Down-To-Earth Financial Advice From A Mountain-Climbing Adviser

Julie Rains — Mon, 18 May 2009 19:23:04 +0000

I just finished reading The New Coffeehouse Investor by financial adviser Bill Schultheis. He's an index-fund investor and discusses his rationale for investing in non-managed funds. What I enjoyed most, besides his conversational style and references to mountain climbing and other adventures, was the way he applied analogies of common activities to making some financial decisions.

The basic plan is:

Put most of your equity investments in an unmanaged stock index fund (“…an unmanaged mutual fund that owns a piece of all the companies of a particular stock market index. The good companies and the not-so-good companies combined.”)
Consider your investment time horizon when placing and keeping money in mutual funds (for example, if you need money in the next few years, then you can take it out of the stock market and put it in more conservative investments)
Buy plain vanilla, unmanaged index funds (such as Vanguard’s 500 Index Fund) with minimal expenses rather than souped-up versions that are actively managed and charge heftier fees
Have fun exploring your passions

for the following reasons:

Capture stock market’s average returns, and help manage inflation risk
Minimize fees associated with fund management
Free up time to pursue interests, such as mountain climbing (Bill reminds me of Wise Bread blogger Nora Dunn, who also likes trekking around high, icy places) rather than spending time analyzing mutual funds and watching Wall Street news reports every day
Have energy to deal with financial planning issues such as determining spending needs, buying insurance, and developing asset allocations among various asset classes

Most mutual fund managers would receive failing grades if their results are compared to the stock market average; that is, they flunk the “beat-the-market” test.

Bill explains that most actively managed funds do not beat the stock market average and the typical rationale for buying an actively managed fund is to beat the market.

“I’ve had a few bad report cards in my life, including the one I got from Sister Lucida after telling her that I didn’t get much out of her religion class. But I have to say, in my eight years of attending Guardian Angel School, I never had a report card quite as ugly as the report cards of mutual fund managers. If these report cards were handed out by Sister Lucida, I suspect most mutual fund managers would be stuck in eighth grade.”

Don’t choose a mutual fund the same way you would choose a household appliance.

Buying a mutual fund based on its past performance seems like a logical thing to do, despite warnings on mutual fund prospectuses that say something like “past performance doesn’t guarantee future success." Bill discusses why this approach – what he calls the “dishwasher method” of choosing a mutual fund -- seems reasonable but isn't useful.

“Maybe investors are attracted to past performance numbers because past performance numbers work so well when selecting things like dishwashers…We do a little research, like maybe asking our friends and neighbors which ones they’ve liked, and then combine that information with research from something like Consumer Reports to find out which dishwasher has performed best in the past, and then buy it. Unfortunately, there is one small problem with using the dishwasher method to select mutual funds. It doesn’t work.”

Several years ago, a sales rep from a (formerly) top-ranked financial institution pitched a mutual-fund portfolio with future projections based on prior 10-year returns to my family; the projections were impressive but the plan turned out to be a losing one. I didn’t buy it but kept the presentation for future reference; certainly, the plan may have been adjusted at some point but I found it unsettling that someone representing a reputable and trusted organization would just map out future-year results based simply on prior-year performance.

Similarly, using Morningstar ratings to select, and not just screen (that is, begin the process of researching mutual funds), means using this method. Star ratings assigned by Morningstar reflect past performance with some adjustments for risk/volatility and sales charges, rather than anticipated performance.

If you received a monthly invoice of fund management fees, then you’d be more likely to switch to a lower-cost fund.

Bill tells us that the average expense ratio for a managed stock mutual fund is 1.41% compared to index funds as low as .25%. And, though 1.16% doesn’t seem like a large amount, these fees can make a significant impact on your wealth. Over a 30-year period, for example, the cost associated with a $500 monthly investment getting a 10% annual return is $221,628.

“They (the mutual fund companies) don’t send you a bill every month like your utility company does, but believe me, you pay it. Mutual fund companies simply collect their fee by reducing your price per share. Maybe if mutual fund companies sent a bill each month, more investors would take the time to see whether they were getting their money’s worth.”

He also mentions that many people think that no load mean zero expenses but the load refers to sales commissions rather than management fees.

Near the end of the book, Bill allows investors to have some fun and perhaps get bragging rights for beating the market. Here are a few of his ground rules:

Start off with investing no more than 5-15% of your portfolio in stocks of your choosing
Buy stocks that you have selected rather than ones Wall Street has recommended
Compare the return of your stock portfolio with the market average each year to see if you have beaten the market
Know when to sell

Although I would have liked a bit of discussion of addressing ownership of not-so-good companies (from a socially responsible rather than a cost savings, market return perspective), The New Coffeehouse Investor offers easy-to-read, valuable insights on mutual-fund investing with welcome encouragement for spending time not worrying about Wall Street but enjoying the things you love to do.

Disclosure: I received a copy of The New Coffeehouse Investor in exchange for a book review.

Written by Julie Rains and published on Wise Bread. Read more articles from Wise Bread.