IFA Index Fund Advisors

[johnbears]

The other day I came accross a thread where akula points to IFA (Index Fund Advisors) as a good starting point to learn more about the stock market. I do agree that one should read the book that IFA has on there website as it's claims are mostly scientific based and will give a investor quite some insights into the markets.

However, I do not agree with IFA's underlying claim that Index Funds are the best performing financial securities in the long run (10+years). I hope we can have an intelligent debate why or why not Index Funds are best.

My argument:

Look at Warren Buffet. His is the "best known" investor (not necessarly the best) heading Birkshire Hathway with a track record of 21.1% gain per year from 1965 to 2004 and this is after-tax.
Source: http://www.berkshirehathaway.com/letters/2004ltr.pdf
First Page

Index Funds Performance: 15.32% for the past 20 years.
Source: http://www.ifa.com/Book/Book_pdf/01_..._Investors.pdf
Table 1.1

Their argument is:
Stock pickers can get lucky in the short run.
In the long run, stock pickers will underperform the market.
Stock prices move randomly and that stock pickers can not predict a stocks perfromance.

However, Warren Buffet is a stock picker. He does not get lucky for 40 straight years.


What do you guys think????

[jasaunders]

Berkshire is much closer to an index fund than most other specific index funds that exist. The purpose of an index is to diversify holdings based on the beta risk of individuals stocks and the correlation assets have to each other; essentially the foundation of portfolio theory. Berkshire is a conglomerate that is diversified in almost every type of industry imagineable. You are disproving your own argument when you say look at Warren Buffet.

[Doodyps]

Warren Buffet is currently engaged in $100k bet I believe with fellow investors. His argument is that the market (index) will almost ALWAYS BEAT handpicked funds. Even if you just look at your own argument, Warren Buffet is the greatest investor of all time and only beat the market by about 6%. Index returned 15.3 and he got 21.1. The index involves almost no risk and hand picked stocks and funds are much riskier. When the greatest investor of all time only beats the market by 6%, then why would you trust some manager to attempt to do the same? My opinion anyway...

[johnbears]

Berkshire is much closer to an index fund than most other specific index funds that exist. The purpose of an index is to diversify holdings based on the beta risk of individuals stocks and the correlation assets have to each other; essentially the foundation of portfolio theory. Berkshire is a conglomerate that is diversified in almost every type of industry imagineable. You are disproving your own argument when you say look at Warren Buffet.

When you compare Birkshire to an index fund you will see similarities as well as differences. However, they are not the same. I ask you, why does Warren Buffet not just invest all of his money into index funds?

I never disputed that diversifying is a bad thing. I am an advocate of it. However, that does not mean that you need to have 3000 different companies, small and large, national and international, from every imagineable industry. In fact, Birkshire has most of its money invested in about 100 companies of which it owns 51.

What I am trying to say is that S&P list 500 companies and of which some are going to do well, some will be flat, and others will do bad in any given period. Warren Buffet tries to pick the winners whereas the index funds take in winners, losers, and the others into its portfolio. This is the very reason why Birkshire has preformed better.




P.S.: Birkshire owns these 51 companies:

Acme Brick Company
International Dairy Queen, Inc.
Applied Underwriters
Iscar Metalworking Companies
Ben Bridge Jeweler
Johns Manville
Benjamin Moore & Co.
Jordan's Furniture
Berkshire Hathaway Group
Justin Brands
Berkshire Hathaway Homestates Companies
Larson-Juhl
BoatU.S.
Marmon Holdings, Inc.
Borsheims Fine Jewelry
McLane Company
Buffalo NEWS, Buffalo NY
Medical Protective
Business Wire
MidAmerican Energy Holdings Company
Central States Indemnity Company
MiTek Inc.
Clayton Homes
National Indemnity Company
CORT Business Services
Nebraska Furniture Mart
CTB Inc.
NetJets®
Fechheimer Brothers Company
The Pampered Chef
FlightSafety
Precision Steel Warehouse, Inc.
Forest River
RC Willey Home Furnishing
Fruit of the Loom®
Scott Fetzer Companies
Garan Incorporated
See's Candies
Gateway Underwriters Agency
Shaw Industries
GEICO Auto Insurance
Star Furniture
General Re
TTI, Inc.
Helzberg Diamonds
United States Liability Insurance Group
H.H. Brown Shoe Group
Wesco Financial Corporation
HomeServices of America, a subsidiary of
MidAmerican Energy Holdings Company
XTRA Corporation

Source: LINKS TO BERKSHIRE HATHAWAY SUB. COMPANIES

[jasaunders]

When you compare Birkshire to an index fund you will see similarities as well as differences. However, they are not the same. I ask you, why does Warren Buffet not just invest all of his money into index funds?

I never disputed that diversifying is a bad thing. I am an advocate of it. However, that does not mean that you need to have 3000 different companies, small and large, national and international, from every imagineable industry. In fact, Birkshire has most of its money invested in about 100 companies of which it owns 51.

What I am trying to say is that S&P list 500 companies and of which some are going to do well, some will be flat, and others will do bad in any given period. Warren Buffet tries to pick the winners whereas the index funds take in winners, losers, and the others into its portfolio. This is the very reason why Birkshire has preformed better.

Index funds don't always include such a large portfolio. Many index funds include only a few dozen stocks, some are heavily invested in only 10 stocks. Sure, some funds track the S&P500 and other indexes, but others track small segments of industries. Different funds are different for different individuals with different goals, strategies and risk levels. I'm not sure you understand the definition of an index fund. Berkshire is far more diversified than many index funds.

Additionally, I don't see how what you are describing is different than a mutual fund portfolio manager. You say "index funds take in winners, losers, and the others into its portfolio." No they don't, most of them adjust their portfolios to try to take all winners and adjust this with risk, because we don't know what the winners are. It's the exact same thing Warren buffet is doing. In fact, if anything, Warren Buffet is worse because he is more of a long-term investor, whereas mutual funds or ETF's adjust their portfolios much more often to try to "pick the winners" and adjust their risk.

[Doodyps]

Buffett's bet: Hedge funds can't beat the market - Jun. 9, 2008

need i say more?

[johnbears]

Index funds don't always include such a large portfolio. Many index funds include only a few dozen stocks, some are heavily invested in only 10 stocks. Sure, some funds track the S&P500 and other indexes, but others track small segments of industries. Different funds are different for different individuals with different goals, strategies and risk levels. I'm not sure you understand the definition of an index fund. Berkshire is far more diversified than many index funds.

Additionally, I don't see how what you are describing is different than a mutual fund portfolio manager. You say "index funds take in winners, losers, and the others into its portfolio." No they don't, most of them adjust their portfolios to try to take all winners and adjust this with risk, because we don't know what the winners are. It's the exact same thing Warren buffet is doing. In fact, if anything, Warren Buffet is worse because he is more of a long-term investor, whereas mutual funds or ETF's adjust their portfolios much more often to try to "pick the winners" and adjust their risk.

So I don't understand the definition of an index fund?
What is your definition of an index fund?

According to Investopedia:

"A type of mutual fund with a portfolio constructed to match or track the components of a market index, such as the Standard & Poor's 500 Index (S&P 500). An index mutual fund is said to provide broad market exposure, low operating expenses and low portfolio turnover.
Investopedia Says... "Indexing" is a passive form of fund management that has been successful in outperforming most actively managed mutual funds. While the most popular index funds track the S&P 500, a number of other indexes, including the Russell 2000 (small companies), the DJ Wilshire 5000 (total stock market), the MSCI EAFE (foreign stocks in Europe, Australasia, Far East) and the Lehman Aggregate Bond Index (total bond market) are widely used for index funds.

Investing in an index fund is a form of passive investing. The primary advantage to such a strategy is the lower management expense ratio on an index fund. Also, a majority of mutual funds fail to beat broad indexes, such as the S&P 500. "

Source: Index Fund


1) I am sorry, I don't think you can have a few dozen companies or as little as 10 to mirror the market? If you want to prove it, why don't you name one?

2) I think you are confusing index funds with "Enhanced Index Fund - EIF" and "Active Index Fund". These are different types of index funds. You need to differentiate my friend, otherwise we are comparing apples and oranges.

3) Berkshire may be more diversified than some of the other "types" of index funds but it is not as diversified as an index fund.

4) These other types of index funds as you say
a) "adjust their portfolios to try to take all winners and adjust this with risk"
b)"mutual funds or ETF's adjust their portfolios much more often to try to "pick the winners" and adjust their risk"

This is being active but index funds are NOT active, they are passive. Being active results in more operating expenses and higher portfolio turnover wich in turn will cost more taxes. This goes against the very idea of an index fund.


From what I can understand is that you do NOT think index funds are best performing financial securities in the long run (10+years). Am I wrong?

[Doodyps]

Warren Buffet thinks indexes offer the best outcome in ten years. Just saying. I mean, your theory was based on the fact that he was a picker and wildly successful so you started doubting indexes. But, in truth, Warren Buffet prefers indexes, so shouldn't you reconsider?

[jasaunders]

I don't think I articulated my point clearly. Not all index funds are broad like the S&P500. An index fund by definition invests in a segment of the market. Many index funds are invested in small segments of the market, whether it be real estate, small caps, emerging markets, international, etc... When you invest in index funds you are often betting on an industry or segment of an industry. These index funds are allocated based on risk (in almost all cases the portfolio is not equally weighted). These index funds are much less diversified than a holding such as Berkshire. I am invested in the Financial Select Sector Fund which has approximately half its holdings in 10 companies, over a quarter of its holdings are in 4 companies. This is an index fund.

When you talk about Warren Buffet, you make it sound like he is picking individual stock winners. He's not, he's picking stocks as part of a portfolio.

It all goes back to modern portfolio theory. Essentially, you are debating that modern portfolio theory is incorrect and that there is no efficient frontier in which a portfolio will outperform a single asset at the same risk level.

[johnbears]

Warren Buffet thinks indexes offer the best outcome in ten years. Just saying. I mean, your theory was based on the fact that he was a picker and wildly successful so you started doubting indexes. But, in truth, Warren Buffet prefers indexes, so shouldn't you reconsider?

Okay my friend, to clarify things:

1) Warren Buffet does NOT think indexes offer the best outcome. He thinks indexes will beat hedge funds. This is not the same thing. For one, Birkshire has beat the index by over 6% annualy for the past forty years as I have proven above. But then again, Birkshire is not much of a hedge fund, is it?

Warren Buffet has made this bet because hedge funds have huge fees. You gotta read what you reference my friend, don't be a retard (think before you talk).

"So that's 2.5% of an investor's capital that continually goes for these fees, regardless of the returns earned during a year. In contrast, Vanguard's S&P 500 index fund had an expense ratio last year of 15 basis points (0.15%) for ordinary shares and only seven basis points for Admiral shares, which are available to large investors. Admiral shares are the ones "bought" by Buffett in the bet.

On top of the management fee, the hedge funds typically collect 20% of any gains they make. That leaves 80% for the investors. The fund of funds takes 5% (or more) of that 80% as its share of the gains. The upshot is that only 76% (at most) of the annual return made on an investor's money accrues to him, with the rest going to the "helpers" that Buffett has written about. Meanwhile, the investor is paying his inexorable management fee of 2.5% on capital.

The summation is pretty obvious. For Protégé to win this bet, the five funds of funds it has picked must do much, much better than the S&P."


Source: Buffett's bet: Hedge funds can't beat the market - Jun. 9, 2008


2) I don't doubt indexes. In fact, I think they are awesome. However, I think there are even better preformances over the long run.

By the way, put $50,000 into an index fund and add another $400 each month for 20 years and you got yourself $1,000,000


3) I don't even know if Warren Buffet is the best investor alive. I know he is well known and very successfull but that doesnt mean that there may be others out there that have preformed better in the long run. Unless, you think only famous people are the best.

[Doodyps]

Index Funds | Index Mutual Funds | Investing in Index Funds

It is not just hedge funds that charge large fees. All funds charge fees, even indexes. Indexes charge substantially less of course. ALL managed funds charge fees and I can't think of any that charge less than an index. The point is, index funds almost guarantee high returns over the years. Why would you take on the risk of under performing the market (which is not rare among managed funds) when you will very rarely find a managed fund vastly outperforming the indexes. It just doesn't make sense to take on that kind of risk to try and beat the indexes by 2-6%. You could easily end up under performing by 17%. If you want to take risks like that just invest in stocks.

[Gaulkin]

I still advocate CGMFX as one of the best funds out there. There manager Ken Heebner has been hailed as a money manager genius. His fund may be risky but his track record speaks for itself. When 911 came along he returned 12% and when the tech boom was over he still returned 14%.

[akula]

Their argument is:
Stock pickers can get lucky in the short run.
In the long run, stock pickers will underperform the market.
Stock prices move randomly and that stock pickers can not predict a stocks perfromance.

However, Warren Buffet is a stock picker. He does not get lucky for 40 straight years.

1. Absolutely, active management equals negative value. You're always gonna lose money in trying to pick stocks, so it's much better to let the computer do the picking and invest in an index fund. However, you can of course, add very significant value by managing your leverage and taxation. Doing these two things will always add more to your net return on investment than any decision to rebalance a portfolio.

2. Now, in terms of comparing the performance of the investment team at Berky; first of all, it's not a statically significant comparison (because it's only one team out of thousands). Any evidence of manager value add that this analysis may find, does not mean that all managers can add value. Berky can be a mere statistical outlier, uncharacteristic of the rest of the market. Secondly, because Warren's on the team, their results are probably skewed. In other words, Buffett, like Sorros, can probably move markets. The mere fact that Warren has invested in something, instantly appreciates the value of that investment. Like Richard Ashcroft, Warren has a lot of groupies. This makes Warren's results different to other investors.

That said, this really isn't a moot point. Countless and countless dissertations have been written on this subject and it's now a matter of scientific fact that stock pickers are losers.

3. Alternatively, in the future, i believe that exponential increases in computing power will allow fund managers to make better predictions about future fluctuations in securities prices. Do I think that this increased computing power will help people outperform the market? I don't know. I'd doubt it, but i don't know as yet.