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Archive for July, 2015

14
Jul

A Harvard professor of economics thinks inveseting is complicated

The article’s title,  “Why Investing Is So Complicated, and How to Make It Simpler”, caught my attention.  The article was in the July 11, 2015 edition of TheUpshot NY Times.   Sendhil Mullainathan (the author of the article) compared investing to “taking a final exam in a class” he never attended.

Sendhil concludes his article with his realization that paralysis is the biggest cost of procrastination.  The paralysis was caused by his fear of making a mistake in choosing an investment.  During the time he did not act his money did not earn anything as his money was not invested.

He identified some of the reasons why investing is so difficult.  One reason is the lack of sound employer-provided pension plans.  Today we must take the steps to provide the comfortable retirement that we want.  Savings  becomes a primary activity required to meet our financial goals.  I am including investing as part of savings for this purpose.  Maximizing contributions to 401(k) accounts and IRAs (Traditional and/or Roth) become important. Adopting tax favored retirement plans are an important tool for the self-employed entrepreneur.

Finding quality financial advisers was another issue he identified.  A study he was associated with “…examined advisers who did not charge clients directly.  Their advice was ‘free,’  but under current rules, their advice only had to meet a very low standard – it only had to be ‘suitable’ in a broad sense of the word.”  Mr. Mullaimathan referred to the need for a meaningful fiduciary standard.  The struggle to adopt a fiduciary standard has been going on for a long time.  Congress seems to have been the roadblock.  I leave to your imagination why they resist holding all financial advisers to a fiduciary standard.

The discussion included the variation in funds (mutual funds and exchange traded funds).  His approach was to find a broad-based indexed fund.  He mentioned the Standard & Poor’s 500 and the Russell 2000 indexes.  Many funds do not include the entire index.  There are funds that use statistical sampling to include a desired portion of all the securities in the index.  Other funds filter out some securities.  A fund may use one or more factors to determine the securities to be included. Some, but not all the, factors are: how may years the firm has existed, how long the security has been listed, profitability, dividends,  balance sheet and sales.  There are indexes that only include specific sectors, specific regions, specific firm size, growth characteristics, social responsibility, etc.  Another variation is the weight each security has within the index. Some, but not all, determine the amount of each security by: the firms total market value, by the value of a share, and equal amount of each security.

There are a lot of advantages to using index funds.  Look for what is included, what is excluded and weighting the fund gives to each security included in the index.   The number of funds and types of funds you should have should be determined based on your specific situation.  Pay close attention to cost.  One potential advantage of an indexed approach is reduced cost.  Too many indexes could defeat the diversification of a portfolio. You should also look at how the index fund compares to the index.  If the performance is not close to the index, then you may not get what you are looking for.