Archive for August, 2011

David Swensen Rips into Mutual Funds

August 15, 2011

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In an op-ed piece in The New York Times (available here; if you are unable to read the article run a Google search for the term ‘The Mutual Fund Merry-Go-Round’ and click through), David Swensen, author of Unconventional Success: A Fundamental Approach to Personal Investment, rips into the mutual fund industry for putting its profits ahead of producing returns for investors. He charges the industry with abetting investors in chasing performance through marketing campaigns that prominently play up the mutual funds in the line-up that have managed to garner coveted four- and five-star ratings from Morningstar.

Unfortunately for investors, many of the newly-minted four- and five- star funds are successful in attracting a flood of new money but go on to post poor future returns. The fund company isn’t suffering though. Some of the old dogs are now star mutual funds that can now be advertised with their recent performance prominently displayed and the process starts all over again.

Mr. Swensen offers a couple of suggestions for getting off the mutual fund merry-go-round. (1) Investors should learn to avoid the siren song of mutual fund advertisements and invest in a well-diversified portfolio of index funds such as those from Vanguard and (2) Aggressive policing of the mutual fund industry by regulators. Investors may be better off voting with their wallets now instead of waiting for regulators to do the job for them.

We are all above average

August 11, 2011

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A recent survey of American motorists by The Allstate Corporation provided further evidence of how much we are prone to overconfidence. The survey found that while nearly two-thirds of American drivers rate themselves as “excellent” or “very good” drivers, they also say that just 29 percent of their close friends and 8 percent of drivers from other states are deserving of the same rating. More men consider themselves as excellent drivers (36 percent) than women (26 percent).

The survey also found that actual driver behaviour does not gel with the glowing self ratings. 45 percent of respondents said they have driven when excessively tired, 15 percent said they have driven when under the influence and 34 percent admitted to sending a text message or email while driving. More than half said they have been involved in an accident but only a quarter of them admitted the accident was their fault.

Like motorists, investors are also prone to overconfidence. We are confident that our stock picks will provide us with above average returns. Even worse, we fool ourselves into thinking that our investment returns are better than they actually are. Michael James recently quoted one such study that found that investors overestimated their returns by 11.6 percent a year.

European Credit Crisis: What to do Now?

August 8, 2011

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In past market downturns, I’ve always maintained that an investor should stay the course, as long as she has a suitable asset allocation that she is comfortable with. Even though markets have been losing big chunks of their value seemingly every single day, the mantra remains the same: hold the course.

However, a number of investors are unfortunately finding out only now that their asset allocation was far too aggressive. What should these investors do?

The answer is easy for investors who find that they have an asset allocation that is inappropriate for their financial goals. For example, an investor who finds that the education savings of their child who is attending school pretty soon is mostly invested in stocks should take action now. She should reduce the risk of the portfolio right away by selling some stocks and parking the proceeds in savings accounts or cashable GICs. For all we know, it could get a lot uglier and it may be better to take the lumps now and preserve whatever capital is left.

It is harder to think of a suitable course of action for investors who have the ability to take risk but are only now finding out that their risk tolerance is a much lower than they had earlier estimated. There are no easy choices. They could sell some stocks now but they may be locking in their losses but selling may also mean that they don’t take an even more drastic action should stocks fall even more. Or they could resolve to reduce risk at the first available opportunity and plan to endure the current downturn. The obvious risk here is that things get a lot worse and they sell at an even worse time down the road when they feel they can’t take the heat anymore.

Personally, I’m opting to hold the course. My rebalancing spreadsheet indicates that the bond portion has increased to 2.5% of the portfolio. If current trends continue, it will soon be time to sell some bonds and buy some stocks. Until then, I’ll just be content to watch the horror show on Bay Street from the sidelines.