Your Complete Guide to Index Investing with Dan Bortolotti

Podcast 11: Fighting Evil With Index Funds

2018-05-28T22:25:26+00:00October 5th, 2017|Categories: Podcast|Tags: , |33 Comments

The waiting is over: we’re back with another episode of the Canadian Couch Potato podcast:

Our featured interview this time around is with Mike Foy, senior director of the Wealth Management Practice at J.D. Power, the well-known research firm. Mike was the lead author on the Canadian Self-Directed Investor Satisfaction Study, released in September. The survey included some 2,500 clients of the major online brokerages in Canada.

The full J.D. Power survey is not available to the public. But if you’re interested in comparing online brokerages in Canada, MoneySense has been doing an annual survey since 2013, and I was closely involved in establishing the criteria and writing the articles during the first couple of years. The 2017 edition includes a handy comparison tool that lets you scan for the features that are most important to you.

If you want to dig more deeply, you can visit the website for Surviscor, the research firm that provides the raw data for the MoneySense rankings.

Rob Carrick and the Globe and Mail also do an annual review of online brokerages and robo-advisors.

Indexing is the new Satan

I’m having little trouble finding new media items to feature in the popular Bad Investment Advice segment of the podcast. In this episode, I feature an article that appeared in the September issue of The Atlantic with a title that is pure clickbait: Are Index Funds Evil?

Here’s the main argument in a nutshell: index funds may be a triumph for ordinary investors, but their success has led to some collateral damage: namely, consumers may be paying more for certain goods and services.

The reason, say some economists, is that a small number of mutual fund firms—Vanguard, BlackRock (the parent company of iShares), State Street and Fidelity—hold trillions of dollars’ worth of shares in U.S. companies. And because index funds, by their nature, include the stocks of almost all the companies in their universe, they will frequently be major shareholders of firms in the same industry. This kind of common ownership can reduce competition and lead to higher prices for consumers.

The academic paper cited in the article, for example, says that Vanguard, BlackRock, and State Street together own about 15% of the shares of major U.S. airlines. They suggest this common ownership is correlated with higher ticket prices.

This is just the latest in a parade of popular articles targeting ETFs and index investing as a threat to capitalism and a blight on society in general. On the podcast, I offer a rebuttal.

Coping with a 2% loss

In the Ask the Spud segment, I address a comment posted recently on an online forum. The investor recently started using my ETF Model Portfolio and chose the aggressive version with 90% equities. Over the previous six months, his portfolio was down 1.94%, and he seemed shocked by this result.

Of course, it’s not unusual for equity markets to fall 2% in a few hours, let alone six months. These kinds of comments make me worry that many new investors have overestimated their risk tolerance because they have never experienced a bear market. A portfolio of 90% equities can easily see a drawdown of 30% to 40%, and it can take years to recover from a loss like that.

Here’s some context from a research brief prepared by Vanguard Canada. It looked at the 36-year period from 1980 through the end of 2015 and found the following:

  • During this period, there were 12 corrections (generally considered to be a 10% decline from peak to trough), or about one every three years. The average correction was –13.7%. It took an average of about three months for the market to bottom out, and about four months to recover.
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  • Since 1980, there have been seven bear markets (defined as a peak-to-trough decline of at least 20%), or about one every five years. The average loss during these bear markets was –33.4%. On average, it took just over a year for prices to touch bottom, and about 26 months for them to recover.

If those numbers surprise you, then you may want to reconsider your asset allocation before the next bear market is upon us. Consider your ability, willingness and need to take risk in your portfolio, and don’t make the mistake of thinking that the long-term average for equity returns looks anything like the year-by-year returns you’ll actually experience.