Cannot index bonds or international??

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Cin2511
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Cannot index bonds or international??

Post by Cin2511 » Mon Feb 06, 2017 10:58 am

My company 401k rep always tries to to walk me back from the indexing approach. His four (4) main comments:

1. He states that indexing is great in bull markets but not ideal in bear markets when you want to have someone with a finger on the button, so to speak.
2. Bonds are difficult to impossible to index and it’s better to have an actively managed fund
3. International is even more difficult to index. Pointed out some actively managed funds performance vs. index funds as evidence.
4. He says that PERFORMANCE NET OF FEES is more important indicator that EXPENSE.

Thoughts, especially on indexing bonds & international?

Elbowman
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Re: Cannot index bonds or international??

Post by Elbowman » Mon Feb 06, 2017 11:52 am

I'll just focus on the most important bit because I should be working :) .
Cin2511 wrote:He says that PERFORMANCE NET OF FEES is more important indicator that EXPENSE.
Performance net of fees GOING FORWARD is the most important factor. You can't invest in the past, and past performance (net of fees) is not actually a great predictor of future performance. The best predictor of future performance is EXPENSE. Morningstar, in an impressive bit of honesty, said that low expense ratios were a better predictor of strong future performance than even their own Morningstar rating system.

The main benefit of indexing is not actually the index itself, but the incredibly low cost of implementing it. If I was faced with a choice between a 0.75% ER index fund and a diversified, 0.25% ER active fund, I would invest in the active fund (but of course that almost never happens).

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ruralavalon
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Re: Cannot index bonds or international??

Post by ruralavalon » Mon Feb 06, 2017 11:53 am

Cin2511 wrote:My company 401k rep always tries to to walk me back from the indexing approach. His four (4) main comments:

1. He states that indexing is great in bull markets but not ideal in bear markets when you want to have someone with a finger on the button, so to speak.
2. Bonds are difficult to impossible to index and it’s better to have an actively managed fund
3. International is even more difficult to index. Pointed out some actively managed funds performance vs. index funds as evidence.
4. He says that PERFORMANCE NET OF FEES is more important indicator that EXPENSE.

Thoughts, especially on indexing bonds & international?
Impossible index bonds and international?

BlackRock, Fidelity, Schwab, State Street, and Vanguard all do operate both bond index funds and international stock index funds.

Of course the company 401k rep, and anyone else who can use a fund screener, can find examples of actively managed bond or international funds that beat bond or international index funds in the past. That's not at all difficult to do.

The difficult thing to do would be to pick the actively managed fund that will do well in the future, not picking one that did well in the past.

Please Google "SPIVA scorecards", most actively managed international stock funds have underperformed comparable international stock index funds.
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ruralavalon
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Re: Cannot index bonds or international??

Post by ruralavalon » Mon Feb 06, 2017 11:53 am

Duplicate post deleted.
Last edited by ruralavalon on Mon Feb 06, 2017 2:14 pm, edited 1 time in total.
"Everything should be as simple as it is, but not simpler." - Albert Einstein | Wiki article link:Getting Started

avalpert
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Re: Cannot index bonds or international??

Post by avalpert » Mon Feb 06, 2017 12:02 pm

Cin2511 wrote:My company 401k rep always tries to to walk me back from the indexing approach. His four (4) main comments:
I'd stop talking to your company 401k rep.
1. He states that indexing is great in bull markets but not ideal in bear markets when you want to have someone with a finger on the button, so to speak.
A common assertion by those making money off of your investments in active funds - isn't backed up by the data though. It assumes that the someone with a finger on the button know when markets turns from bears to bulls and back again - history has not been kind to that assumption.
2. Bonds are difficult to impossible to index and it’s better to have an actively managed fund
I think there are certain areas in the bond world (like treasuries) where the distinction between active and index is blurred enough to not be all that relevant - of course that just means price is paramount and a bond index fund is likely to be cheaper.
3. International is even more difficult to index. Pointed out some actively managed funds performance vs. index funds as evidence.
Utter nonsense. International is very easy to index - sure some pockets of the markets are hard to get at just as they are in the US (like microcaps) but they don't amount to much impact and active managers haven't demonstrated any better ability to win big in those spaces than in others.
4. He says that PERFORMANCE NET OF FEES is more important indicator that EXPENSE.
Of course performance net of fees is more important than fees - the thing is for comparable risk exposures the best predictor of performance net of fees is fees.

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nisiprius
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Re: Cannot index bonds or international??

Post by nisiprius » Mon Feb 06, 2017 12:40 pm

They're standard anti-indexing talking points. I could give you the standard Boglehead pro-indexing talking points--in fact I will--but that's secondary.

You're not going to convince him. If he can convince you to play a game, in which the rules are "if you do not out-debate me, you must use active funds," you've lost the game. Your position is not "indexing is better." Your position is "you might be right but nevertheless, I am an indexer, I want to index, I am an employee, you are here to serve me within reason, and I personally want to use index funds. It's not a crazy request. Could you give us a few more in the list of fund choices? Pretty please?"

There is some truth in "bonds are more difficult to index than stocks," Vanguard people have occasionally said so, and many of Vanguard's bond funds are not index funds--but it's not that hard. Vanguard has been doing it for years and tracking the bond indexes accurately, and it's not just Vanguard. Fidelity is able to do it, Schwab is able to do it, iShares is able to do it. I got my employer to add a bond index fund by politely requesting it--but since the 401(k) manager was Fidelity, I said "a bond index fund such as FBIDX."

"International stocks are hard to index" must be nonsense, there are lots of international stock index funds.

It is frequently claimed that active mutual funds successfully protect investors during bear markets, but this claim has been debunked over and over again. You can probably debunk it yourself simply by charting how your 401(k)'s favorite managed fund compared to Total Stock during 2008-2009. Sometimes there's no effect at all. Sometimes there is, but hardly worth talking about. For example, Total Stock dropped 52%, Fidelity Contrafund 48%, American Growth Fund of America 49%. It doesn't live up to any dreams of earning normal stock-market returns, but riding out 2008-2009 without a hitch while your foolish indexing friends are suffering.

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The point that what matters is investor returns after expenses is obviously both true and misleading. The unstated implication is that although actively managed funds have higher expenses, they overcome those expenses to give you higher returns after expenses. The problem is that past performance doesn't predict future results--Morningstar itself has said that its star ratings do not have any persistence or predictive value. Furthermore, Morningstar has said that expenses do have predictive value--predictive of returns after expense. That's pretty strong pair of statements, especially coming from a company that's in the star-rating business. (The star ratings are intended to be fair comparisons of past performance, fairer than raw return, because they take risk and fund style into account).

It's a pair of strong statements: star ratings don't predict, and expense ratios do predict!

Fund Fees Predict Future Success or Failure
Russell Kinnel of Morningstar wrote:we have updated the data to show just how strong and dependable fees are as a predictor of future success. That's not to say investors should use them in isolation. There are many other things to consider, but investors should make expense ratios their first or second screen...

The Answer: Costs Really Are Good Predictors of Success
We've done this over many years and many fund types, and expense ratios consistently show predictive power.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.

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