Your Complete Guide to Index Investing with Dan Bortolotti

The Making of a Couch Potato

2018-06-17T20:50:47+00:00March 21st, 2011|Categories: Indexing Basics|Tags: , |20 Comments

I know very few people who began their investing lives as Couch Potatoes. Most started out in mutual funds or as stock pickers and, somewhere along the line, realized they were overpaying and underperforming.

These days, it’s easy to learn about the indexing alternative, but that wasn’t true even a decade ago. And when Rick Ferri began his career in the financial industry, it was heresy.

I recently had the pleasure of interviewing Ferri about his newest book, The Power of Passive Investing (Wiley, 2010), and I asked him about his own journey.

After earning a degree in finance, Ferri was an officer and fighter pilot in the US Marine Corps. He left active service in 1988 at 30 years old, earned his CFA designation, and started a new career in the financial industry. At that time, passive investing was almost unheard of, at least among retail investors. (Vanguard had been around since 1975, but by the late 1980s it still held only $30 billion in assets, compared with $1.4 trillion today.) Certainly Ferri knew nothing about indexing when he joined Kidder, Peabody and Co., a veritable old Massachusetts-based brokerage.

“Who wears the pants?”

I asked Ferri to describe what his early days a broker were like.

“This was 1988, so you would say things like, ‘Hello, this is so-and-so from Kidder, Peabody. Is Mr. Jones there?’ If Mrs. Jones answered, you’d ask her to put Mr. Jones on the phone — you did not talk to Mrs. Jones. And if Mr. Jones said something like, ‘I have to speak to my wife about that,’ you were told to say something like, ‘Who wears the pants in this family?’  Honestly, this is what they told you to say.  This was the broker playbook.

“They would have contests, where the person who got the most orders in one day got dinners and show tickets.  And you had to try to sell the stock of the day — whatever some analyst was promoting. Even if I didn’t know anything about the person, I would call and say, ‘You’ve got to buy a thousand shares of this company.’ These ideas about suitability, know-your-client, we’d get to that later.

“I tried managing stock portfolios myself, but quickly realized I didn’t know what I was doing. So I started using money managers. The clients would hire the managers, pay them 1% or 1.5% per year to select the stocks. Then our firm would also get 1%, or there would be brokerage commissions, which were extremely high. We made sure we picked money managers who had a decent amount of turnover so we would get paid.  The ones who did tactical asset allocation were great, because they always had a good story, and there was a lot of trading going on.”

The awakening

Ferri later joined a larger brokerage that functioned the same way. He quickly became uneasy with the whole industry:

“I caught on to what was going on: they were trying to pick managers, but they weren’t really believing they would outperform the market. They just wanted managers with a good story, so the brokers could sell the story and we could collect our 3% wrap fee. They would say to the client, ‘These are superior managers who you can’t get on your own because their minimum account size is $10 million. But under our program you can get them with just $50,000.’  Of course, that’s completely irrelevant. Managers are not going to outperform just because they set a high minimum. Especially once you charge 3% in fees — then the client is just screwed.”

By this point Ferri’s interest had been piqued by Burton Malkiel’s classic 1973 book on the futility of active management, A Random Walk Down Wall Street. Then one day in 1996, he was browsing in a bookstore and stumbled upon Bogle on Mutual Funds, by Vanguard founder John Bogle. “The book was inspirational to me. This is was not just theory: Bogle had the data in there, showing how the managers had underperformed the markets, and why. And I thought, ‘This is exactly what I have been seeing every day for the last eight years.’”

Then Ferri committed an act of financial treason. He fired most of the managers handling his equity portfolios and bought SPDRs (pronounced “spiders”), one of the earliest ETFs that tracked the S&P 500. “I still had to use active management for international equities, and I was using some commodities, which were unbelievable cash cows for brokerage firms. We’re talking 5% to 6% a year in cash flow. But my deal was that I would use index funds as much as I could — for which I would get paid nothing.”

“Screw the client”

You can imagine how this went over with Ferri’s supervisors. “They were saying, ‘How are you going to hit your 1%?’ They didn’t care what you sold clients, as long as you hit your revenue target — and if you weren’t going to hit it, then you should get rid of the client. They never, ever asked you, ‘How are your clients performing?’ That wasn’t even in the equation.

“I was using SPDRs and bond ladders, and there wasn’t much revenue from that, so they told me to use more commodities. I said, ‘That’s not prudent, because the clients already have 10% of their portfolio in commodities.’ And they said, ‘Well, make it 15%, or 20%.’ It’s like the word prudent wasn’t even in their vocabulary.

“I realized I needed to do something. So I went to my boss and I said I wanted to create an index-fund wrap program, where we would just use Vanguard index funds and ETFs. We’d charge 50 basis points for doing the asset allocation and creating portfolios with the right blend for each individual client’s needs. And he laughed at me. ‘What are you, nuts? What business do you think we’re in?’ I said, ‘But this is the best thing for the clients.’ And he said, ‘Screw the client! We’re not in business for the clients. We’re in business for the shareholders. Don’t you get that?’ And I said, ‘I get it loud and clear.’ But I needed that confirmation — to know that this was not the right place for me. I needed to leave the brokerage industry.”

Ferri went on to found Portfolio Solutions, a Michigan-based investment management firm that builds index portfolios and charges clients 0.25% (subject to a minimum annual fee of $2,500 per household). So far he has never asked any of his clients who wears the pants in the family.

In my next post, we’ll hear more of Ferri’s investment ideas and I’ll offer readers an opportunity to win a copy of his latest book.



  1. Steve in Oakville March 21, 2011 at 8:58 am

    Yikes – those stories gave me a stomach ache.

    Kudos to Mr. Ferri for 1) realizing the best path for his clients, and 2) having the strength to follow his convictions, despite the seedy industry he was operating in.


  2. Canadian Couch Potato March 21, 2011 at 9:04 am

    Lest anyone think Rick’s experience in the industry was unique, I highly recommend this great article by Michael Lewis (author of Moneyball and The Blind Side), “The Evolution of an Investor.” It’s also a good introduction to the philosophy of Dimensional Fund Advisors:

  3. Lyne March 21, 2011 at 11:28 am

    Very interesting, thank you. I’m looking forward to the next post.

  4. The Dividend Ninja March 21, 2011 at 12:48 pm

    Great post Dan! look forward to part 2. It’s always great to hear of people in the financial industry working with integrity – far and few these days ;) Rick, congrats on taking that step forward early in your career to help others.

  5. Canadian Capitalist March 21, 2011 at 1:52 pm

    “Who wears the pants?” cracked me up. But I’m sure the clients won’t find this a laughing matter.

  6. Canadian Couch Potato March 21, 2011 at 2:01 pm

    @CC: Don’t you miss the good old days when you could say things like that? In the Blaine Lourd profile I linked to above, he shares an anecdote that’s almost identical. His brokerage told him to say, “Mr. Johnson, if you’re driving at night with your wife in the city, it’s snowing, and you have a flat tire, do you ask your wife to go out and change it?”

  7. Michel March 21, 2011 at 4:00 pm

    WOW, this is incredible! Although we all know, that at some brokerages, that’s the way it worked, and I know for a fact, still works. When I challenged someone I know, who works in this business, he simply said “I have a right to make a living too!” Somehow, I think he misses the point. Hurray for index funds, and long term, good dividend paying stocks.

  8. Canadian Couch Potato March 21, 2011 at 4:08 pm

    @Michel: Of course, an advisor has the right to make a living, and investors who use one should pay a reasonable fee. But the advice had better be in the investor’s best interest, and usually it is not. In the case of these brokers, the conflict of interest is truly appalling. Hurray indeed for alternatives that weren’t available back then.

  9. My Own Advisor March 21, 2011 at 8:19 pm

    Good on Ferri:

    “But I needed that confirmation — to know that this was not the right place for me. I needed to leave the brokerage industry.”

    Takes guts, but look where this guy is today…

    Nice article Dan.

  10. Steve in Oakville March 21, 2011 at 11:05 pm

    The Blaine Lourd article is just ridiculous. I haven’t read Liar’s Poker, but I did recently read The Big Short, and nothing surprises me with the investment industry (although it often still makes me feel ill). Is there another industry where the conflict of industry is so apparent? (and so damaging to the client?)

    I’ve read Ferri’s Asset Allocation, but I didn’t know about his past – thanks for the post Dan.

  11. MoneySheep March 22, 2011 at 1:21 pm

    This is true in any financial service industry. One example, say you are listing your house for $310,000. If any offer comes in at $300k, do you think a realtor will fight for you to get the extra $10k for you? Let us take a look. 6% comm is $18k (this is a robbery). Typically buying brokerage and selling brokerage split 50/50. And then split again between brokerage and realtor. So 18k now is down to $4.5k. An extra $10k for you is significant, but for the realtor, $150. I will bet the realtor will push you to sell at $300k.

    When I first read about this analysis in Freakonomics, I realized that realtors are not working for you at all.

  12. CanadianInvestor March 24, 2011 at 5:00 am

    Great post! It’s quite shocking to read the bald exploitative intent (though most of the time the industry obfuscates with soothing bafflegab). Sometimes a personal account like this has more impact than a whole pile of statistics about mutual funds under-performing etc

  13. […] Bartolotti, at The Canadian Couch Potato,  just published a fabulous interview with Rick Ferri.  A money manager with his CFA designation […]

  14. […] Canadian Couch Potato interviewed Rick Ferri to find out why he went from being a stock broker to building index portfolio for clients. […]

  15. BasilTheSecond March 26, 2011 at 1:56 am

    Read one book from Malkiel and another from Bogle? Switched to index funds because his bolier plate brokerage was ripping off clients? Wow, this is a good reason to become a passive investor.

    These days of the Internet era individual investor is not at a disadvantage it used to be in the ’80. There are far more options available today that an individual investor can pursue and index investing is one of them but reason for adopting that strategy shouldn’t be the reason outlined in this interview. It sounds so shallow and stupid.

  16. Canadian Couch Potato March 26, 2011 at 10:01 am

    @Basil: The point here wasn’t that Ferri read two books. It was that he discovered over eight years that the entire brokerage industry (not just his firm) was specifically designed to rape the client, and that the active management strategies they were peddling were a sham. That was actually an outstanding reason to advocate passive investing at the time.

    It’s true, there are more options available today, and active investors can do quite well with discount brokerages or even low-cost mutual funds. But the obstacles thrown up by the investment industry (high costs, bad advice and dishonesty) are still part of the argument in favour of passive investing. Not the whole argument, of course, but certainly one of them.

  17. Doable Finance March 26, 2011 at 10:44 pm

    Can’t wait to read the next post about the Ferri . It’s a learning experience.

  18. BasilTheSecond March 29, 2011 at 12:47 am

    Dan, reader is led to believe that the solution to the deceitful practises is passive approach. I would say that transparency and jail time is the solution to the problem. And I’m not clear what the role of this individual advisor would be should one choses to go passive way. All one need to do is go to his local branch and talk to the mutul fund person.

  19. Farhan Thawar May 7, 2011 at 8:28 am

    Is there something as cheap as Portfolio solutions for Canadians? DFA advisors charge 1% :(

  20. Canadian Couch Potato May 7, 2011 at 9:46 am

    @Farhan: As far as I know there’s no similar model here in Canada. However, let’s remember that the service you get from different advisors is going to vary widely. For 0.25%, you’re not likely to get a lot individualized service, retirement planning, tax planning and the like. It’s probably portfolio design and maintenance only, and in some ways, that’s the part that’s easiest to do yourself.

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