Related Resources
Track your investments on MSN Money
Start Investing Archive
Recent articles:
• Leaving the fast lane is harder than it looks, 9/9/2002
More...
| | Start Investing
Why planners now say: Simplify and forget it
With clients groping for security and common sense, financial planners find the soundest advice is often the simplest.
By Harry Domash
Sam in Hawaii recently posted this question in the Start Investing Community: Where should I invest $30,000 for the best possible growth over the next 30 days? Sam is a high school student participating in his schools stock investing contest. His team is doing poorly and he feels desperate for advice. Perhaps the best answer he got was to put it in a money market fund.
We used to get lots of questions like Sams in the community, except that they were from real investors who expected to make money overnight. Now most of those regular investors are counting themselves lucky if they havent lost their shirts. Paul Sage, whom I once saw as one of the more aggressive investors in the community, has been 100% in cash for months now.
But we all know that were not going to hide our money under the bed forever. What should we be doing going forward? In the years that Ive been writing about investing and financial planning, Ive heard a rule of thumb that goes something like this: The institutional markets lead the way in investment trends and planners follow what's going on in institutional markets. However, consumers end up lagging three to five years behind those trends.
The new mantra: Simplify and forget about it
That being the case, I think its worth looking at what planners are doing now. Their new approach is: Simplify. Index. Forget about it.
Investment specialists, like Eleanor Blayney, a financial planner in McLean, Va., are rethinking the categories of large and small and value and growth. Blayney believes a lot of us are fooling ourselves by thinking were well diversified with a growth fund and a value fund.
People feel theyre getting a good differentiation in behavior by going to growth and value funds, she says. I think you need to be more discriminating.
The value vs. growth argument was based largely on the Fama-French study of 1992, which defined value as a high book-to-market stock. (Book to market is the ratio of book value to market value of an equity. Book value is simply the companys assets minus liabilities.) The study by finance professors Eugene F. Fama and Kenneth R. French determined that stocks that were high book-to-market were distressed stocks that behaved very differently from other stocks. But Fama and French were very discriminating, looking only at the group of stocks on the extreme of the continuum. Today most investors or portfolio managers simply divide the stocks in half based on some value measure and call the top half growth and the bottom half value. When you get to the middle, theres very little difference between the stocks.
Another problem is that stocks identified as value tend to be clustered in certain market sectors like financial, energy and utilities, so that investors end up buying a sector fund when they think theyre buying a value fund. Ideally value would be sector-neutral, Blayney said. We try to define value without buying a sector fund.
Like more and more planners, Blayney uses a substantial core of index funds, sometimes using a pure value fund such as Dodge & Cox (DODGX) as well. But she doesnt fiddle so much with the sometimes-artificial distinctions between stock classes.
An evolution in planning
Bob Veres, who hired me in the mid-80s to write a column about financial planning, has been in the industry much longer than I have. Veres, who publishes a newsletter called Inside Information, said he sees an evolution in planning. Once upon a time, most advisers were looking for home-run returns and chasing hot performance, he says. Today, when managers screen funds, they want consistency of returns, manager tenure, low expenses. Savvy consumers have moved in the same direction.
But Veres argues that the cutting-edge planners dont waste any of their valuable time screening funds. Paul Resnik, a planner in Sydney, Australia, told Veres: "The chances of picking three or four managers who outperform the index are almost zilch." So why bother?
In a paper he presented at the Financial Planning Association Retreat, Harold Evensky, a planner in Miami, went through a complex evaluation of funds and then told planners that even if he were able to identify, with absolute consistency, the top-quartile performers in each asset class, he would still be incurring costs and expenses in the fund portfolio that would eat up those excess returns. Because Evensky isnt convinced that he can make those judgments with that much accuracy, the screening process for active managers looks to him like an inevitable loser's game.
Finally, Paul Solli, a planner in Larkspur, Calif., told Veres that studies have shown that taxable investors have a roughly 14% chance of beating their benchmarks by roughly 1.28% a year, and an 86% chance of losing, on average, 3.19% to the benchmark.
So, these advisers, according to Veres, changed their approach from spending a lot of effort looking for slightly above-average performance to spending little effort looking for average performance.
Veres argues that a financial adviser can add more value by counseling clients and helping them with things they have more control over: budgeting, taxes, making more informed life decisions.
So Veres suggests that this is the next evolution in financial planning, that planners will tend client portfolios in the most cost-effective, time-efficient way possible and spend more time on clients' personal issues.
Financial advisers will still give advice to clients: Keep investing through the downturns, continue to diversify, pay attention to expenses, avoid active trading and never follow the herd.
The indexes will come back
This sounds like pretty good advice to me. I know that Ill never convince some of you -- like my colleague Tim Middleton -- that screening for top funds is a waste of time. Depending on how much time you have and the other demands on it, perhaps it isnt. As for me, Im trying to wrap up a book on deadline and help my daughter, who is a high-school junior in the midst of SAT preparation and the college search. I dont have one extra moment.
I never argue for selling off all your holdings and starting fresh, and I wouldnt do it myself. But my last purchase was the Standard & Poors 500 SPDR Trust (SPY, news, msgs), and I own a good deal of the Nasdaq 100 Trust (QQQ, news, msgs) as well.
We dont know when these indexes will come back. But the chance that they will come back is high. Compare that to another question we got in the community this week: Which of the penny stocks is the best buy? Thats a question it would take me the rest of my life to try to answer.
At the time of publication, Mary Rowland owned the following securities mentioned in this article: Dodge & Cox Stock, SPDRs and the Nasdaq 100 Trust.
|
