Your Complete Guide to Index Investing with Dan Bortolotti

The Powerful Pull of Possibility

2013-12-15T22:14:13+00:00December 16th, 2013|Categories: Behavioral Finance|46 Comments

If the evidence in favour of passive investing is so strong, why isn’t the strategy more popular? I hear that question all the time, and there are several answers, including effective marketing by investment firms and a general lack of awareness. But there’s another reason that affects even those who are well aware of the research. It’s the deep emotional appeal that comes from the possibility—however small it might be—of achieving market-beating returns.

I thought about this recently during a conversation with an investor who was considering moving from his current advisor (who used a highly active strategy) to an indexed approach. Robert had been with his advisor for more than 10 years, and it was clear his portfolio had lagged the indexes over that period. He also complained the advisor was providing no financial planning and no tax management: there was only active investment management, and it had failed for more than a decade. Why, then, did Robert find it so hard to break free?

As we spoke, the answer became clear: Robert wasn’t disputing that indexing had a higher probability of success. He just wanted to hold onto the possibility of outperformance.

“Might” makes right

This has always been a stumbling block for investors weighing the merits of active and passive strategies. If you make decisions based on a rational assessment of the evidence, it’s easy to come down on the side of indexing. But if people were always coolly analytical when making financial decisions, no one would ever walk into a casino or buy a lottery ticket. People who play the slots or buy scratch-and-win tickets are well aware their chances of winning are slim. But they’re not zero: you might win the jackpot. And as long as there is a possibility of winning, the games will hold enormous appeal.

In the same way, Robert was well aware that future outperformance was highly unlikely, but it wasn’t impossible if he stayed with his active advisor. With indexing, however, the probabilities would be in his favor but the possibility of earning market-beating returns would fall to zero. And it was awfully hard for Robert to accept that. It was like letting go of a dream.

Play the odds

Robert’s advisor seemed to understand this instinctively, and she exploited it skilfully. She showed him performance figures over carefully selected periods when her strategy did outperform (typically when she was sitting in cash during a down market). Then she showed him the impressive back-tested results of a new active strategy she was planning to use. She couldn’t explain why she hadn’t actually used the strategy in the past, but she didn’t have to. She just needed to dangle the possibility that it might continue to work.

I understand it can be hard to let go of the hope you’ll earn market-beating returns, but I encouraged Robert to look at it differently. For years he was paying for something that delivered negative value. If he wanted to keep using an advisor, why not accept close-to-market returns and pay for services that always have value, such as financial planning, tax management and long-term discipline? And if he wanted to invest on his own, why not enjoy the guaranteed boost he’d get from cutting his investment costs by about 75%?

Viewed in that light, a strategy based on high probability rather than remote possibility shouldn’t be depressing: it should be liberating.


  1. Jason December 16, 2013 at 8:16 am

    Good Article, that sums it up beautifully.

  2. Ram December 16, 2013 at 9:02 am

    Very good analogy Don.

    I think comparing active-fees to lottery ticket prices could be a wake up call to some, if not many. If spending hundreds Of dollars on lottery that has a possible huge upside is foolish, how do you call spending thousands for a possible modest upside.

  3. Brian December 16, 2013 at 9:13 am

    Because you can’t fight human nature and the desire to score big is an undeniable part of our make-up, why not approve a 5-10% equity gamble as part of the ideal portfolio? Having individual stocks keeps us engaged with the financial markets whereas 100% couch potato is a recipe for a long nap.

  4. Andrew F December 16, 2013 at 10:30 am

    What if you index and use some of the savings over active management to buy lottery tickets?

  5. Tristan December 16, 2013 at 11:08 am

    I think it’s better to find less expensive forms of entertainment.

  6. Richard December 16, 2013 at 12:57 pm

    Another analogy might suit this situation well: picking up pennies in front of a steamroller. In that light the gamble doesn’t look quite as appealing :) Remember, even an outperformance of 0.1% is enough for a manager to claim they “beat the index”…

  7. David L December 16, 2013 at 1:20 pm

    Very appropriate article. It also explains why people are drawn to penny stocks, even though the probability of hitting it big is very small. This reminds me of the article in Money Sense that talked about the person who grew his TFSA to $300k through penny stocks.

  8. Brian G December 16, 2013 at 8:34 pm

    I use and recommend passive investing but there is one reason why I personally don’t use passive investing 100% of the time, that’s because judicious use of non-passive strategies have served me well over my 20 year investment. So, I guess I am damaged goods. Specifically, the one thing I don’t like about 100% passive investing is that it never says when risk is increasing and thus when to maybe get out of some asset classes. I dodged the dot-com bubble and 2008. Maybe I was lucky, but I don’t think so… both had all the signs to make you nervous. It’s not that I think I can outperform passive investing on the upside, it’s that I think I can outperform it on the downside but maybe I’m fooling myself, time will tell.

  9. Chris December 17, 2013 at 2:38 am

    Well, I think a question to ask is whether passive investing is really worth the risk.

    When I look at the 15 year report cards, I see 5-6% annual returns … with 30% downswings. For myself, that’s simply not worth the risk when I can get 3% in a TSFA account, and 2% in savings account. After inflation, I might break even … but I’m not going to risk my life savings for a few percent a year. And truth be told, not many passive investors will stay passive after they watch the market fall in half. So, they … at best … maybe break even with me. But probably not.

    I sleep well knowing my money is not being gambled with on Wall Street, subject to flash crashes, algos, insider deals, Fed manipulation, and other corruption.

    That’s just me.

  10. Robert M December 17, 2013 at 5:59 am

    I have to tip my hat to Robert’s advisor for doing her job very well.

    First, she has the advantage of being the incumbent who knows the client and their motivational buttons.

    Second, she proves her worth by choosing select criteria that indicates some measure of success over her time as his advisor.

    Third, she offers a strategy that gives the appearance of providing better returns with certain assumptions while ignoring the strategy downside thus demonstrating her future worth and giving the appearance of adding value.

    This 1-2-3 punch is hard to resist because the client doesn’t have the technical knowledge to see through the back testing strategy while not realising that he is inclined to align with people that he already knows. The weakness is that the advisor has to mention that mantra: “Past performance is no guarrantee of future performance”.

    This one to one selling approach is hard to resist and I fell victim to it myself. I broke free when I finally realised that my advisor really had no control over the execution of the strategy as that is under control of the fund management.

    Sometimes the “appearance” of change is more enticing than the actual change itself and if it doesn’t work then it is the advisor’s fault and not your own.

    There is quite a bit of psychology at work here. I can understand completely Robert’s indecision as it reflected my own.

  11. CB December 17, 2013 at 10:19 am

    I find this topic fascinating.
    Six months ago I made the decision to go 100% couch potato. All my savings were handled by two different brokers (one for stocks the other one for mutual funds) and I certainly experienced the anxiety of making such a big change (not to mention the fun part about having to announce my decision to my two brokers…).
    For years I never bothered asking questions about the risk connected to my investments in mutual funds and stocks – I felt “safe”…these two brokers were giving excellent service and one was even sending me flowers at Christmas time….
    I never asked about commissions and such (I was horrified to discover this year that commissions on mutual funds were about 3%!)
    Yet, now that I no longer do pay these high commissions and fees and that just let my money follow the indexes, some people working in the finance industry try to convince me that I am taking on a big risk and that passive investing is only good when there is an upward trend (very similar the the comment of Chris above).

  12. Andrew December 17, 2013 at 10:31 am

    I get what you are saying because the longer you are saving and invested the larger the absolute amount of risk. Seeing a 20% drop on paper is not so bad when there’s $10,000 at stake ( unless it was very hard to save that first $10k which is why am advising my kids to take the opposite of mainstream advice when they first begin saving – the old “you’re young you can afford to take risk because you have time on your side”- losing a fifth of ones saving at the beginning of an investing career might make a person extreemely risk averse the rest of their lives. Plus why risk the down payment on your house or the savings you accumulate to buy a first car?).

    Seeing 20% of several hundred K vanish is another matter, particularly when it might hayve taken many decades to save that much.

    However on balance I don’t see an alternative to a passive portfolio that has any chance of getting the returns people will need given the current savings rates.

  13. Canadian Couch Potato December 17, 2013 at 10:31 am

    @CB: The idea that indexing “only works in a bull market” is part of the same mythology. It allows active managers to plant seeds of fear in the minds of passive investors, i.e. “When things go bad, you’ll be sorry.” It’s true that active managers can sometimes protect investors from short-term dips by moving into cash, but they frequently miss the rebound, and over the long term they still underperform. This article explains more, with data:

  14. Richard December 17, 2013 at 10:54 am

    @CB: good move to switch to index funds! Those who are paid to try to outsmart the index will of course insist that is dangerous. You could remind them that an active manager is only good until their luck runs out.

    @Andrew: investing the money for a down payment in stocks is rarely a good idea. Short term savings should be in cash or short-term bonds. For actual retirement savings stocks make sense for young people not because they can afford a loss but because they have a lot to gain and little risk of a loss if they follow a good plan and understand what they are doing.

    When you don’t need to make withdrawals for several decades, nothing else gives you the same chance of ending up with a high balance as you commented. The power of compounding over a long time period can easily turn even the modest savings from an entry-level job into a significant retirement portfolio.

    Many people who start with an overly conservative plan eventually recognize this after watching several years of big gains in the market and jump in at the worst possible point, then see the subsequent crash as a confirmation that the stock market is too dangerous (only to repeat the cycle later). If they had chosen a reasonable plan to begin with and then stuck to it over time they would have far less risk. The fear that leads to these mistakes can be difficult to control but education is the best way. Reading this blog is an excellent start :)

  15. Brian G December 17, 2013 at 3:12 pm

    @Chris You sound very risk adverse. One thing to remember though is that even with GIC’s you are taking risks. You have the risk of drawing down your retirement savings and running out of money before you die, risk of inflation lowering purchasing power, risk of currency devaluation/exchange rate lowering purchasing power and the risk of losing your money in a bank failure if you have more than $100K of GICs at one bank. Some of these risks have an almost certainty of happening as your time horizon extends (e.g. inflation.) You also have opportunity costs, such as higher taxes, interest rate increases and giving up the ability to live at a higher standard of living in retirement.

    Given all this, a 100% GIC’s is not the lowest risk portfolio even for the most risk adverse person. For example, a Couch Potato portfolio adjusted to have 80% bonds (or GICs) would almost certainly be lower risk over any reasonable length of time.

  16. Francis December 17, 2013 at 3:41 pm

    @ Chris : I think you should review to rule of 72 in investment. The difference between 3 and 6% is actually huge and worth the risk to get it. This rule give an approximation of when your money double, you just have to divide 72 by the annualized performance of your portfolio.

    In this example 3% double every 24 years and 6% double every 12 years, so if the time of horizon for you money is 30 year then your money would double only one time at 3%. A lot of complicate strategies in passive investing try to enhance return only by around 1% and it worth the hassle if you have a lot of money invested. 1% more at years 20 with a million dollars make the difference between having 2M$ or around 200 000$ less at year 30.

    That 3% rate at people trust is far from guaranteed over the long term they can change it at anytime and it limiting at the TFSA, you can’t plan to retired only with your TFSA. There nothing risk free in investment, the trade off here is you will never be able to retire that 100% guaranteed and you should spend all your money you won’t need it since you will work all your life.

  17. Jamie December 17, 2013 at 3:58 pm

    Interesting post.
    One question – doesn’t a regular pattern of re-balancing actually lead to outperformance of the indices? I thought that Burton Malkiel made this point in The Elements of Investing. In other words, through regularly buying low and selling high to re-balance, one could actually beat the indices while using index funds or ETFs.

  18. Brian G December 17, 2013 at 4:08 pm

    @Francis, your point is valid, but I don’t think it will resonate with a very risk adverse person. I know this because I’ve tried this logic with my wife who is very risk adverse. :)

    For some people seeing any numerical dip in the value of their savings is crushing and leads to very high anxiety. All the logic in the world doesn’t remove this feeling for these people. This people would rather work longer or live with less than face this anxiety.

    The only strategy I’ve found works with these types of people are: a low risk passive portfolio (e.g. a Couch Potato like portfolio with 80% government bonds held to maturity or GIC’s). Additionally, I’ve found that regularly adding to their investment portfolio via contributions deducted from their paycheck also has a positive psychological effect because combined their low risk portfolio growth + savings growth almost always leads to growing portfolio every month which allows them to sleep at night.

  19. Alan December 17, 2013 at 5:47 pm

    I think part of the problem in convincing people to go passive is that the government is sending people mixed messages. We’re constantly being told things like “the CPPIB is doing great! Canadians are getting a better deal than anything they could do on their own!” So we’re left with the message from the media and the government that the *active* managers at the CPPIB (and OTPP, etc.), etc. are beating the markets. So the average Canadian probably thinks, if they can, why can’t I? Or, alternatively, if passive investing can’t be beat, why would be we paying the CPPIB managers serious money to pick stocks, shift in and out of markets tactically, etc.? It doesn’t make sense.

    I’ve never been able to figure out for sure if the big funds like CPPIB consistently underperform the indexes (like most hedge funds) because their performance reporting is inconsistent, but it seems like they have been underperforming for the last decade.

    If the government would switch our CPP funds to be invested in passive instruments, it would send a big message that passive investing is the way to go. Until then, I think Canadians will keep getting mixed messages.

  20. Chris December 17, 2013 at 8:17 pm

    Hey gentlemen, thank you for the feedback.

    I see the logic of all that has been mentioned. In fact, I came across a post that made a convincing argument that there was less to fear from market crashes, than low returns. But that largely depends what decade you invested in, when the crash occurred, and where.

    The problem I see here is that we simply don’t know when the market will crash, the extent, and the subsequent recovery. We also don’t know the return from the market. Over the last 100 years, it’s averaged about 10%/year. And had one only invested in SPY over the last 2 years, you’re looking at 60% returns. But had one invested in the 1930s, you’d have a decade of no returns. And in the 2000s, another decade of no return. In Japan, nearly 60% over the last year alone., but you applied a passive approach in Japan back in 1990s, you would have waited two decades to find your money cut to a third.

    We are really leaving to chance whether you retire in luxury and splendor, or food stamps and catfood. I remember talking to a financial advisor at the bank just over a year ago and he pointed out that big chart and the 10% return over the long run. I then pointed to the chart high of Sept 2000. and asked what the return was for the past 12 years.

    He shrugged. I didn’t. The return was zero. Had I been fully invested, and assuming inflation was around 3% a year, I would have lost 1/3 of my money. In between two drawdowns that would have cut my net worth in half.

    So I disagree that I am being risk-averse. I think this is just rationally looking at the data and realizing that the advocates of passive investing came of age in the 80’s and 90’s where the market averaged 18% a year. This is not a slam against passive investing, as it is a slam against the market. As Dan has pointed out, passive investing simply aims to capture the return from the market. And what if there is none? How long will your faith last? Had any of you lived through the 1930s, or in Japan for the last three decades, I doubt you would be so fond of a passive approach. Actually, I doubt there are many passive investors that started in the 2000s that are still continuing today. A decade of no returns tend to dampen the enthusiasm … along with those 50% drawdowns (Sept 2002 and Feb 2009).

    (note: 60/40 maximum drawdowns appear to be capped, so far, at about 30%. Their return during the 80s and 90s was an impressive 15%)

    This field attracts some of the best and brightest individuals in the world, and the conclusions so far are:

    1) We don’t know when to time the market.
    2) We don’t know which stocks will outperform.
    3) We don’t know what the returns will be for any given year, or decade.
    4) We don’t know the future.

    In fact, all we really know is that over the last century, the US market has averaged about 10% a year with a few lost decades.

    If I told you to wear a blindfold, cross the street, and then informed you cars were coming but you can’t predict when, how fast they are moving, or how many of them, but that most people generally made it as far as we know…would you? How about if we were in Japan and no one made it across for the last twenty years?

    However, even this analogy doesn’t quite capture all the nuances. The truth is, after inflation, a 3% real return (from a 60/40 passive approach) isn’t much of a return unless you are talking millions invested, in which case you’re probably doing okay irrespective of the market.

    So this is why I don’t invest in the market. I think a fair question might be why someone would invest their life savings in a field they don’t understand, can’t predict, with only faith that the future will repeat as the past has … even though the latter is no indication of future performance. And even at that is rife with pitfalls, where only chance and circumstance created a favorable outcome. And that the median favorable outcome is only marginally better than when you started.


    (ps I hope this doesn’t come across hostile to anyone. I would be delighted if someone were to find fault with my *current* conclusions.)

  21. Brian G December 17, 2013 at 8:32 pm

    @Chris there are some flaws in your argument. Here are a few:
    – passive investing is not that new, it started big time with John Bogle who started Vanguard in 1975
    – diversity in world equities would avoid your US or Japanese lost decade investor scenario (the Couch Potato portfolios have this diversity but are a tad too heavily weighted to Canada for me… but they are okay)
    – you forgot that after the “lost decade” the returns picked up … equity investments have a 10-15 year time horizon (many people forget this)
    – draw downs can be controlled by just choosing a higher bond percentage (I personally use a 65% bond, 35% equity ratio because I’m approaching retirement.)

    But here’s the biggest flaw:
    – what’s your alternative, and what are the risks?

  22. David L December 17, 2013 at 9:43 pm

    When you look at the lost decade, Chris, you see whatever indices ended up at the same point 10 years later. That’s quite a discouragement, but you’re assuming that you put your life saving in the beginning of the lost decade, and withdraw it at the end of it.

    You forgot that dividends is being paid out on a regular basis. And if you have the intestinal fortitude, you’ll keep buying the market even when there is a drawdown, bear market or crash. The resulting recovery is the territory of bull market, making the recovery all the better.

    As for your analogy, I have no qualm about it, except you have to add that Inflation Monster will make you poor, and that you have multiple lives (multiple markets) to help you achieve your goal.

  23. Canadian Couch Potato December 17, 2013 at 9:50 pm

    @Jamie: Rebalancing is primarily a risk management tool: it’s not specifically designed to boost returns, though it can have that effect in a volatile market. During a period where asset classes have long trends in the same direction, it could actually lower returns:

  24. Brian G December 17, 2013 at 10:43 pm

    I was playing around with a retirement calculator spreadsheet comparing a zero risk GIC only portfolio which we’ll assume as a 0% real rate of return and Couch Potato portfolio which we’ll assume has a 3% real rate of return. Additionally, let’s assume a person starts investing at age 25, retires at 65 and dies at 85 and wants a $40,000/year income during retirement as has no pension. All dollar amounts are given in current dollars. Hopefully, I did the math all correctly… somebody correct me if I have made a mistake.

    GIC portfolio requires $800,000 to be saved with monthly contributions from 25 to 65 to be $1667/month.

    Couch Potato portfolio requires $601,036 to be saved with monthly contributions from 25 to 65 of $649/month.

    So, for an average Canadian who makes $40,000 a year, saving 50% of their salary required by the GIC route is just a nonstarter. That 3% makes a huge difference over the long run.

  25. Richard December 17, 2013 at 11:55 pm

    @Chris: all your examples of bad scenarios have one thing in common: they are in relatively short times and they rely on measuring from specific dates. If you were investing for 20 years would you rather get a steady 3% return every year, a “lost decade” followed by 10% per year, or 10% per year followed by a crash of 50%? Those options are in order from lowest to highest total returns so even some of the worst outcomes you fear in the stock market can give you a better end result than cash.

    Even if the long-term investor assumes they will lose 50% of their portfolio the day they retire, the worst-case floor is better than most of their other options. The loss isn’t permanent if they behave well. And in the likely event that the worst doesn’t happen they get a very large bonus.

    There are two risks with all-cash savings. First, as you said past performance doesn’t predict future results. The returns on cash depend on both the short-term interest rate and the rate of inflation. If either of those doesn’t behave as you expect, then you don’t know if the results will be better, worse, or the same as before. The best case for cash is a strong deflation which is not something you want to live through. On the other hand if inflation outpaces the interest rate then you’re running just to stay in place. The second risk is that if someone does this and the amount they are saving isn’t enough to satisfy them they are more likely to make desperate gambles later, having lost a lot of the time that they need to ensure a better outcome. In that case they will be exposed to things worse than the risks you mentioned.

  26. Chris December 18, 2013 at 11:43 am

    Hey guys, thanks for the responses.

    @Richard: Well, the situation with Japan extended for a good two decades. And after the great crash of 1929, it took nearly 25 years for a rebound to occur. And depending how you wish to look at things, it could be argued that the S&P has largely been in a consolidation period for the last dozen years.

    @David: Actually dividends are no safe haven. After 1929, dividends were slashed for two decades as well. And unfortunately, do to inflation, investors were in the red for 56 YEARS before they finally had a gain on their investment.

    This article, I think, is worth a read for those passive investors that believe that if they hold long enough, they will see a return. You probably will, but the thread may be longer than you imagine.

    “None of this is to suggest that we are going to see a 1929 scenario unfold again in the future. But because we have not seen such an episode take place in our lifetimes does not mean that we should simply dismiss it as a possibility either. For the reality remains that were it not for the extraordinary intervention by global central banks in the wake of the financial crisis in late 2008 and early 2009, chances are we would have seen an outcome far worse than what took place during the Great Depression when it was all said and done. And while the U.S. Federal Reserve was indeed successful in pulling the global economy back from the brink, the story remains far from complete at this stage with a Fed balance sheet that continues to expand seemingly out of control five years after the initial outbreak of the crisis with an economic recovery that remains sluggish and fragile at best. Thus, a scenario where the stock market crashes and takes decades to bounce back cannot be completely ruled out.”

    When I first posted, I had no knowledge of this article. I stumbled across it when I was examining the comments from all of you. It expressed a great many of my feelings. Largely, that the recent run up should not be trusted, and if we extend our sights beyond a few decades, the market is not the safe haven financial planners would have us believe.

    @Brian Thank you for your insights, they are very much appreciated. John Bogle did form Vanguard in 1975, that is correct. But his bestselling book “Common Sense on Mutual Funds: New Imperatives for the Intelligent Investor” was published in 1999. Right after the market had averaged 18%/year for two decades.

    You state: But here’s the biggest flaw:
    – what’s your alternative, and what are the risks?

    The article I linked to concluded with the following paragraph. What I find interesting about it, is it’s exactly what I have contemplated in the past. And I believe it’s the exact approach I will take going forward:

    “Investors today would benefit from the perspectives of those that came in the generation before us. Indeed, it has been a wonderful lifetime of investing for those born over the last 86 years. But for those that came before, they had a decidedly different perspective on the stock market. Irving Gerring, my grandfather for whom my company is named, would have turned 101 years old this month were he still alive today. His introduction to investment markets did not come with the conclusion of World War II like the oldest among us today. Instead, it came with the end of the Roaring 20’s. And instead of buying at the top of the market like so many did at the time, he waited until after the market had fully crashed in 1933 to make his first stock purchase in General Electric (GE). For him, the discipline to resist rushing in with the crowd at the top and waiting until the correction had taken place proved far more rewarding for many decades in the future. This same discipline served him equally well at the end of his life when the tech bubble finally burst in 2000. Today, a whole new generation of investors have the potential to set the course for their own investment future, but only if they have the patience to wait for the truly good opportunities to present themselves in the aftermath. It is this very discipline that will set them on the road to long-term success in the end.”

    I apologize for not addressing all of your excellent points. But I feel this best represents my current views.

    And this post is plenty long, lol!

    All the best,

  27. Brian G December 18, 2013 at 3:23 pm

    @Chris You make it out like the 29 crash was the end of the world. It was bad but it wasn’t the end of the world especially when you consider the run up until then. A diligent index investor would have rebalanced and captured some of those stock gains into the bonds. It also turns out that my scenario of an investor starting investing at 25, retires at 65 and invests monthly into a balanced portfolio would have done just fine even through the 20’s through 40’s, no matter what year they started. So even during the worst period, this would have been a good way to save for retirement. GIC’s were not guaranteed back then so it was only good luck whether your bank survived and you got your money out of a bank with those “safe” term deposit investments over the same time period.

    Your alternative seems to be holding GIC’s and then to time the market and wait for a big drop and buy. If so, all I can say is good luck because this strategy is not testable until you do it. Many have tried that and failed. The most famous recently being Nassim Taleb. The guy talks a lot but he hasn’t shown he’s out performed an index portfolio during any time period. He should have made a killing during 2008 but he didn’t. His Horizon’s ETFs are dogs. He makes money off of writing books.

    I myself just don’t worry about these things because over a 20 year investment time, I’ve been through 2 crashes and survived just fine. In fact, at one point I lost 30% of my portfolio value in 1 day on paper thanks to me being greedy with a single stock investment I had before I indexed. But that same stock had made me well over 200% up to that point so was it really a 30% drop… it’s al perspective. Through continuing my day job, not panicking and continuing to invest, I recovered from that in about a year and a half. Having lived through that I know I can withstand a drawdown. To me the worst case scenario is that I have to work longer than I wanted… not that big of a deal in the whole scheme of things so I sleep well. But that’s me.

    You may want to look into a Permanent portfolio style of indexed portfolio. Possibly replacing some of the gold in it with other hard assets.

  28. Brian G December 18, 2013 at 5:01 pm

    @Chris, one other thought I had while eating lunch. :)

    Reading your linked article and especially the last quoted paragraph, it screams that anybody not in the market should have invested heavily in the market in 2009 once it started to pick up. So how did this timing thing work out? Did the author buy? Did you buy? I did (one big purchase in June 2009 and another in October 2009) and I’m up 60% on my equities.

    How about selling? Has the author sold the market now? Have you? How did he/you know to sell now? Is that criteria objective and repeatable? I haven’t sold, just rebalanced so I know I’ve captured some of that gain, I still have potential to capture upside and I have a limit to my downside. My strategy is objective and repeatable.

    This sort of decision making fuzziness and lost opportunity is why the idea of timing the market and holding on to cash/short term GIC’s for extended periods of time waiting for the perfect buying opportunity rarely works out in the long run.

  29. Richard December 18, 2013 at 11:31 pm

    Chris, I have to say you’re surprisingly reasonable and well-informed for someone with your views :) That’s nice to see.

    It sounds like you’re not saying the best bet is to avoid stocks altogether, but instead to wait for more reasonable prices. That would certainly be nice and I agree that the only best future is one where they do look more attractive at some point. However there are a lot of ways to get there. If you believe it’s possible there will be a crash when no one expects it, isn’t it also possible that a seemingly overvalued market will never go down to the level where you would currently want to buy?

    The fact that it’s at record highs (again today) is of course a reason for caution. I was curious about this a few months ago and looked back at the historical data. I was able to find a few points where the market reached a record high and then never fell below that level again (more if you include occasions where it fell back for a couple of days). So that’s not a 100% reliable signal. It has also been noted that the real value of the S&P 500 in 2000 would be equivalent to over $2000 today. In those terms it’s lower than the record high nearly 14 years ago which doesn’t sound overly concerning.

    Personally a crash would suit me just fine because I would gain a lot and likely lose nothing permanent. But even so I have to make my decisions with a full view of all possible risks, which includes the risk of sitting out a market that has a lot more force behind it than I expected. The balance of all reasonable information I can find, combined with knowledge of my own needs, has me 100% in stocks.

    Technically I could do marginally better if I did things differently and a very specific sequence of returns happens but from my current position I have lots of excellent options regardless of how things turn out and I believe that is the best goal to aim for. If you can say the same then your plan is working for you.

  30. Chris December 19, 2013 at 2:39 am

    Hey Brian!

    Thank you for your views, they are of great benefit to me, and I appreciate your patience.

    You wrote:

    “It also turns out that my scenario of an investor starting investing at 25, retires at 65 and invests monthly into a balanced portfolio would have done just fine even through the 20′s through 40′s, no matter what year they started.”

    In the article I linked, the author states:

    “On a real basis, it would have taken an investor that first allocated in September 1929 over 56 years in 1985 before they would finally achieve a permanent price gain on their investment.” [when accounting for inflation]

    Now, I’m not prepared to give the author the final word here. I’m not certain what investing strategy is being used, I suspect it is simply confined to that specific market with no bonds or diversification in play. Nonetheless, I do find it chilling that for those who are heavily reliant on the market for their returns, you can be at the wrong place at the wrong time.

    That said, I do find the compound interest a compelling argument, even with a few hiccups along the way. Barring investing at the peak of the market, followed by a downturn rivaling the Great Depression, 40 years of compounding interest tends to give one a fair amount of breathing room. Unfortunately, my situation only allows about 25 years, but it’s still workable.

    Regarding Nassim Taleb:

    I’ve enjoyed reading his books. I think I requested “Antifragile” for Christmas. From all accounts, he actually became financially independent from the stock market crash in 1987:

    Nassim is a chief advisor for Universa which made returns of 65% and 110% in Oct 2008 during the economic crisis. Now here’s the curious bit, the Wall Street Journal alleged that the large purchase of put options by Universa funds leading up to the 2010 Flash Crash was among the primary triggers, Mark Spitznagel of Universa was actually subpoenaed by the US Securities and Exchange Commision.

    Anything connected with these guys will have years of marginal, negative returns, punctuated by rare, blinding moments of prosperity.

    But moving on …

    You make a strong point regarding market timing and waiting for the perfect buying opportunities, or even good ones. How do we quantify a crash? After I read that linked article, it resonated with me, but on further reflection:

    ” … he waited until after the market had fully crashed in 1933 to make his first stock purchase”

    Well, he nailed it. But there were some fakeouts in 1930 and 1931, and it dropped back to nearly 1933 levels in 1943. Again, I am reminded how volatile the market can be.

    I honestly don’t know whether the author capitalized on his own advice. Perhaps I’ll drop a line and ask. I know I was oblivious to the markets for most of my life, even the most recent crash. I remember everyone immersed in doom and gloom back in 2008, but I just kept going to work wondering what the fuss was about.

    Sometimes ignorance can be bliss.


    All the best,

    (ps I am currently all in cash, as I previously mentioned. However, I am becoming receptive to the idea of investing, but I still have some strong reservations.)

  31. Chris December 19, 2013 at 2:45 am

    Hey Richard,

    Thanks for the kind words. Truth be told, I’m fluctuating a bit. Brian has put forth a compelling case for long term investing, and your thoughts regarding the impact of drawdowns combined with long term returns had me bust out my calculator to look at possible scenarios.

    I played out all sorts of futures, some favored a cash only strategy (particularly in the short-term, natch)… but most didn’t. Coupound interest, indeed, gives you breathing room for those disasters that may come, and not simply over 40 year time periods. Now, I do have reservations about the potential returns from the market in the future. I also have reseverations regarding the recent highs the market has made. Nonetheless, as you point out:

    “If you believe it’s possible there will be a crash when no one expects it, isn’t it also possible that a seemingly overvalued market will never go down to the level where you would currently want to buy?”

    So I must be fair and apply the same skepticism to my pessissmism and acknowledge that could happen.


    As you are 100% in stocks (good day for you today!), you mentioned that a crash would suit you fine as:

    “I would gain a lot and likely lose nothing permanent”

    Is this on account that you would simply buy more to add to your long term investments? While perusing the web I came across some exceptional individuals that had significant resources that allowed them to take more risk in the market, as their income would cushion any blow. Whereas the average investor was more inclined to take a less volatile approach.

    As I examine this, though, it seems that provided we are not retiring in the near term, a 100% stock approach over the long run would make more sense than a more conservative split … for the very same reasons that ~6% from a Couch Potatoe portfolio whumps ~3% from GICs.


  32. Richard December 19, 2013 at 8:12 am

    I have several different targets I’m aiming for since I just want assurances of potential backup income rather than a fixed retirement date. But any of those targets will require a portfolio that is a good multiple of the current value. So there are two ways to get there.

    Either it will grow a lot on its own, estimated at several decades of good returns, or I will have to add a lot more than I have currently. In short my plan is to stay into the market until my investment has paid off. I can’t tell if that will be in 3 years or 30 years so I keep adding as much as I can to shorten the timeline. A crash would mean that I’m investing more at a higher yield which is good. And since I’m investing as much as possible, if the market happens to rise rapidly I also benefit from that.

    At the point where a crash wouldn’t benefit the majority of my future assets, I will consider shifting the asset allocation because I will be close to “filling up” the stock portion. Since it has the highest long-term growth I find it best to focus there first and give it the most time.

    Personally I have a fairly high savings rate which helps at any income level. I wasn’t always doing that much though, and small amounts invested for a long time are just as good as large amounts invested for a short time (better really, since there is less chance of disaster over a long period). I am counting on that high savings rate rather than long-term compounding which means I’m ignoring one of the most powerful tools for individual investors. Buying a couple of decades can require saving several multiples. Of course if I don’t retire once I have enough then I can let that compound which I expect will be quite productive.

    The problem with predictions is that you have to take virtually anything as a possibility. If you want a very thorough analysis of every possible past scenario, which may not be repeated but is realistic because it happened, then check out Jim Otar’s Unveiling the Retirement Myth.

  33. Chris December 19, 2013 at 12:58 pm

    Hey Richard, thanks for the book recommendation.

    Reading the author’s website (retirementoptimizer) and the Amazon reviews suggests this is exactly the sort of analysis I needed. I was always skeptical of “x” amount of “average” return. I see huge fluctuating periods of returns over decades that are glossed over on many financial planning sites. It looks like Jim takes this into account not only in building your retirement funds, but living off them as well.

    This is really what led me to be skeptical of the market and its value in my retirement. What if I took my nest egg, the market crashed, and then was followed by abysmal returns for the next 20 years? IE, what happened if I started investing in another 1929-like era? Or a major market correction occurred on the eve of one’s retirement? It appears that at least the odds of this can be quantified and factored into one’s planning.

    I know from my own profession the impact that variance can have on one’s outcome over various time lines, even with a favorable edge. It sounds like Jim accounts for all possible futures, and by doing so, allows an investor to know what he’s in for. It may be, also, that chance does play a larger factor than we care to admit. As the previous article I linked suggested, if we were born in the last 86 years, we’ve been pretty lucky. But things weren’t always this way, and we shouldn’t assume they will continue.

    Thanks again for the great discussion, one and all.

    All the best,

  34. Brian G December 19, 2013 at 1:59 pm

    “On a real basis, it would have taken an investor that first allocated in September 1929 over 56 years in 1985 before they would finally achieve a permanent price gain on their investment.” [when accounting for inflation]

    Notice how specific the author had to be to get to the conclusion he wanted. This is what he has done: out of the last ~1000 months he found the worse case scenario of when to invest a lump sum 100% into the stock market. I could turn it around and say 999/1000 months the results were better. :)

    But I can go further and give my original scenario of somebody investing a fixed amount monthly into an annually re-balanced 60%/40% stocks/bonds portfolio over 40 years (25 to 65). In that case, If they invested starting in the early ’20’s they would have seen a nice gain as they started to invest, they would have captured some gains into their bonds during annual re-balancing, then after the crash their subsequent investments would have bought at the low. Had they started investing in ’29 right before the crash, they would have had little in the market, so any crash would have been insignificant for the long term and their monthly buying would have been able to buy at lows going forward. Had they started after ’29… well you see the picture.

    The moral here… young people with lots of time ahead of them have some very easy strategies to invest. Just do month contributions to a annually rebalanced low-cost diversified balanced 60/40 portfolio (such as a Couch Potato portfolio or any good, diversified, low cost portfolio.) Then as you come within 10-15 years of retirement, every year during rebalancing, ramp down your equity holdings so that you reach your target post-retirement allocation at retirement. That’s it. Is it guaranteed to work? Nope, but back-testing says in the last 100 years it would done okay.

    So what do you do if you have a huge lump sum of money to invest? Two strategies… enter the market slowly or use options (e.g. protective put) on the broad market ETF you hold to “buy insurance” to protect yourself from a large drop in first few years… like all insurance, this will cost money but if you’re worried it’s an option.

    Regarding Taleb, I think I’ll just quote him from his Bloomberg profile:
    – He says 97 percent of the money he has ever made was on Black Monday in 1987. “There are concentrated pockets of luck.”
    – “I make no claims of being able to beat markets”

    One place where I agree with him is that market returns don’t have a normal distribution and they do have long tails (e.g. some really bad days and some really good days.) This is why Modern Portfolio Theory has it’s limits and why you cannot over optimize asset allocations within a portfolio.

    The simplest take away is, diversity into assets that don’t behave like one another and don’t put all your eggs in one basket. Always consider the worst case scenario and ensure you can live with that, even if it is not likely.

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  37. Mark Zoril December 20, 2013 at 3:41 pm

    Good stuff! As an advisor who was encouraged to employ the type of tactics (and then some) you refer to, I am completely convinced that consumers should use index investments and look to advisors for planning and educational guidance instead of actual active investment strategies. Over the years, I became disgusted with the ridiculous sales and marketing ploys used to promote overpriced and/or unnecessary advisement. I am still an advisor but I changed my model so I could charge clients a flat fee for service. It has been liberating for me and much better for my clients.

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  39. Roy December 21, 2013 at 9:09 pm

    Interesting article. In 1987 I started using Index Investing, a plain S&P 500 fund through my employer’s thrift plan. A few years later, they added a small cap index, and EAFE index. All charged .25 basis points per year (good but not the cheapest out there). I retired 2 years ago, and rolled that 401K to my own Vanguard account, where I bought similar funds for their lower .10 basis point usual rate.
    While having the opportunity of looking back, I see I contributed just a shade over 100 grand while the value sits today at $540K (that’s after taking about 28K out over 2 years to supplement my retirement). Didn’t do the math on what the returns have been, but there were good and awful years there. Stay the course is the best advice, and watch those expenses. Enjoying a decent retirement today!

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  44. Jerry January 10, 2014 at 2:31 am

    I personally think that it’s near-impossible for non-professional investor to beat the market other than by chance. It might be possible but it would be difficult to actually proof and even if it is true, very few people would be able to do it anyways. Index funding is just easier cheaper and even safer on the long run as long as you diversify with different asset class. I personally am not very risk-advert because of how I view life, and I suppose “desperately” want to reach my goal, though not foolishly.

    I do however think it is possible to foresee signs of big crashes like the dot-com and the 2008 if one closely follow up on current events in details and possibly mitigate the impact, especially given with how easy information to get these days and then follow up when the market begins to rise again at a reason time. I think one can even see the trend the long term health of a state with some accuracy over a long horizon of time, assuming nothing like an alien invasion or something along that happens.

  45. Rob January 13, 2014 at 11:18 pm

    Why does one switch from indexing to ETFs or can you just stick with indexing even if/when your portfolio grows over $50K?

    I’m still sitting on the sidelines – new to investing.. not sure where to put the cash (maybe Streetwise, may TD e-series) – we’d start with $10,000 and contribute regularly.

  46. Canadian Couch Potato January 14, 2014 at 8:44 am

    @Rob: “Indexing” refers to the strategy itself, and it can be employed with many different products, both mutual funds and ETFs. Choosing the appropriate product depends on several factors, including MER, transaction costs and the desire for simplicity. In my opinion, if you’re new to investing and the portfolio is five figures, simplicity is far more important than keeping fees to an absolute minimum.

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