You may have guessed that I’m a bit of a freak when it comes to personal finance. Only a freak would get up at 5:30 a.m. on a Saturday to write about money. Right?
Given that, it shouldn’t surprise you that Freakonomics (www.freakonomics.com) is one of my favorite podcasts. Freakonomics explores the hidden side of human behavior and how we make decisions – behavioral economics – through stories and interviews.
A recent episode, called “The Stupidest Thing You Can Do With Money,” grabbed my attention.
The show addresses two options for investing:
1. Hire an investment adviser, who studies the financial markets using sophisticated tools and actively manages your money to get you the best return.
2. Do-it-yourself investing – passively invest with a set-it-and-forget-it attitude.
Investment advisers give their clients advice about where and how to invest, charging fees either as a percentage of assets under management, typically 1 to 2 percent, or a flat amount. There are about 300,000 investment advisers in the United States. Most of them must beat the market, right? Why else would we keep paying them?
The truth is most people are paying fees to their investment advisers for sub-par returns on their investments. Ninety-five percent of actively managed portfolios can’t consistently beat the S&P 500 index after subtracting fees.
An S&P 500 index fund is a low-cost way to own a diversified portfolio. The fund owns stocks in 500 of the largest U.S. companies – the S&P 500, which spans many different industries and accounts for about three-fourths of the U.S. stock market’s value.
And it’s not just your investment adviser who can’t beat the market. Harvard University has an endowment of $38 billion and access to some of the best and brightest minds and top computer-modeling tools. Yet, the university’s annualized net return on investment for the past 10 years was less than 6 percent. The S&P 500 earned 7.72 percent over the same period.
Welcome to the low-cost, index fund investing DIY revolution. Not only are low-cost mutual funds, such as S&P 500 index funds and total stock market index funds, beating actively managed portfolios, they are doing it at a lower cost.
Jack Bogle, founder of Vanguard and the world’s first index fund, says this about fees: “If the market return is 7 percent and the active manager gives you 5 after that 2 percent cost, and the index fund gives you 6.96 after that four basis point cost – you don’t appreciate it much in a year – but over 50 years, believe it or not, a dollar invested at 7 percent grows to around $32 and a dollar invested at 5 percent grows to about $10.”
It’s time to join the revolution.
Durango resident and personal finance coach Matt Kelly owns Momentum: Personal Finance. www.personalfinancecoaching.com.