimized with a passive strategy. Also, 30 of these 37 funds were small cap or specialized funds, such as precious metals which a prudent person would not put their entire portfolio into. Furthermore over half the funds are now under $250M in assets so given the growth over 20 years they were likely tiny funds 20 years ago and on few people’s radar.
The situation is no different in the US or internationally and (with all due respect) private active money managers do not as a whole show better performance. So, given this and setting aside those lucky people that just happen to choose the top performing mutual funds or private active money managers in advance (and there are now over 14,000 mutual funds in Canada alone), I am curious why you aren’t as enthusiastic about passive management as Dan or we CCP devotees.
Again, remember I am asking this question with fees, execution and client behavioural issues set aside.
Noel, I appreciate your passion but I will not have this debate. I’ve had this discussion/debate more times that I care to remember – at the old FundLibrary discussion forum in the 1990s, the WealthyBoomer discussion forum (late 1990s & early 2000s) and at the Financial Webring forum (mid-late 2000s).
Nothing personal, but I really prefer not to relive debates I’ve done a dozen times already when it’s clear that people on either side of the debate seem to get almost religious about their particular stance. A decade debating this issue is enough for me, thanks. But I will leave you with an article I wrote a year ago related to this theme.
http://thewealthsteward.com/2012/01/active-or-passive-process-not-politics-should-drive-choice-of-strategy/
I was hoping actually to simply be directed to an article that you may have written as I don’t wish to argue either or engage in any big debate, but have to say that article did not refute anything I have said.
It’s really simple in the end. Client behavioural issues aside, the results are overwhelmingly in favour of the returns from executing a passive index fund approach over the long-term. The numbers I have shown simply do not lie.
@Dan Hallet and Noel:
A financial advisor has access to series F mutuals funds with minimal MER… once the MER difference between active and passive management is minimal, active mutual funds have much better chances of outperforming passive mutual funds. If investors had access to F series mutual funds, the active vs passive debate would be different I guess..
The good performance of a few balanced active mutual funds (like Mawer’s) compared to the Couch Potato Portofolio is a good example that passive isn’t always better than low fee active mutual funds with low turn-over and prudent management.
https://canadiancouchpotato.com/2011/04/20/how-did-the-couch-potato-stack-up/
@Jas – It is trite to say that series F mutual funds ‘have much better chances of outperforming passive mutual funds’ without any proof of numbers as I have shown.
I never claimed the absolute that passive is ALWAYS better ‘than low fee active mutual funds with low turn-over and prudent management’, just that the numbers that I have presented just show that it is better than active management MOST of the time. Probable and possible are two different things.
As such, I like it when the odds are overwhelmingly in my favour.
http://www.globeadvisor.com/servlet/ArticleNews/story/gam/20100428/HALLETTATL
http://thewealthsteward.com/2012/09/a-simple-but-successful-actively-managed-portfolio/
@Noel:
I think the numbers are there in the post I cited. CPP compared the couch potato portfolio to the few balanced active funds available in Canada with low MER around 1%, each of them (5) did as good or better than the couch potato portfolio.
I do agree with most of what you’ve said in this thread though.
We seem to be going around in circles here.
That article does not show that it is more probable that F-Series mutual funds that would beat the index over the long-term (ie 20 years), nor does it show that balanced funds do the same over the long-term. In fact it doesn’t even talk about F-Series mutual funds. All it shows is something neither of us are refuting, which is that over a shorter term, ie 10 years, that it is possible that an index portfolio can be outperformed by a small number of low-cost actively managed funds. It certainly does not show that it will be outperformed by the majority of such funds, or that we will be able to pick the ones in advance that will.
But since you brought up the 10-year numbers, the S&P/TSX Composite Total Return Index average annual return for 10 years was 9. 06% (using XIC, not the actual index, which was 9.22%). 233 of all 2,795 Canadian mutual funds which have 10 year returns, or 8.3%, beat this performance. This % would have been even lower as there is survivorship bias. Again, the numbers overwhelmingly favour a passive strategy. I am not saying this will always be the case in the shorter term, but the odds certainly favour it. That’s all I am saying. But, if you are a short-term investor then go with active funds because 2,687 of 3,404, or 79% of mutual funds in Canada beat XIC’s average annual performance of 0.56% over the last 5 years. But passive index investing is not about short-term time horizons.
As usual, specifics with actual proof in the form of numbers always trumps general random statements.
@Noel: Again, I’m not refuting anything you’ve said.
One reason why I think some active low cost balanced mutual funds like Mawers have a chance of outperforming simple total market index funds over the long term (20-30years) it that they include a “small cap tilt”. In Canada, unlike in USA, it is much more difficult to include easily a small cap tilt in one portfolio, without using US-based ETFs and a complicated portfolio including 6-8 funds . In his book about passive investing, Keith Matthews argues that the few active mutual funds outperforming total market index funds may do so mostly because of the small cap and value tilt.
http://canadianfinancialdiy.blogspot.ca/2009/02/book-review-empowered-investor-by-keith.html
I will also add that will I truly believe in passive investing, the reality is that the options are quite limited in Canada and more expansive compared to US citizens if one prefer investing in canadian-based mutual funds instead of using US-based ETFs (which have many implications already discussed on this blog).
@Noel:
Mawer vs index porfolio
http://www.theglobeandmail.com/globe-investor/funds-and-etfs/funds/summary/?compareBench=3155&FromMonth=2&FromYear=1988&ToMonth=1&ToYear=2013&id=17966&symbol=MAW104&style=globe_bal&profile_type=ROB
Leith Wheeler Balanced vs Index portfolio:
http://www.theglobeandmail.com/globe-investor/funds-and-etfs/funds/summary/?compareBench=3155&FromMonth=9&FromYear=1987&ToMonth=1&ToYear=2013&id=17960&symbol=LWF001&style=globe_bal&profile_type=ROB
Great returns! I wish I was lucky enough to pick them out of the thousands of funds and put all my money in them way back. They probably still beat their benchmark even with the drag due to tax payable due to turnover, after the first 14 years or so anyway, because before that their return wasn’t any better than the benchmark. Sadly, though, and this likely goes for most people, even if I had been actively picking actively managed mutual funds I would have likely bailed out in the 11-14 year range when the benchmark far exceed the fund performance, to my detriment. At least with a passively index portfolio I don’t waver from my Investment Policy Statement and pull it out any time I feel weak (ie when the markets go down) and just keep investing regularly the same way I did before.
As Warren Buffett said “Investing is simple, but not easy.”
Hope you’re enjoying the debate ;) Here are a couple of other articles that I thought you might enjoy…
http://www.globeadvisor.com/servlet/ArticleNews/story/gam/20100428/HALLETTATL
http://thewealthsteward.com/2012/09/a-simple-but-successful-actively-managed-portfolio/
@Jas and @Noel: Actually, I could have done even better. As I now know the winning number of the latest national big lottery draw, all I needed to have done was purchase a ticket and enter that number. I don’t see why other people could question the irrefutable logic of my investment approach.
@CCP: Seriously, now, I have found this site to be very informative, and the discussion that follows very stimulating to challenge my own understanding and new belief in the merits of Passive Investing, and hopefully, to strengthen this understanding by such challenging.
However, for the neophyte, I see now that it may be confusing to interpret comments in posts without understanding the author’s point of view. For instance, Dan Hallett, above, has explicitly clarified his stance. While I wholeheartedly accept his convictions and the absolute right to hold and express them, perhaps neophytes viewing this site may make the unwarranted assumption that all knowledgable posters on this site are committed advocates of Passive Index investing. (I must admit that when I first started following this blogsite I thought so too, and was initially puzzled by some comments posted, until I understood how it worked.)
I think the introduction of different points of view adds to the value of this blogsite, but I wonder if there exists the possibility of self designation in the form of some sort of labelling. For instance, I would designate myself as “Neophyte, recently converted but fervent believer in Passive Index Investment”. Then If I made a statement that seemed to imply favouring market timing or strategic selling, someone could rightfully comment that this was contrary to my stated beliefs. And another neophyte reading my comments, but understanding the Couch Potato Principle better than me might then not be confused but could realize that this was merely the misguided pronouncements of a neophyte.
Someone who self-designated himself as “Favours Passive Index Investing but does not rule out Active Calls or purchase of certain stocks when warranted” or “Completely Skeptical of Passive Index Investing Principle” and made an investment suggestion that was essentially a timing call or a stock pick would then not provoke further comment or puzzlement from readers. Just a thought.