Imagine that it is 1935, and the US has just survived the Great Depression. You think to yourself – if a company can survive this, it’s got to be pretty solid. So you buy equal amounts of stock from 30 of the largest US companies, and hold them… forever! If a company splits, you just keep the two new companies. If a company gets sold, you just keep the new shares of the purchasing company. If they go bankrupt, you let them. 80 years later, you would have the Voya Corporate Leaders Trust Fund (LEXCX), which has beaten 98% of other Large Value fund peers over the last 5 and 10 years. It’s also beaten the S&P 500 over the last 40 years:

I found about the fund via this Reuters article, which outlines its interesting history and helps explain some of its holdings. Standard Oil is now ExxonMobil and Chevron. Santa Fe Railway is Berkshire Hathaway. The remnants of retailer Woolworth eventually became Foot Locker.

Let’s be clear, I am not saying people should run out and invest in this fund. I just want to point out that this is a very early predecessor to the first index fund – it is passive, low-turnover, transparent, and (relatively) low-cost. I have no idea how the future performance will hold up, but I view it is another example of the power of less stock-picking and more patience. Even Jack Bogle seems to approve:

Its unique nature has often drawn attention including from Vanguard Group Inc founder Jack Bogle, who said he remembers the fund from his days as an undergraduate around 1950. “It’s not a bad idea at all,” he said.

The expense ratio today is 0.52%, which is lower than average for all funds but somewhat expensive given that the managers don’t seem to do much beyond administrative duties. Given the simplicity of this method, can’t we avoid the middleman costs and do even better?

I’ve written about Motif Investing (review) before, which allows you to essentially create your own ETF (“motif”) of up to 30 stocks with zero management fee. Well, only 21 stocks are left in the Voya fund, so that’s perfect. Motif is a registered brokerage firm that will let you trade all 21 stocks at once for $9.95 a trade. I couldn’t find anything similar in their existing catalog, so for kicks I created my own Community Motif using the LEXCX holdings as of 12/31/2014. I called it Depression Survivors – Blue Chip Stocks Since 1935. Here’s the widget they made for it:

 
If you create a custom motif, they have a Creator Royalty program which gets you $1 royalty if someone invests using it. If I get even a dollar I’ll be highly amused. You can build your own motif by tweaking things or adding your own dividend stocks or whatever. Motif Investing still offers a $150 sign-up bonus if you open with $2,000 and make 5 trades.

I enjoy reading articles by Scott Burns (also here) because he sometimes offers a unique perspective on things. He recently released the 2015 Annual Letter for his asset management company AssetBuilder. The whole thing is a good read, but here are two items of note:

Keep in mind the effect of currency fluctuations on your portfolio returns. In 2014, the MSCI European Index fell 6% in dollars. However, that index actually rose nearly 7% in Euros. Most international stock funds sold to US investors, including the Vanguard Total International Index fund, are not currency-hedged. The strong dollar in 2014 has made international returns looks worse from a dollar-based perspective.

At the same time, the dollar rose against other currencies. Over the year, the dollar gained 12.5 percent against a basket of widely traded currencies tracked by the Wall Street Journal. That increase created a looking glass problem. U.S. investors felt investing in Europe was a losing proposition, with the MSCI Europe Index falling 6.18 percent in dollars.

Europeans, meanwhile, felt differently because the index rose 6.84 percent in Euros. Indeed, the world looked strangely positive to an internationally diversified Russian investor. Thanks to the miracle of modern currency collapse, international portfolios measured in Rubles soared. We doubt that gave Russian investors great comfort.

I still like the idea of having my portfolio diversified globally, and hopefully this makes you feel a little better about the recent performance of your international holdings. This will someday work in reverse, where currency fluctuations makes returns look even better.

Also included is an interactive table of asset classes ranked by returns over the last 15 years, similar to the Callan Periodic Table. But with this graphic, you can hover your mouse over any asset class and see it in highlighted. Here it is with the S&P 500:

Notice that the S&P 500 has had quite a run the last 6 years. Since the -37% drop in 2008, in subsequent years 2009-2014 the S&P 500 has went up 26%, 15%, 2%, 16%, 32%, and 14%. It would have been really hard for the “I’ll buy on the next dip” folks to time their way back in the market. If you’ve been invested throughout the entire time, you should be rather pleased with yourself.

Dividend distributions from mutual funds and ETFs are either qualified or non-qualified, and the difference could have you paying double the taxes. Qualified dividends are taxed at the lower long-term capital gains rate, which varies from 0% to 20%. Non-qualified dividends are taxed at ordinary income rates, which can be as high as 39.6%. Even though they all show up as “dividends” in your account, their classification can make a big difference in your final after-tax performance.

At the end of each year, Vanguard provides a list of their mutual funds and what percentage of their dividends are qualified. Here is their 2014 report and 2013 report [pdf]. I don’t know if other fund companies do the same. The Vanguard (US) Total Stock Market Index ETF and mutual funds had 100% of their dividends as qualified for 2014 (VTSMX, VTSAX, VTI). The Vanguard Total International Stock Index ETF and funds had 72% of their dividends as qualified (VGTSX, VTIAX, VXUS). The numbers for 2013 were similar. To me, this establishes a sort of baseline expectation.

I recently made a tweak in my portfolio and replaced my value-tilted holdings with a couple of WisdomTree ETFs. While doing my 2014 taxes, I noticed on the 1099-DIV tax form that only half of the dividend distributions were counted as “qualified dividends”. What was up? I took a closer look.

Here are the specific Wisdom Tree ETFs, their closest Vanguard competitor ETFs, and their respective 2014 qualified dividend income (QDI) percentages with the WisdomTree numbers based off my 1099-DIV form:

• WisdomTree SmallCap Dividend ETF (DES) 64%
• Vanguard Small-Cap Value ETF (VBR) 72%

• WisdomTree Emerging Markets SmallCap Dividend ETF (DGS) 34%
• Vanguard FTSE Emerging Markets ETF (VWO) 37%

After comparing these numbers, I guess the WisdomTree ETFs aren’t that inefficient on a relative basis, but I’m still not very happy about it because I am holding these ETFs in taxable accounts. My current ordinary income tax rate is pretty high, and I need to figure out a way to fit these inside an IRA or 401(k) plan.

I hadn’t realized that the dividends from nearly all Emerging Markets ETFs were so tax-inefficient. (I usually just hold Emerging Markets exposure inside a Total International fund.) As the dividend yield on these Emerging Markets ETFs range from 2.5% to 3%, it makes a difference over the long-run to keep these in tax-sheltered account if possible.

By the way, I think noticing these types of things is one of the benefits of doing your income tax returns yourself. Even if you hire a professional, try running the numbers on your own and see if they match up. Even CPAs can make mistakes.

The purpose of Vanguard’s commitment to low-cost investing is not just to be cheap, it is to give their clients higher performance. Whenever a money manager charges higher fees for themselves, they will have to compensate by creating that much higher returns through whatever combination of skill or luck.

Over long periods of time, the luck tends to shake out and the higher expense ratios usually become a very hard hurdle to continually overcome. (In turn, this pressure also leads some managers to take increasingly risky bets and have luck either save their butts or lose all their client’s money!)

Taken from a recent Vanguard article, the chart below confirms this tendency. It shows the percentage of Vanguard funds in each major asset category that exceeded the average returns of their competing fund peer groups (as determined by industry-standard Lipper) over the 1-, 3-, 5-, and 10-year periods ended December 31, 2014.

Every single number on that 10-year return column is 90% or higher. Every asset class. Is that something I could interest you in?

The debate between active and passive investing has come full circle. We’ve officially gone from “index funds will never work!” to “index funds are working too well, it can’t keep on going”. Check out the Forbes article Is Vanguard Too Successful?

Passive vs. active is just a smokescreen. You know what really works? Low costs! There was a big hubbub when Morningstar admitted that expense ratios were a better predictor of performance than their much-advertised star ratings system. Vanguard has many successful actively-managed funds and that is due both to good managers and low costs. Wellington, Wellesley, PrimeCap, they all have expense ratios that are fractions of their competitors.

In addition, what makes Vanguard special is their inherent, longstanding commitment to low costs. Look at how the asset-weighted average expense ratio of all Vanguard funds (including actively-managed funds) has dropped since their inception:

Providers like Schwab and iShares all have some ETFs that are very low cost now, but they also have a duty to maximize shareholder value. If you’re a for-profit company and you think you can keep prices the same even as your assets rise, you do that. The very structure of Vanguard states that the investors themselves own the funds, which means they naturally pass on any savings onto the retail investor. (I do believe that the recent competition is good however and it keeps everyone, including Vanguard, on their toes.)

The “at-cost” investing structure is why the majority of my assets are invested in Vanguard funds and ETFs.

It is now 7 years in on the 10-year bet between Warren Buffett and a successful hedge fund manager. In 2007, Warren Buffett challenged any hedge fund to a long-term bet against the S&P 500. He found a taker.

Fortune magazine announced “Buffett’s Big Bet”, where $1,000,000 would go to the charity chosen by the winner. The bet would run from 2008 to 2018. Buffett would take the S&P 500, represented by the Vanguard S&P 500 index fund (Admiral shares). Protégé Partners would stand behind hedge funds, represented by the average return of five hand-picked hedge funds.

Carol Loomis has just posted the 2015 update in Fortune. The hedge funds were in the lead early on, but started lagging behind in the 2012 update. In 2013, the performance gap widened to about 30%. The gap has widened even more. In 2014, the S&P 500 index fund went up 13.6%, whereas the hedge funds only rose 5.6%.

Through the entire 7-year period that runs through the end of 2014, the S&P 500 index fund is up 63.5%. The hedge fund marker only went up an average of 19.6%. That’s now a gap of over 40%. With three years left, the hedge funds have some serious catching up to do.

Through the seven years, Vanguard’s 500 index fund, as represented by its Admiral shares, is up 63.5%. That’s the portfolio carrying Buffett’s colors. Protégé’s five hedge funds of funds are, on the average—the marker the bet uses—up an estimated 19.6%. (The “estimated” takes into account that not all of the five funds have final figures for 2014).

Will this collection of hand-picked hedge funds be able to outperform a simple, low-cost index fund over the long run? Hedge funds may employ some bright minds but also charge hefty fees of roughly 2% of assets annually + 20% of any gains. At the start of the bet, the past performance of the hedge funds were excellent – from inception in July 2002 through the end of 2007, the Protégé fund gained 95% (after all fees), soundly beating the Vanguard S&P 500 index fund’s 64%. But lots of funds have good performance when looking backwards. It is much harder to pick out winning managers ahead of time (and harder on those managers when everyone is looking and there is too much money to deploy).

Read the terms of the bet and each side’s opening arguments at LongBets.org. This carefully-tracked bet was part of the inspiration for my transparent Beat the Market experiment. Too often, people are not honestly and accurately tracking the performance of their portfolios… again, starting ahead of time! It is natural to point out your winners and conveniently forget the losers.

Read my original 2008 blog post and halfway 5-year update here.

The following is a chart that I usually like to pull out during a crisis when people are scared of investing in the stock market, but since I just found a nicely updated version of it, I had to share. It is taken from Jeremy Siegel’s book Stocks for the Long Run and found via this Vox article about how most people incorrectly view real estate as the best long-term investment*.

Here is a chart showing the historical range of real (after-inflation) returns for US stocks, long-term bonds (bonds), and short-term bonds (T-bills) from 1802 to 2012.

The chart shows that over bried time periods, the stock market has been historically more of coin flip than anything else. Over a year, you could get anywhere from +70% to -40%. With bonds and cash, the swings are much less wild. But as you lengthen your holding period, your risk of losing money over that time decreases significantly. For time horizons of 20 and 30 years, only stocks never lost you money after inflation.

Note that the average annual returns for each respective asset class remains the same across all time periods. Via the CFA Institute:

This supports the advice that it doesn’t really matter as much what your plan is, but more that you pick one and stick with it. Going heavy on stocks and then bailing out when they are in a funk, or going heavy on bonds and bailing out when they are in a funk, all that is worse than doing NOTHING and simply riding it out. As they say, it’s not about timing the market, it’s about time IN the market.

I believe it was one of William Bernstein’s books that suggested that young folks who understand this should put as much money now into stocks as possible, as to increase your time horizon. Put 100% of your money into stocks now, and then as you get older put more of your money into bonds to get a balanced mix eventually. This can be hard though, as you’re asking the people with less experience and smallest assets to hold the thing that is most volatile. Going 80/20 or 70/30 from beginning to end is also a reasonable approach in my opinion (and personal experience with my own portfolio).

Now, another well-known professor Robert Shiller reminds us that the period above includes the most economically successful century of the most economically successful country in the world so far… and will not necessarily repeat itself. I’m not saying that you should expect 6% real returns from stocks. Shiller’s CAPE ratio model itself forecasts a 3% real return for stocks over the next decade. I’m focusing on the fact that stocks are investments in productive businesses and that the volatility of the pricing of such businesses will stabilize when held across longer holding periods.

* I would actually argue that the long-term return of real estate is actually not that far behind that of stocks, if you add in the imputed rent from the house. Yes, it may be true that the value of a house doesn’t increase that much over inflation over the long run. But houses are also productive in that they can create their own income! If the value of the rent that you could get from that house is included, that could add another 4% to 6% to the return historically. 5% real return would be smack dab between bonds and stocks.

Via The Reformed Broker, investment manager Research Affiliates shares how a simple, balanced 60/40 portfolio (specifically 60% S&P 500 stocks, 40% 10-Year US Treasuries) did pretty darn good in the past 100, 50, and 25 years:

It even did well over the last 10 years, considering that “blip” we had in 2008. The 60/40 portfolio outperformed 9 of 16 core asset classes, all while maintaining lower-than-average volatility.

Of course, they also predict (using sound reasoning, in my opinion) that the same 60/40 portfolio will only produce a 1.2% inflation-adjusted return for the next 10 years. Still, I don’t know of any better options.