Charles D, Ellis is a giant in our industry. He is also a really smart guy — retired academic, founder of Greenwich Associates, former Investment Committee Chair of the Yale Endowment, and the author of fifteen books, including two of particular import. These two books are Winning the Loser’s Game: Timeless Strategies for Successful Investing and The Elements of Investing (with Princeton’s Burton G. Malkiel). I met Charley today after he spoke here at the CFA Institute Conference. That’s us above (the giant is on the left). He was delightful.
Ellis sat for an interview with Consuelo Mack recently (it may be seen here). As most of my audience will know, Ellis is a proponent of index investing for individuals. Over the course of the interview, Ellis makes a number of interesting and provocative points, consistent with his books.
- For individuals, everything begins with saving, and the earlier we start, the better (because “catching up is hard and keeps getting harder, the longer you wait”).
- A few great investors (like Warren Buffett and David Swensen) can beat the market, but most don’t, which is why indexing is smart policy.
- The competition among the hoards of industrious and talented investors to outperform is vigorous, effectively cancelling each other out.
- A few investment firms have clients’ interests as central (such as the Capital Group, Wellington, T, Rowe Price, American Funds and Vanguard, but most are simply “commercial” and do not.
- Investors should diversify as broadly and deeply as possible.
- Commodities offer no economic productivity, making investment in them entirely speculative and to be avoided generally.
- A key to investing is simply to avoid mistakes, like panic selling and greedy buying (but doing so isn’t simple).
- Investors need accountability to someone who knows and cares about them.
- Individual investors need to “stabilize” their portfolios as they get older, usually by owning more high quality bonds.
The interview is well worth your careful attention. In essence, Charley is making the case for careful asset allocation using low-cost index funds with regular re-balancing and adjustments as needed to keep the portfolio in line with one’s risk tolerance. This carefully articulated viewpoint leads to my statement of what I call “the Charley Ellis Challenge” — to the extent that you do not agree with or follow his advice, why don’t you and upon what evidence do you rely for not doing so?
Your real-time notes from the CFA Conference are a great service, and I’m glad to see it is garnering you new readers!
Thanks, Wade. It’s great to be appreciated.
I agree. I was at the conference and have already gone back to Bob’s notes for reminders. They are excellent!
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Much of what Ellis says makes sense (start saving early, avoiding mistakes, and being accountable to someone else). The issues surrounding investor psychology are difficult to comprehend, much less recognize in oneself. I have implemented some sort of facsimile of discipline to avoid mistakes by sticking rigorously to my written-down methodologies and criteria, and moving slowly. After all, if I miss a bus, another one will come along soon, to paraphrase Buffett. A tendency to inaction can serve investors well, I think.
As I’ve discussed before, I categorically reject the notion that only a handful of people can earn meaningful excess returns. I might not be able to manage a multi-billion dollar portfolio and beat the market, but I believe that a small investor with less than $50 million can be nimble and find bargains that are inaccessible to those who need to move the needle on a gigantic wad of capital. The small-cap markets are essentially closed at any meaningful level to the large funds.
His point on diversification is worth discussing. Buffett would say that diversification is just diluting your potential returns. In fact, small investors are already more diversified than they are given credit for by virtue of the fact that their income is probably mostly uncorrelated to the S&P500, as are the value of their future Social Security benefits, any pension plan, and their home (if they own). Look at the present value of those income streams along with the PV of the retirement nest egg, and you’ll see that there is now less need to widely diversify the next egg.
On stabilizing portfolios on aging, this makes sense, but probably not as young as many advisers recommend. A large risk is the one of outliving one’s savings. Given a 20-30+ year retirement period, most retirees would do well to remain largely in equities in the first decade of retirement (depending on their financial situation). A notable exception is when a known payment is due on a specific date — for example, shifting a kid’s 529 plan into less volatile investments like cash or short-term bonds by picking a spot before high school graduation approaches — four years of college is not a long-enough duration to overcome any serious market crashes with certainty.
Personally, in 401(k)’s with limited investment options, I would recommend following an index and rebalance strategy. Period rebalancing has been shown to provide excess returns. For rollover assets, take a value-focused, dividend-growth approach — this allows one to invest in dividend payers in a tax-advantaged manner. And finally, on non-plan assets, use a value-based approach for stock-picking, or give your money to great allocators of capital (e.g., invest in L, LUK, MKL or Y, FFH, SEQUX (which gets you exposure to BRK-A), and/or FAIRX or GOODX).
To touch on diversification again, I think it is important to diversify not on a portfolio risk approach, but based on political risk. Put your money in various buckets (real estate, stock brokerage accounts, 401(k), Roth IRA, traditional IRA, cash, overseas investments, direct interests in non-public businesses). In a country where 30% of near-retirees in their 60s have saved less than $25,000, and on average poll respondents aged 20-65 had saved 7% of their desired $550K nest egg, it is highly likely that Congress will change the rules of the game. Already, some Congresspeople have been quoted as saying that it is unfair that some people have saved a lot for retirement and others have no nest egg. We have a huge national debt repayment issue in the future, and a generational bulge whose pensions and old-age medical care we need to fund. It does not take a big leap to imagine that Congress may decide to make Roth IRA withdrawals taxable, or to impose huge capital gains or dividend taxes, to implement 10% charges on IRA/401k withdrawals even after retirement age, or to outright roll retirement plans into social security.
I am writing up some answers to questions from a webinar I gave. I would like to link to your blog post elaborating on the point here: challenging active managers to demonstrate how they provide value. Can you please direct me to that post? I am having trouble finding it.
Best wishes, Wade
I think you mean this one, Wade: https://rpseawright.wordpress.com/2012/03/06/the-active-mangement-challenge/
Related posts: https://rpseawright.wordpress.com/2012/03/07/more-on-the-active-management-challenge/
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