The Money Guy Show discusses the pros and cons of index funds versus actively managed funds. They explain that index funds have become increasingly popular due to their low cost and tax efficiency, and that data suggests they often outperform active management, especially in large-cap and international equity categories. While target retirement funds are a good starting point, the show suggests that actively managed funds can still make sense in specialized asset classes like bonds and real estate, and when tax diversification becomes a priority.
Key Takeaways
1
In 2017, US investors poured $470 billion into passive equity strategies while $175 billion flowed out of active management.
2
Index funds often have much lower expense ratios than actively managed funds, which can give investors a head start.
3
Active management creates taxable events due to frequent buying and selling, which decreases tax efficiency when compared to the lower turnover of index funds.
4
Target retirement funds are a good option for investors who want a simple, diversified portfolio, particularly when starting out.
5
When an investor has significant assets, customizing their portfolio by strategically allocating investments across taxable, tax-deferred, and tax-free accounts can provide better tax efficiency.
6
Active management can make sense in specialized asset classes such as bonds and alternative investments, where managers may have expertise that helps them outperform the market.
7
The "Amazon effect" and other disruptive forces can make active real estate management a better option than simply buying the index.
8
Don't immediately sell existing actively managed investments just to switch to lower-cost index funds if doing so would trigger significant capital gains taxes.
9
For those with large embedded gains in existing active management investments, consider charitable giving to offset the impact of those gains.
10
Even commission-based investment professionals are likely using index funds in some capacity.
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0:00
index investing secret to financial
0:04
success or should we still be using the
0:06
active guys it's Brian breasted the
0:09
money guy index investing versus active
0:13
management
0:13
this is seems like it's one of those
0:15
battles that you can go find a gazillion
0:17
articles on it and every time I read an
0:19
article on index investing where they
0:22
try to compare and contrast to active
0:24
management it's always lacking in detail
0:28
and so I've tried to create an analysis
0:31
that gives detail but here's the other
0:34
thing I'm actually not going to
0:35
completely throw the active managers
0:37
under the bus I mean I think that there
0:39
are is still a time and a place for a
0:42
section of your investments with active
0:45
management but I will tell you I do feel
0:47
like the battle has been decided in
0:49
several asset classes do you agree or
0:51
disagree no I do agree and I think
0:54
what's interesting is this bat I mean it
0:55
was what Bogle who came up with the
0:58
first idea of this index fund and so
1:00
they've been around for a long time and
1:02
even it seems like since the inception
1:03
the fight for them has gotten stronger
1:06
and stronger and stronger it almost
1:08
sounds like you're willing to lay the
1:09
claim now the war has been won the
1:12
battle is over yeah I mean it let me
1:14
give you some stats I you know I love me
1:16
some numbers that way everybody out
1:19
there and money guy land can see we
1:21
actually do some research and we don't
1:23
just start jibber jabbering on here so
1:25
in 2017 that's the most recent data that
1:27
I could find because this stuff comes
1:29
out around April May so we won't get the
1:32
2018 data for a few more months but in
1:35
2017 US investors poured four hundred
1:38
and seventy billion into passive equity
1:40
strategies during the same time period
1:42
there's an outflow of a hundred and
1:44
seventy five billion dollars from active
1:46
management so if you look at add those
1:48
two together you can see we're getting
1:49
close to seven hundred billion dollars
1:51
spread between what's coming and what's
1:53
going truly amazing passive investments
1:56
account for almost forty five percent of
1:58
all equity assets and the u.s. mutual
2:00
funds and ETFs and if you think about
2:03
this that makes complete sense with the
2:05
progression of transition to 401k or
2:08
self-directed retirement plans and then
2:11
people using you know target retirement
2:14
index funds these things are all
2:15
interrelated it's just it's amazing to
2:17
me to think about hat cuz it hasn't
2:19
always been half I mean you think about
2:21
when we used to work with clients you
2:22
know ten years ago we'd look at their
2:24
401k investment options there wouldn't
2:25
be a ton of indexes in there now we look
2:28
at them and we are kind of seeing more
2:30
so it's definitely but something that's
2:31
got become more prevalent over the last
2:33
decade I said a show on this it's been a
2:37
few years I can't remember dates I
2:39
probably should have looked it up that'd
2:40
have been a good exercise that we did
2:42
this is before we started being on
2:43
YouTube this was more of a podcast well
2:47
I think it was my stat was 70 the seat
2:49
your top secret weapon for financial
2:51
success that seventy percent of the
2:53
populations not using yeah at the time
2:55
it was talking about index funds but you
2:58
know now I would say we're probably
3:00
close to you know definitely majority to
3:03
half of the people who are using index
3:06
funds and you're starting to see it now
3:08
is that leads to who's the fifty five
3:10
percent still an active manager yes of
3:12
half the people are doing it that means
3:13
half the people aren't doing it I always
3:16
think there's a lot of brokers out there
3:20
and this is something because I know a
3:22
lot of people if you're watching the
3:23
money got show you're probably doing
3:24
index funds right but that doesn't mean
3:26
you don't have friends you don't have
3:29
parents who might be a little more
3:31
traditional and they got their you know
3:33
the guy who shows up in the the code
3:35
Utah you know has the mahogany bookcases
3:38
walk in he smell the the rich wood and
3:42
leather that's in there though they're
3:43
lobbying and you go in there and you
3:45
wonder are they buying index funds here
3:48
and probably not right because a lot of
3:50
your commission base or old guard
3:52
brokers or even fee-based they have some
3:56
issues doing index funds because their
3:58
platforms just don't support it or
4:01
they're buying what we like to call
4:02
closet index funds which is even worse
4:04
thing we'll talk about that necessarily
4:07
critique you if you are with a
4:10
commission person or you got a relative
4:11
with a commission person and I'm not
4:13
gonna pick on them too much ask the
4:15
Commission person what they're actually
4:16
using their money with I will tell you
4:18
we we buy index funds for ourselves and
4:20
we do it for our clients because I think
4:22
that there's a reason these things are
4:24
taking over the world and you have
4:26
to pay attention to that and I also have
4:28
to be careful the platforms for a lot of
4:30
these Commission guys they will they've
4:33
caught on that indexing is catching
4:35
passive equity management is - catching
4:37
on so they've created their own
4:39
Frankenstein's broad version of these
4:42
things but I found when I was doing
4:43
research from the investment company
4:45
Institute that's the company comes out
4:46
every year with a lot of really detailed
4:48
data on flows the difference between
4:50
active management and you know an
4:52
indexing they said that they actually
4:54
had on their list of index funds there's
4:55
an index fund that has an internal
4:57
expense of 1.53 percent that that's
5:00
unbelievable to me because what's really
5:01
interesting is I'm looking at the live
5:03
chat right now Brian so if you're
5:04
someone out there who's not lose
5:05
listening and you're not in a live chat
5:07
you should go do it because it's a lot
5:08
of fun and somebody just asked this and
5:10
I promise they've not seen my show notes
5:11
but they said hey anyone have FX AIX and
5:15
you may not know what that is but that's
5:16
the just large cap S&P 500 offering from
5:19
fidelity the cost of that fund is point
5:22
zero one five percent so the one that
5:25
you just threw out there that's an index
5:28
fund that's one point father it's a
5:30
hundred times more expensive than
5:33
fidelity's offering which is really
5:35
fifty three times it's mind-blowing
5:37
yeah I mean that's that's what's crazy
5:38
it to be careful and I will tell you I
5:40
ran into you know there's the insurance
5:42
company that all the military families
5:44
are associated with I don't want to get
5:45
brand names but I think everybody knows
5:47
who I'm talking about they had an index
5:48
fund and it's still well over 20 basis
5:51
points I'm still it's a good in I don't
5:53
want it I'm not picking on that because
5:54
but it's just when you compare it to
5:56
point zero one point zero one five
5:58
that's right that you pick up I feel
5:59
horrible for picking on them for being
6:01
in the 20 basis points but it still is
6:03
20 times more expensive so it's
6:04
something to pay attention to and
6:06
truthfully a lot of this guys is so
6:08
exciting because it's technology and
6:09
innovation and then just as price war
6:12
between fidelity Schwab and and Vanguard
6:15
just beaten their heads in to try to get
6:18
the lowest cost products out there and
6:20
we are the beneficiaries of that think
6:21
about we did a show on fidelity zero
6:24
funds that have zero cost to get into
6:26
them zero minimums and then they have
6:29
zero internal expenses ongoing cost it's
6:31
it's crazy the world we live in so take
6:34
advantage of some of these opportunities
6:36
that are coming our way so now I want to
6:38
transition the show to
6:39
are these things good for your portfolio
6:43
in your investment strategy and is I
6:47
mean is there any reason to not just
6:49
have all right photos because I mean
6:51
obviously you know this it sounds like
6:53
we're sharing our opinion we like index
6:55
funds better so we thought well rather
6:56
than just sharing our opinion of that
6:59
let's look at some actual heart because
7:01
there's some data out there and I would
7:03
make the argument it's some pretty
7:04
compelling data that should influence
7:06
your decision one way or the other but
7:08
hang around all you active people out
7:10
there hang around to the end because we
7:11
are going to tell you the exceptions to
7:13
the rule because I don't want people to
7:15
think well man why don't we just do
7:17
everything in index funds because we
7:19
know we also know we have clients that
7:20
are in these chapters right and I want
7:23
them to know that we really are trying
7:24
to walk the walk on all sides of this so
7:27
let's kind of jump into this I like to
7:31
look at if you go to s P IV a speedo
7:36
it's it's actually it's the standard and
7:38
poors compiles all this data of how
7:41
because you can imagine they have they
7:43
have a dog in that hunt and the fact
7:44
that they have all these index funds
7:47
ETFs and mutual funds that they that
7:50
they represent plus you gotta realize
7:51
anybody who calls it the S&P 500 they're
7:54
probably getting got a little bit of the
7:55
royalty off of that so I just pulled me
7:58
you notice look let me go ahead and tell
8:01
you guys because I saw it in the
8:01
comments last time we are going to have
8:05
a monitor in the new studio so I can
8:07
quit holding up stuff I've heard you
8:09
loud and clear so if you'll put up with
8:11
us while we're getting the new studio
8:12
built out but this is just United States
8:15
everybody who's out there listening the
8:17
podcast
8:18
was he talking about if you're watching
8:19
this on youtube you know what I'm
8:20
talking about he's literally holding up
8:22
sheets of paper this is from the Spiegel
8:25
website this is just the United States
8:27
you see there's two pages worth of data
8:29
of different indices that they have just
8:32
here in the United States and I was
8:34
looking no this is both this is both
8:36
equity and then the second page is fixed
8:38
income but let's talk about the numbers
8:41
and this is all as of June 30th so it
8:43
doesn't even have the horrible fourth
8:45
quarter of 2018 but this is the most
8:48
recent data that they had on their
8:49
website and you know did you mention
8:52
what's peva stands for
8:53
I think it's the acronym because in my
8:56
haste of show preparation right tell
8:58
them what it's it's the SP indices
9:00
versus active management so their whole
9:02
entire study is laid out that way how do
9:05
the indices perform relative to the
9:07
active manage and they update this
9:09
consistently that's right a great place
9:10
to go look at data and process it so
9:14
here's it let's go through some of these
9:15
actual asset classes I thought this
9:17
would be interesting for everybody large
9:19
cap large caps interesting because
9:22
that's the S&P 500 the percentage of
9:26
funds that meaning active managers that
9:28
underperform the benchmark meaning the
9:30
S&P 500 or large cap 5-year seventy six
9:35
point four nine percent so so 3/4 3/4 of
9:40
active of active fund managers
9:43
underperformed just buying the benchmark
9:46
over five year period if you think that
9:47
there's just a fluke that that five year
9:50
there's probably different if you look
9:52
at the three year it's close to seventy
9:54
nine percent I guess we could say over
9:56
the last year back as of June 30th now
9:59
I'm sure it's got blown up with December
10:01
it's it was 63 percent but still I
10:04
always like looking at the five year
10:06
data sure because it's a little longer a
10:07
little more you know a little more
10:09
knowledge there in Tom Pass small cap
10:11
value you know small cap value I will
10:14
tell you this one kind of shocked me
10:15
because forever I was buying the S&P 500
10:19
and anybody who's been a client firm on
10:21
for over a decade knows that I've always
10:23
loved index investing because of and
10:26
I'll get into the benefits in a minute
10:27
but always felt like that was an
10:30
efficient market case small cap I
10:33
considered somewhat inefficient because
10:35
you had all these different small
10:37
companies and unless they were in your
10:39
neck of the woods you wouldn't know
10:40
about them
10:40
but guys the data has changed on this
10:43
small cap value if you look at the
10:48
five-year a hundred percent of active
10:51
managers underperformed the benchmark so
10:54
in this study there was not one single
10:56
small cap value active manager that
10:58
performed better than the S&P small cap
11:01
value small cap 600 alyou exactly
11:03
according to a scoring to speed on I
11:05
mean I
11:05
pretty incredible and this is one I'm
11:07
telling you if you diaspore on press
11:10
then ten years ago I would have said no
11:11
go by the sp500 on large-cap but that's
11:15
an efficient marketplace but in that
11:16
inefficient marketplace like small cap
11:18
or international that's where you should
11:20
buy go buy go buy an active manager
11:22
because they can still probably get you
11:23
some alpha there the data is not showing
11:26
that anymore let's transition to bonds
11:30
bonds Bo you like this because you did I
11:34
can tell you how being a CFA it Christ
11:37
scares you you know it scares me a
11:39
little bit well you know everything is
11:40
done not by there's not you came out
11:44
smart analytics a calculation you like
11:46
to think especially when you get a CFA
11:48
and all these things and you see people
11:49
you know but you might have seen on
11:51
YouTube some of the commercials I've
11:53
noticed on our YouTube channel are
11:55
people out there pushing these trading
11:56
strategies and all this stuff and I'm
11:58
like it makes you as humans we want to
12:01
think we're smarter than just going
12:03
along to get along with the system right
12:05
but the data doesn't always support that
12:07
but I give you a little reprieve with
12:08
bonds because investment-grade
12:10
short-term bonds because who wants to be
12:12
buying midterm or long-term intermediate
12:15
or long-term bonds and a rising interest
12:17
rate environment five-year average forty
12:20
percent so the majority of active
12:22
managers actually outperform the
12:24
investment grade indices sixty percent
12:26
always like to apply a little common
12:28
sense when I talk about taxes or when I
12:30
talk about investing I like to apply
12:31
common sense to the government with the
12:34
quantitative easing distorted so much of
12:37
the bond market place with Treasuries I
12:41
mean they were just so many Treasury
12:42
bills were being purchased it makes
12:44
sense that the end of indices were kind
12:46
of skewed a little bit yeah and when you
12:48
when you think about it at least my
12:50
perception of the fixed income market
12:52
place's when we were in a declining
12:53
interest rate environment really since
12:55
like the late 1970s it wasn't really
12:57
hard to make money on bonds because you
12:59
know it's like a seesaw when intranets
13:01
go down the value of bonds go up and
13:03
vice versa so as interest rates have
13:05
been going down it used to be really
13:07
easy you could just go buy a total bond
13:09
market index and it would perform pretty
13:11
well for you now that we're entering
13:13
into a rising rate environment and
13:14
nobody knows the speed at which rates
13:17
are gonna change or if they're going to
13:19
continue
13:19
moving in the same direction I do think
13:21
that there are individuals out there who
13:22
can navigate that marketplace better
13:24
than just the market cap weighted index
13:26
Justin that that one was for you
13:29
well here's let me give there is one
13:32
where the speed data shows that the
13:34
index still does better and this makes
13:35
sense government short-term fixed income
13:37
over the other one investment grade
13:39
means these are private companies this
13:41
is going and buying corporate bonds and
13:42
so forth but government short-term the
13:45
five year average is 58.62 percent of
13:49
active managers underperform the indices
13:53
yep so that's that's interesting and
13:55
then let's go ahead and let's let's
13:56
shift over to international because I
13:58
told you this is something I've had to
14:00
shift my mindset on in the last five to
14:03
seven years is that Melissa this oh and
14:06
I just took this right from the speed of
14:08
research over the one three five ten and
14:10
fifteen year investment horizon so it
14:12
encompassed at all managers across all
14:15
international equity categories
14:17
underperform their benchmarks
14:19
furthermore the longer the time horizon
14:22
in general the more funds underperform
14:24
that's right but I can hear people
14:27
already saying yeah yeah but but that's
14:29
not but there were some funds that
14:31
outperformed I mean everyone in that
14:32
small cap when it wasn't a hundred
14:34
percent so all I have to do is be able
14:36
to find those funds on outperform it and
14:39
yeah that's true but that's a really
14:41
difficult exercise over the long term
14:43
because you might be able to pick a fund
14:45
that does really well this year but do
14:46
you have confidence that that's gonna be
14:48
the same fund company or fund manager
14:50
that's gonna do well the next year and
14:51
the following and the following so when
14:53
you're designing a portfolio and
14:55
building out your individual pieces you
14:56
kind of have to think through that while
14:58
you may get lucky once right is it
15:02
likely that same managers gonna have the
15:03
same track record moving forward and I
15:05
think you have to be careful it's when
15:07
you get into the data there's also
15:08
what's called survivorship bias is that
15:10
we all guide to go look at some of these
15:12
funds and there are some really great
15:14
long-term active management funds but
15:17
here's the dirty little secret of active
15:19
management is that over five to seven
15:21
years underperforming funds get merged
15:23
into better performing funds so that the
15:25
long-term good performance kind of gets
15:28
bolstered even for the laggards the
15:30
laggards just kind of disappear it's as
15:32
I said survivorship
15:33
is that you have to be careful when
15:35
you're reviewing the statistics of
15:37
active versus the index funds
15:39
let's talk about why our index funds so
15:42
successful first cost that's mean if
15:47
it's cheaper you're getting to keep that
15:49
money in your back pocket well it's just
15:50
naturally it's i think of low-cost being
15:53
like a head start in the investment
15:54
world right so like if you're gonna be
15:57
it's 50 basis points cheaper than an
15:59
active manager that active manager
16:01
immediately has to perform 50 basis
16:03
points better just to break even so
16:05
that's a huge hurdle to have to get over
16:06
right there from Jump Street and that's
16:08
what let's go through so many stats
16:09
because I realize the way that the
16:11
investment comes see I see I the
16:13
investment company Institute publishes
16:15
this annual data is they use what's
16:17
called an asset weighted average meaning
16:19
that they're already giving both
16:21
categories the benefit of the doubt by
16:23
skewing the number down based upon what
16:27
the most successful funds are and for
16:29
both active and for the index funds the
16:31
most successful funds are sometimes some
16:32
of the more cost effective or cheaper
16:35
phones out there so Melissa these
16:37
weighted averages though for expense
16:40
ratios for active management 1996 it was
16:43
1.08 percent so the average internal
16:46
expense ratio of an actively managed
16:48
mutual fund at the end of the 98 a verge
16:50
because the average was actually
16:51
probably closer to one and a half
16:53
percent okay so I was late so it's like
16:56
I said they gave it benefit of the doubt
16:58
for the ones because the more successful
17:00
funds are the cheaper funds they waited
17:03
it so it's 1996 is one point zero eight
17:06
percent 2017 point seven eight percent
17:09
so pretty significant drop almost
17:10
cutting a quarter yeah so listen this
17:12
index funds and by the way I remember
17:14
when Vanguard and you thought you were
17:16
getting a deal and you said you were
17:18
when when Vanguard and fidelity in them
17:20
and their internal expenses of their
17:22
index funds were in the 20 30 basis
17:24
points range so 1996 index funds were
17:27
point two seven percent so already it's
17:30
just still way less expensive even than
17:32
present-day active funds twenty
17:34
seventeen point zero nine percent I mean
17:37
it cut cut in a third not a 30 percent
17:40
drop but literally cut in a third and
17:42
then I you know and I put it on here in
17:44
my notes cuz this is just me
17:45
editorializing that
17:46
point zero nine sounds cheap but there
17:49
are funds that are actually zero right
17:51
now so this this trend is not going away
17:53
imagine we're still getting pressure
17:55
because we've heard that there's funds
17:56
that are point zero one or zero
17:59
I know Vanguard's one point zero four so
18:02
unless you're over certain threshold and
18:03
it's point zero one it's just crazy how
18:05
cheap things are so all this money that
18:07
you get to save on cost savings is
18:09
potentially money that's in your army of
18:12
dollar bills that gets to keep working
18:13
for you you get to keep it essentially
18:15
on the field or the battlefield and
18:17
working for you instead of paying some
18:19
unnecessary fees so that's the first
18:21
thing costs tip here's one I don't hear
18:24
as many people talk about and it's a big
18:26
deal tax efficiency now maybe it's
18:29
because I'll come from an accounting
18:30
back where I kind of dig this stuff and
18:32
I probably nerd it out for something
18:34
that should be a two-minute little blurb
18:36
and I actually did a lot of calculations
18:38
did you notice that when you look at the
18:39
show notes well I did notice it and I
18:41
did sort of in my mind say yeah he's a
18:43
super nerd that's true but here's what I
18:45
love about you dude that when it comes
18:47
to investing we don't get to pick which
18:48
way the market goes right markets gonna
18:49
go up markets gonna go down we don't get
18:51
to pick what it does we can kind of
18:53
alter our risk exposure but there are
18:55
two things that we can control and we
18:57
talk about this all the time if you want
18:58
to be a successful investor two things
19:00
that you get to control or costs what
19:02
you pay and the second one is taxes and
19:04
how tax efficient you are so I think
19:06
even though you nerd it out on it I
19:07
think it makes a lot of sense well what
19:09
I talk about tax efficiency let's talk
19:11
about the difference between active
19:12
management versus index investors and
19:14
what they do there's this thing called
19:15
turnover ratio and it's not uncommon for
19:18
active managers because they're always
19:20
trying to find that you know they're
19:21
trying to do the buy low sell high so
19:23
they're making decisions and they got
19:25
machines and computers and artificial
19:28
intelligence running all these different
19:30
type of algorithms hopefully trying to
19:32
create that great alpha you know better
19:35
rate of return right so every time you
19:37
do that you're creating a transaction
19:39
well there's cost to the transaction but
19:41
then also every time you is in a taxable
19:43
account you do those transaction that's
19:45
a taxable event yep so those are things
19:47
that are going to have to be distributed
19:48
out to the shareholders if you're doing
19:51
an active management mutual fund index
19:55
funds here's what happens with them
19:58
you'll have an old company
20:00
like let's think about like Kodak Kodak
20:03
at some point was on an index oh yeah
20:05
but then you know is is we quit using
20:08
cameras and we start using our phone
20:10
Kodak gets pushed off the industry you
20:12
know it's no longer on the sp500 right
20:15
or whatever so they they make room and
20:17
they put you know Google and Apple or
20:19
some of you know whatever the high flyer
20:21
that's you know the new company that's
20:23
replaced the old company well that's not
20:25
that much turnover that's right so you
20:26
might see you know a two percent
20:29
turnover just because you don't have a
20:32
lot of companies changing over and
20:33
that's all the changes in the index so
20:35
it's not a lot of buying and selling or
20:37
turnover and there's not a lot of
20:39
transactions that create taxes so let's
20:43
talk about what that looks like because
20:44
I knew when I tried to explain it I was
20:46
like that's not gonna hit everybody so
20:48
let's actually put this into an
20:49
illustration that people understand so
20:52
what I did was I went and pulled the 25
20:54
largest u.s. mutual funds and I love you
20:57
to this again in the live chat you're
20:59
about to say once somebody's already
21:00
thrown that name out here in the water I
21:02
just think it's beautiful
21:03
we don't give recommendations on the
21:05
show that's just not the things we don't
21:06
know you as an individual we don't know
21:08
your age we don't know your risk
21:10
tolerance and it just be inappropriate
21:12
but we'd love to know you and your age
21:14
and your risk tolerance so if you're
21:15
looking for I'm just so so how do we
21:18
have so what I did was I chose the 25
21:20
biggest because that's the easiest way
21:22
for us to go choose somebody to use as a
21:23
case study so the number number 19 on
21:26
the 25 largest cuz realize a lot of
21:28
these are index funds so I'd to go a
21:30
ways down where to find actual active
21:33
managers are in the top 25 number 19 was
21:36
the fidelity contra fund and very
21:37
popular phone it's one we're very
21:39
familiar with guys an expense ratio of
21:41
0.74% just to give everybody kind of an
21:44
update of what's going on but listen
21:45
we're talking about tax efficiency in
21:47
this section so in 2018 they had two big
21:50
distributions they had one on twelve
21:52
seven was the record date and then
21:54
february 9th if you added both those up
21:57
the one at the end of the year was 7.2
21:59
percent the one on february 9th was one
22:01
and a half percent of net asset value if
22:04
you added those two together it was a
22:05
distribution in the year 2018 of
22:07
approximately eight point seven percent
22:09
of net asset value so what that
22:12
essentially says is that
22:13
eight point seven percent of the value
22:15
of your holding was was released to you
22:18
in a taxable distribution somebody who
22:20
has a hundred thousand dollars of
22:22
fidelity contra fund would get an eighty
22:25
seven hundred dollar tax taxable
22:28
distribution it's a you know it wouldn't
22:30
be all taxes right right it would be
22:32
income that would be included so that
22:33
leads to the next one number 21 on the
22:36
list of top 25 is American Funds Growth
22:38
Fund of America ticker symbol AG th X
22:43
their expense ratio by the way is 0.62
22:46
percent and they distribute it out in
22:48
twenty eighteen twelve and a half
22:50
percent twelve and a half that's big
22:53
so same example you have somebody has a
22:54
hundred thousand dollars invested in the
22:56
Growth Fund of America that's twelve and
22:59
a half thousand dollars of taxable
23:01
income they're going to have to put on
23:02
their tax return so so pay attention to
23:05
that so then we go and we look at well
23:07
what's the what's the number one index
23:08
fund what's the Vanguard 500 index
23:12
Admiral share V FIA X that's the largest
23:15
in size I said okay by the way it's the
23:18
internal expense ratio is point zero
23:20
four per so again just a fraction of the
23:22
two I did they did have as the Admiral
23:24
show they did have a footnote that if
23:25
you were over a certain size that went
23:27
down to point zero one okay I didn't
23:29
write down what that was but if you
23:31
added up therefore what I thought was
23:33
interesting is these distribute
23:34
distributions were paid out quarterly
23:36
those are probably dividends and other
23:37
things being paid out which might have a
23:39
more favorable tax treatment anyway but
23:41
just apples apples the total comes out
23:44
to be one point nine one percent and I
23:46
want to I want to clarify something here
23:48
Bryce because you just said one of the
23:49
funds paid out twelve point five percent
23:51
and what the other paid out one point
23:53
nine one percent that's not rate of
23:55
return that's not like one fund may
23:57
twelve and a half percent the other made
23:59
one point nine one that's not what
24:00
you're suggesting
24:01
yeah there's taxable distributions
24:03
mutual fund companies at the end of the
24:05
year will have huge asset they have
24:07
distributions that come out you're like
24:09
well that's good I like all that extra
24:11
income I'd like to have twelve and a
24:12
half percent
24:13
what you don't realize they actually
24:14
lower the price right of what the shares
24:17
trade at to bring it down you basically
24:19
just get the tax but that's it you're
24:21
not you're not actually making money on
24:22
that you are breaking even and paying
24:24
the tax so it don't
24:26
don't fall prey to that because that's a
24:28
great point bone I'm glad you clarified
24:29
that so it's more of this is what you're
24:32
going to pay taxes on it's an embedded
24:33
gains that's why we always like I'll
24:35
tell you that this is not my show notes
24:37
when we go through like a crisis like
24:40
2008-2009 I can remember when we one of
24:42
the things key stats we look at in
24:44
portfolio design was how much in
24:47
deferred losses and I built into the
24:49
these mutual funds because you could buy
24:51
into a mutual fund that had a 30%
24:53
deferred loss because of the downturn of
24:56
the Great Recession that's awesome
24:58
because that means that your fund can
25:00
make a lot of gains before that manager
25:02
is going to start distributing those
25:05
gains from you the shareholder there's a
25:07
30% headstart in there that's right it
25:09
works the same way when we're in a
25:11
really good period of market where you
25:13
might have deferred gains that are
25:15
sitting imbedded gains that are sitting
25:17
within your mutual funds that even
25:19
though you buy it you're gonna pay tax
25:21
on that money when it's divvied out to
25:23
you even though you didn't participate
25:24
in that gains right and and and that's
25:26
that's something you need to be very
25:28
aware of but going back to my $100,000
25:30
example there's a huge difference
25:32
between twelve thousand five hundred for
25:36
the Growth Fund of America eighty seven
25:38
hundred dollars for the contra fund and
25:39
then there was the Vanguard S&P 500 fund
25:42
at $1,900 right if you look at the tax
25:45
impact the 12,500 is probably is going
25:48
to generate and I just did 15 per serve
25:50
Airy conservative fifteen percent that's
25:52
eighteen hundred and seventy five
25:54
dollars of taxes the 8700 is thirteen
25:57
hundred and five dollars in taxes
25:59
meanwhile that index fund is only
26:01
generate two hundred eighty five dollars
26:03
in taxes and remember the less that you
26:05
pay in tax the more you like to keep
26:07
your money working the more the more
26:09
soldiers you keep in your army of dollar
26:11
bills so we've got it's caught it costs
26:13
significantly less there's significantly
26:16
more tax efficient meaning that's more
26:18
money in your back pocket the third
26:20
thing I'd written out on why index funds
26:22
do so well is that the behavior and
26:24
structure of large 401ks I mean we've
26:27
got a pile on fashion right now we are
26:30
getting we're totally getting the the
26:32
benefits of economies of scale is that
26:33
they are you got all this pooled money
26:35
coming in all these guaranteed millions
26:37
coming in to the market every month with
26:39
the dollar cost
26:40
of retirement plans it's just a pylon
26:42
and they're getting cheaper they're
26:44
getting cheaper and you are the
26:46
beneficiary of this so take advantage of
26:49
just the structure this is where fortune
26:51
500 companies they're not buying active
26:54
management they're usually I mean you
26:55
see oh my fidelity you see element
26:57
Vanguard
26:58
I mean when we deal with clients there
27:01
at the big gun that Stryker swab there
27:02
at fidelity and there at Vanguard
27:04
typically so how do you personally
27:07
implement this into your investment plan
27:09
that's where I wanted to transition this
27:10
into its because as I showed you guys
27:13
and bear with me I know I don't have it
27:15
on the monitor that we'll have in the
27:16
next studio but this is just the United
27:20
States you see equity has a full page
27:22
bonds has a full page an international
27:24
Co probably fill up three pages with all
27:26
the the indices that you could invest in
27:29
so if I'm the average investor who you
27:31
watch this show because you like
27:32
personal finance content but you don't
27:35
have a degree in it you haven't studied
27:36
this and you're so worried about
27:37
screwing it up like how do I choose
27:40
which one's this material when Theory
27:43
index investing was supposed to make it
27:45
easier right like oh I'm just gonna be
27:46
in the next investor I'll go buy one or
27:47
two things but like you said there are
27:49
hundreds of index indices now it's kind
27:52
of hard to even sift through all that
27:54
even if you know you want to be an index
27:55
investor you could end up with the
27:56
analysis paralysis of too many good
27:59
choices that you just don't know what to
28:02
do so what we've tried to would always
28:04
tell people to do is you look at this
28:06
research it's daunting and you're trying
28:08
to figure it out instead of trying to
28:09
choose one fund there's this new trend
28:12
that's been really successful and we've
28:14
seen lots of opportunity here target
28:16
retirement funds and everybody every
28:18
provider whether they like Vanguard with
28:20
their target retirement funds fidelity
28:22
freedom index funds they build entire
28:25
retirement portfolios or
28:27
target retirement you don't have to just
28:29
be for retirement use these for
28:30
education planning use them for all kind
28:32
of purposes you choose the year that you
28:35
think you want to have the option to
28:37
retire I didn't say you had to retire
28:39
but you want the option to retire and
28:40
then that fund is going to be very
28:43
aggressive in the beginning but as you
28:45
get closer to that retirement data self
28:47
chosen retirement data financial
28:49
independence they there's going to be
28:50
this glide path that makes it more and
28:52
more conservative
28:53
for you and the good news is it does all
28:55
the heavy lifting for you so you can
28:57
focus on the behavior that's actually
28:59
wealth building which is saving and and
29:01
because you've talked about it before
29:03
beau is rate of return or how much you
29:06
save more important when you start out
29:07
yeah when you start out and you're just
29:08
sort of getting your doll army of dollar
29:10
bills going the amount with you of which
29:13
you save your savings rate is gonna be
29:15
exponentially more important than your
29:18
rate of return because you saving ten
29:20
percent of your income early on is
29:23
probably a lot more money than you
29:25
making ten percent on the money you have
29:27
invested so until that switches and we
29:29
think that that switches somewhere
29:31
around the two hundred and fifty three
29:33
hundred thousand dollar ranges when it
29:34
makes sense to like shift that focus you
29:36
really just thought have you focused on
29:37
how much am i saving how much my saving
29:39
how much my saving and target-date funds
29:41
are a great solution there yeah I mean
29:43
the thing first I want to give some
29:44
statistics because I had the research I
29:47
hate to waste a good data point if I if
29:49
I've already done the research
29:50
internal expenses in 2008 on target
29:53
retirement funds was 0.67
29:55
at the end of 2017 is 0.44 so they're
29:58
also benefiting from all this money
29:59
flowing into it but Bo you said
30:01
something really key there so if I'm if
30:03
I'm a person watching this show or
30:05
listening this show I'm thinking index
30:07
funds hung the moon essentially I mean
30:09
you start going wait a minute why
30:11
wouldn't we just use target retirement
30:14
funds forever wouldn't we just this all
30:16
seems good so so is there is there a
30:19
reason not to just use target retirement
30:22
funds or is there a you reason not to
30:25
just use all index funds yes well you
30:27
know I think I think that when you think
30:29
about target retirement funds I think
30:31
they're a very good generalist answer
30:33
right so when you were when you're
30:34
designing a portfolio you want one fun
30:36
to do a lot of things well you want it
30:37
to handle the risk exposure well you
30:39
want it to handle international large
30:41
cap fixed income you want to do a lot of
30:43
things well well our opinion is that
30:45
once you grow past a certain point your
30:47
portfolio gets to a certain size rather
30:49
than having to live inside of that
30:50
generalist portfolio you can allow your
30:53
portfolio me a specialist portfolio
30:54
we're each piece of the pizza pie does
30:57
something very specific so your index
30:59
funds whether you're using in the
31:01
indices or active managers which we'll
31:02
talk about a second are only doing fixed
31:04
income and your international is only
31:06
doing
31:07
your large caps only do in large cap
31:08
you're able to customize each one of the
31:11
different slices of your pie so they are
31:13
now specialized instead of generalized
31:15
we think that makes sense with the
31:17
portfolio if it's a critical mass where
31:18
you can really benefit from that
31:19
diversification I like it maybe it's
31:21
because I come from the Hokey County
31:23
background I love sticking it to our
31:25
favorite uncle on taxes is that once you
31:28
get to a certain size you go find that
31:30
you probably have some tax
31:31
diversification your taxable money you
31:33
have a lot of tax deferred with your
31:35
retirement plan you got some tax free
31:37
with Roth how awesome is it because the
31:40
thing is when you buy target retirement
31:41
funds which we love but we bomb in a
31:43
Roth they all look the same in the Roth
31:46
when you bomb in the taxable they look
31:47
all the same in the taxable and you bomb
31:49
in that 401k all the same there's no
31:51
break out when you get to a certain size
31:54
now we can start gaming the system from
31:56
a tax location stand that's right
31:58
meaning let's put your growth assets in
32:00
that Roth really let those things
32:02
turbocharged and grow you know well
32:04
beyond you know just normal things so
32:06
that's all your growth assets all the
32:08
things that generate ordinary income
32:09
like your bonds let's focus on putting
32:13
those in those tax deferred accounts
32:14
assets there go generate dividends which
32:16
have their own favorable tax treatment
32:18
put those in the taxable account so
32:20
let's you kind of really gain the system
32:22
you can't do that unfortunately we
32:24
target our loved them push them tell
32:27
people to go do that when you're
32:28
starting out because you need to be
32:29
focusing on the behavior not on taxes
32:32
and other things but you are gonna come
32:33
to a level where your enterprise gets to
32:35
the size you got to take it to the next
32:37
level and that's where we hope that
32:39
you'll consider talking to somebody like
32:41
us because there is a graduation point
32:43
from target retirement funds but now
32:45
that leads me to what all my whole
32:48
sellers and lunch-and-learn participants
32:50
have been hoping that I would share is
32:52
Windows Active management work oh that
32:55
was a little industry humor because it's
32:56
always the active management guys that
32:58
are hosting lunch and learns to tell you
33:00
all about and then you know the
33:01
wholesaler is coming around trying to
33:02
get you to sell their buy their products
33:04
so Bo we talked about this and this is
33:06
something you added on is that you said
33:08
Brian we got it we got to share because
33:10
all the people who are in active
33:12
management this is not a completely fair
33:14
representation so welcome through
33:16
windows active management makes sense
33:18
yes so we think that it happens inside
33:19
of specialized asset
33:20
and here's what's really unique we think
33:22
that it kind of changes through time I
33:24
used a great example early in a fixed
33:26
income there was a point in time in the
33:28
not so distant future where an index
33:32
inside the fixed income market place
33:33
made a lot of sense when we were in a
33:35
reclining and and now that rates are
33:37
even rising maybe we're back there now
33:40
maybe in indices do hold a place inside
33:42
the fixed income same thing when we talk
33:44
about what's going on in international
33:46
marketplaces when you actually look at
33:47
what's going on and the countries are
33:49
the economies you're investing in if you
33:53
want to buy an index internationally
33:55
which index do you buy because there's a
33:57
bunch of difference so you have to kind
33:58
of think through what kind of portfolio
34:00
are you trying to construct or what kind
34:01
of exposure you're trying to get and
34:03
then the other place where we think
34:04
inactive management can make a lot of
34:06
sense is in the alternative space if you
34:09
have a sleeve of your portfolio like we
34:10
do when we manage that's supposed to do
34:12
something a little bit different than
34:13
just traditional stocks or bonds whether
34:15
it's a return enhancer in the portfolio
34:17
or a volatility mitigator in the
34:19
portfolio
34:20
sometimes those funds aren't perfectly
34:23
categorized by the index and you do have
34:26
to go with a more active managed fun I
34:28
like to think about more I always bring
34:29
things back to that common sense
34:30
mentality is that I know about every
34:33
other day I have one of those boxes show
34:35
up with a smile on huh I mean I we had
34:38
probably - sure oh yeah right I have the
34:40
studio stuff coming those I was telling
34:42
Morpheus off-camera that I just got
34:44
those under cabinet lights that he lasts
34:46
for in the a studio I bought those on
34:48
Amazon there's this amazon effect where
34:51
unfortunately I worry about all of our
34:54
brick and mortars and if you look at a
34:56
lot of real estate investments if you
34:57
just bind the index there's a lot of
35:00
traditional retail space on there and I
35:02
think that over the next decade you're
35:05
going to see this Amazon effect where
35:06
all of us are buying into this
35:08
convenience of having those smiling
35:10
boxes showings right and that is going
35:12
to have a direct impact on what happens
35:14
in the real estate marketplace so it
35:16
would be nice
35:17
I love index funds I love the cost
35:19
savings I love the tax efficiency but
35:21
when you know that there's something
35:24
that is going to disrupt or cause things
35:28
not work as efficiently that's the whole
35:30
purpose of in inefficient markets versus
35:32
efficient markets you have
35:34
to plan accordingly and that's why I
35:35
think active real estate does do better
35:38
with that on the horizon and active
35:40
managers they can make those judgment
35:42
calls the index can't it has to operate
35:44
inside of market capitalization or
35:46
whatever the state did in ex mandate is
35:47
so it's nice having someone who can have
35:49
that flexibility inside the portfolio
35:51
here's why I also want to close it out
35:52
with is because I don't want you because
35:54
I love a good deal but I don't want you
35:56
to and I'm going to kill the saying bow
35:58
so you have to fix it was it
36:00
penny smart pound foolish or what I came
36:03
yeah yeah yeah penny smart pal if you
36:06
have huge embedded gains in your
36:09
existing active management because
36:11
grandpa you know you know you we started
36:13
buying this because my father-in-law was
36:15
buying like the fidelity Magellan back
36:17
when he was a lot if you had one of
36:19
those and you started buying theirs and
36:20
had huge embedded gains you're not gonna
36:23
go do apple cart turnover just so you
36:25
can get that super low internal expense
36:27
ratio it doesn't make sense to pay all
36:28
those capital gains just to get in a
36:30
lower cost I'm saying maybe change your
36:32
behavior going forward but don't throw
36:34
out those active managers if you do have
36:36
some huge taxable gains that donate
36:39
those that say if you I was gonna say if
36:44
you are someone who has huge embedded
36:46
gains go listen to our show on
36:48
charitable giving from last year because
36:49
that's a great solution for a cheerful
36:51
gift fund so bow in summary I mean it
36:53
sounds like we talked a lot about we we
36:56
are we're pro in index investing and I
36:59
will tell you I think that and I think I
37:00
don't know if I can't remember if I said
37:02
this because I talked about it
37:03
appreciate this the problem with doing
37:04
live shows as we mentioned things
37:06
pre-show too I think it is the dirty
37:08
little secret for most investment
37:10
professionals even your Commission guys
37:12
are probably secretly buying index funds
37:15
so make sure you understand how index
37:17
funds work and then figure out how to
37:19
you know most effectively implement this
37:22
in your own financial portfolio and by
37:24
the way if you don't feel up to it
37:25
because you look at the three pages of
37:27
steve-o data and you're like this is for
37:29
the birds
37:30
yeah consider taking the relationship to
37:32
the next level we have this whole
37:33
abundance mentality where you come to
37:35
watch the money guy show where you come
37:37
to listen to the money pot money got
37:38
podcast and we've been doing this now
37:40
since 2006 for many people come we love
37:43
on you give you all this great free
37:45
advice all that we ask if you ever want
37:47
to pay us
37:47
back is it when you get to that level of
37:49
success when you get to 250 300,000 and
37:52
greater in assets where you can move
37:54
past the target retirements let us let
37:57
us get a look over your shoulder let us
37:58
help you out let us be help you be your
38:00
personal CFOs to make those right
38:02
decisions for your finances going
38:04
forward bow did I miss anything nah
38:06
Today Show I think you nailed it I'm
38:09
excited about 2019 you know the the last
38:11
part of the last part of the end of the
38:14
year 2018 was a little interesting it's
38:16
gonna be fun to to to watch 2019 I liked
38:20
you know we did us some shows on market
38:22
volatility there at the end and when
38:24
bear in a bear market attack attacks
38:27
yeah I love the titling but I never can
38:30
remember everything it really a lot of
38:32
you guys have shared was that it's
38:34
helped you get you through these
38:35
downturns and market cycles pay
38:37
attention to that
38:38
you know whenever you go through
38:39
downturns like what we had at the fourth
38:42
quarter bottle up the feeling you had
38:44
but then when you come out the other
38:45
side and you see it wasn't as bad as
38:46
maybe what you were feeling in the
38:48
middle of it use that as a learning
38:50
experience I tell that to every young
38:51
associate that we bring on is because
38:53
your emotions are it can be great for
38:57
finding the love of your life but they
38:59
are horrible for your wallet so don't
39:01
let your heart and your in your emotions
39:04
betray you so make smart financial
39:06
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financial publications that rake
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on social media they use Twitter yeah
39:21
Wow but they do so if you're not
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40:00
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40:03
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Index Funds vs. Actively Managed Funds: Are You Making a Mistake?
The Money Guy Show