Index Tracking is your only (wo)man

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Index Tracking is your only (Wo)Man

by Gerard Sheehy on June 29th, 2010
24 Comments

“There are three classes of people who do not believe the markets work: the Cubans, the North Koreans, and Active Managers.” Rex Sinquefield

I came across this quote while reading ‘The Elements of Investing’ by Malkiel & Ellis. The book is concise, to the point, and a good read for anyone who is considering investing in any asset class via pension or other long-term savings accounts. But, do bear in mind that it is directed at the US market and there are some anomalies in terms of the products and funds that they refer to.

The Irish Funds market is dominated by offerings from ‘Active’ Fund Managers. The underlying premise of these; is that the Fund Manager will somehow outperform the market by actively managing your investment. He/She will try to do this by applying his/her skills in selecting stocks, bonds etc that will beat the market.

Passive Funds (Index-Tracking), on the other hand, simply ‘track’ the performance of a basket of assets. For example, the passive fund that tracks the 500 largest Company shares in the US is the S&P 500 Index. Put another way, there is no ‘human’ involvement in asset selection so there is less of a chance of ‘someone’ messing it up.

In my humble opinion, the average investor is better off with Index-Tracking Funds: as opposed to trying to pick stocks or active fund managers that will outperform the market. The fund managers past performance should be ignored, as it has no bearing on what may happen in the future. It doesn’t seem to matter how many times you tell this to people, they still want to consider it in the decision making process. It’s folly, pure and simple.

It is my firm belief that low-cost, well diversified [by asset class and region], index-tracking funds are the most suitable investment vehicle for folks who do not consider themselves expert stock pickers. As the above authors say: “Nobody knows more than the market”.

If you want to tease this out a bit more or have an opinion on this type of investment strategy, please share your comments below.

Category: Financial Planning

Tags: Funds, Invest, Passive 'Management', Pension, Save

The Author: Gerard Sheehy

I am a Financial Advisor who is authorised to provide broad based financial advice in relation to PRSA's, Pensions, Life Insurance and other Insured Investment Products in Ireland. Special Focus: Low-Cost 'Execution Only' Financial Products http://www.investandsave.ie

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http://www.channelship.ie/blog facundo

Hi Una, I wonder what your thoughts are for B2C companies who are really tight on budget and must choose were to spend wisely (only one option): Would you say that the rule is to put all the chips con Marketing and hold on tight for the consumer sentiment to go up or concentrate on pricing/punctual promotional efforts & sales to get the cashflow in?
http://www.channelship.ie/ Fred

Good one Una. I believe that sentiment plays a big role here. The fact that nobody wants to spend money in anything unless it’s a 100% formula for success (that doesn’t exist), it makes business owners wait longer and take no action against the problem… There’s also a huge portion of disbelief, so even if a great, fantastic formula to save a business arises… it would still be difficult for many companies to recognise it as such..
http://www.btbtraining.com/blog Niall Devitt

Hi Una, Marketing as a profession is suffering from both the economic climate and the rise of online marketing such as social media. I agree that companies should increase rather than decrease spend, however I would add that I do feel we have lost our way a little in terms of how to market effectively. Sales has suffered a very similar fate of late, trust me I know . Again I think a huge amount comes down to the skill of the person doing the marketing. The point is that throwing money at marketing alone without a plan and a strategy is in itself fruitless. I’d love to know your thoughts and those of others?
http://www.cubeonlinemarketing.ie/google-buzz-for-business-get-your-wallet-out/ Leslie

I think cutting some areas of marketing spend are a good idea as some are purely ego vanity driven.
Anonymous

Duh!? Can you expand on that?
http://www.codegaconsulting.com/ Una Coleman

Thanks Facundo for reading and commenting. Of course, companies in the current climate have no choice but to look at opportunities to cut costs and focusing promotional efforts to bring in cash is a good strategy. However, in an international context, Irish companies are competing against local market competitors who may not be quite as constrained as we are. So, I would suggest that some competitor research first to determine what strategy is likely to lead to best results.
http://www.codegaconsulting.com/ Una Coleman

Agree Fred. While online marketing gives us much better tools to measure success, many marketing initiatives are about building brand and name awareness, over the longer term. That’s harder to measure in the short term. And yes, sentiment does influence. Sentiment is impacting the economic recovery – the global stimulus packages are not having the impact that was expected as consumers, at the heart of the economy, are nervous of spending, even those currently safely employed.
http://www.codegaconsulting.com/ Una Coleman

Thanks Niall. I agree. One of the downsides of Web 2.0 technologies is that everybody can be a DIY marketer. But, just because you are able to put an email marketing campaign together doesn’t mean it’s going to be a success. Yes, sales are suffering too – again it’s back to budget and cashflow issues. The upside, taking the postive view this morning, is that this economic recession should have a very positive impact on global warming and carbon emmissions!
http://www.codegaconsulting.com/ Una Coleman

Leslie, like Lewis below, I’d love to hear your further thoughts on this. Maybe during the Celtic Tiger era some companies had the luxury of having a less than firm hold on their marketing budgets but, in my experience, competition is so demanding these days, in every vertical, business that all expense items are managed in the context of contribution to ROI.
http://twitter.com/whatclinic Caelen King

A great way to increase your effective marketing that I am currently writing a blog post on is spend is to reduce the time it takes for you to recycle your marketing spend. If it normally takes you two months to see cash from a marketing campaign because of sales & payment cycles then work at reducing it to one month. This effectively doubles the amount of money you can spend on marketing in a given period without requiring any additional capital. This is something that we are actively doing in RevaHealth.com with great results. Every day you can cut off your business cycles is a day quicker you can get the money out there working for you.
http://www.codegaconsulting.com/ Una Coleman

Thanks for this Calen. Please come back and let us know when you’ve finished your blog on the subject.
http://twitter.com/Micheal_Nagle Micheal Nagle

Hi Niall. From my research and from talking to SMEs alot of firms that cut costs when it comes to Marketing, just do it for the sake of it and dont have any effective Marketing Plan in the first place. They often do not understand the implications in the medium and long term of reducing Marketing spend. You are quite correct in saying that throwing money at marketing without a strategy is pointless. SMEs need to take a root and branch review of their business to try and establish what their core business is and determine who their customers really are. Businesses should rate the value and volume of their customers and decide who they really wish to target with their Marketing strategy. By focussing you can improve the perceived quality of your product which will help to survive the tough times.
http://www.btbtraining.com/blog Niall Devitt

Thanks Micheal, we are in full agreement
http://twitter.com/Micheal_Nagle Micheal Nagle

Hi Facundo, if I may jump in I might offer my opinion on this question. As mentioned in the article, reducing Marketing spend is quite common among SMEs in a recession. It is for this very reason in my opinion that firms should grab the bull by the horns and invest aggresively in Marketing. Many competitors will be feeling the pinch of the recession and may decide to cut back on their marketing efforts, therefore any marketing campaign your business undertakes will stand out from the crowd simply due to the attrition of competing campaigns.

Concentrating on pricing cutting can be a tricky one and is sometimes shortsighted. The problem as i see it is two-fold. Firstly, as mentioned in the article if prices are cut due to the recession consumers are less willing to return to higher prices once there is a recovery. Secondly, budgets are based on projected revenue and firms need to understand that reducing prices may help to stabilize the number of units sold but if spending plans are not adjusted, profit margins can quickly turn negative. Literature has shown that the failure to update the impacts of sales forecasts on margins is a major factor in business bankruptcy during a recession. Therefore in my opinion prices should only be reduced as a final attempt to maintain cashflow.
http://www.sianphillips.ie Sian Phillips

That’s a great post. Speaking from the other side as in the seller of advertising obviously we have noticed a huge drop and the main excuse in the last two years is 99% because of the recession and lack of funds. However there have a been a few customers who have actually taken more advertising, therefore effectively jumping into their competitors shoes and they have done very well. It’s almost like others dropping off and these clever advertisers ensure that they are definitely still seen.
Indeed a few years ago when working for the London online directory, one of my customers increased his advertising by more than ten-fold when his competitors dropped away. He really reaped in the benefits and doubled his advertising the following year – and I see he is still going strong with advertising all over the directory. So it worked for him to increase and not decrease. I do appreciate that times are hard and sometimes money just isn’t there. That’s why at Whatswhat.ie we reduced our advertising charge to €5 a month which has attracted a lot more advertisers because it has catered to their pockets
http://recessionsolution.wordpress.com/ scott aughtmon @rampbusinesses

Michael’s advice is totally correct!

After interviewing 38 business, marketing and sales experts I discovered that the common mistake most business owners in a recession is that they stop marketing. As best-selling author Jay “Guerilla Marketing” Levinson said, “Stopping your marketing to save money is like stopping your watch to save time.”

There are two dangers for business owners when times are tough:

1. The danger of doing the wrong thing. (As Micheal warned here.)

2. The danger of doing nothing.

Another common mistake that business owners make during a recession is they do nothing at all. They “bury their heads” hoping it’ll all be over soon. The problem with doing that is that this action can many times cause your business to be over soon!
http://www.codegaconsulting.com/ Una Coleman

Thanks Scott for your comments. Good to get feedback and other experience. Please do come back again to comment on future posts.
http://twitter.com/Micheal_Nagle Micheal Nagle

Hi Sian. Thanks for the comment. Its really great to hear some first hand experience that backs up the main point of this post. The majority of businesses that I have spoken to make the common mistake of reducing marketing & advertising spend, it is sadly rare to see a business which increases marketing spend in a recession such as the one you mention from the London online directory. Many Irish businesses could learn from this example.
http://twitter.com/Micheal_Nagle Micheal Nagle

Thank you for the comments Scott and for a great quote from Jay Levinson!

It is fascinating how many businesses the world over are guilty of reducing marketing spend in a recession, this fallacy seems to arise time and time again. While it has to be acknowledged that managing in a vacuum has its difficulties, like you say the last thing a business should do is take an ‘ostrich approach’ and bury its head in the sand or be paralysed and overcautious. Businesses need to take a ‘boxer in the ring approach’ and meet their problems head on if they wish to survive the recession. This includes implementing aggressive marketing strategies such as this post preaches.
http://www.codegaconsulting.com/ Una Coleman

Micheal, thanks for participating in the discussion and getting involved. Your commentary has been most informative. Good luck with your new venture: Greenpages.ie and greenbizpages.ie and your linkedin group, “Green Business Ireland. a “how to” guide for businesses to become more cost efficient by minimising waste and reducing energy consumption.
http://twitter.com/fredchannel Fred

Thanks Gerard. Interesting, I would have guessed that the past performance would be important. I know the fund managers need to predict the future but wouldn’t that “world view” help them predict better?
http://www.seefincoaching.com/blog Elaine Rogers

I would suggest that it’s important for some to base their decision on “past performance” or “past experience” when choosing a fund manager. That way, if they don’t perform, it’s all their fault, and the decision maker’s decision is exonerated.
By not relying at past experience, the decision maker/investor is taking responsibility for their own decisions and actions, so is open to failure. For some, failure is not an option.
Thanks for clarifying in simple terms, the difference between active and passive funds
Gerard Sheehy

I am of the opinion that the single most important factor in deciding which fund/s to invest in is, cost . Actively managed funds tend to have higher Annual Management Charges (AMCs) than passive funds. If a passive fund has an AMC of 1%pa and the active fund charges 1.25%pa then the active fund manager had to beat the market by 0.25%pa. It might seem like this would be easy to do; but it’s not, over a prolonged period of time.

Don’t forget that we are talking about medium to long term investments here. Any investment manager can provide you with past performance figures showing you where they are ‘Number 1′ over a certain period of time, but you have to put that in context. Is that ‘Number 1′ position measured against all Active Funds in that sector or is it measured against a Benchmark Indexed (Passive) Fund and how do costs influence the results.

You may get the odd fund manager that does really well over a certain period, but it’s not sustainable. How do you identify this guy/gal before you invest? How do you know he/she will not move to a different company? It’s possible that he/she may become overconfident/arrogant and make serious mistakes, yes/no?

If you are a DIY Investor in Funds, you eliminate the risk of choosing the ‘wrong’ fund manager by electing for Index-Tracking Funds.

If you rely on a Financial Advisor for their input/recommendation on picking the ‘right’ fund manager, based on past performance, you might get them to share their crystal ball with us lesser mortals .
Tferguson25

hi Scott can you let me know where this quote from Jay Levinson originated from? I would like to use this in a research proposal for my MBS. thanks, Tony.

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