Wednesday, May 22, 2013

First Post - Why Indexing?

I have had a interest in passive, index linked, or enhanced indexing portfolio construction since 2007 and I took some major steps to further develop my understanding and use of these solutions over the past 12 months with a career shift into a fee-based financial planning practice here in the beautiful Fraser Valley.  For years, working at a different bank-owned brokerage, I was a prolific earner of trailer fees, which is a rather opaque and undesirable way to conduct business from my point of view.  Now, working for a different and more open bank-owned brokerage, I operate a fee-based financial planning practice to provide transparency and objectivity for my clients. 

In terms of portfolio construction, after determining client needs, asset mix and a financial plan, currently, I almost exclusively use index based solutions when building client portfolios with only a few exceptions for tax or other planning reasons.

My hope with this blog is to deepen my own understanding of the plethora of index based products available to Canadian investors by featuring and analyzing the various products from time to time.  Additionally, I hope to provide insight to readers that will help them understand why index based investments are the preferred method of portfolio construction after developing a suitable asset mix.  Lastly, I hope to profile why fee-based financial planning, in combination with a passive investment approach, works out exceptionally well for clients over the long-term.


And to finish today's post I quote William Sharpe:

"Today's fad is index funds that track the Standard and Poor's 500. True, the average soundly beat most stock funds over the past decade. But is this an eternal truth or a transitory one?"

"In small stocks, especially, you're probably better off with an active manager than buying the market."

"The case for passive management rests only on complex and unrealistic theories of equilibrium in capital markets."

"Any graduate of the ___ Business School should be able to beat an index fund over the course of a market cycle."
Statements such as these are made with alarming frequency by investment professionals1. In some cases, subtle and sophisticated reasoning may be involved. More often (alas), the conclusions can only be justified by assuming that the laws of arithmetic have been suspended for the convenience of those who choose to pursue careers as active managers.
If "active" and "passive" management styles are defined in sensible ways, it must be the case that
(1) before costs, the return on the average actively managed dollar will equal the return on the average passively managed dollar and
(2) after costs, the return on the average actively managed dollar will be less than the return on the average passively managed dollar
These assertions will hold for any time period. Moreover, they depend only on the laws of addition, subtraction, multiplication and division. Nothing else is required.

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