How to EASILY Outperform Index Investors

It is EASY to outperform index investors? Why?

• They don’t really try to get index returns. They try for: “Reasonable return with less risk”.
• This makes them use “performance drags” that typically reduce their returns by at least 1-3%/year:

You would think that people that consider themselves “index investors” would just own 1 or 2 broad indexes and try for the index return. However the ones I see usually do not invest this way.

Most of them have suboptimal portfolios that may contain:

1/ Bonds – They usually invest partly in bonds, even though studies show that over 20-year periods, equities (stocks) are more reliable. Equities have a lower 20-year standard deviation after inflation than bonds.

2/ Home country bias – They invest in Canada because it sounds safer, even though returns have been 1-3%/year lower than global stocks. Canada’s index is not a diversified portfolio. It is a resource & financial sector fund. Canada’s TSX60 is only 3% of the world’s stocks, but the 2^nd most popular for index investors.

3/ Riding the brake – Many ways to invest conservatively, like dividend, low volatility, or covered call ETFs. They sound good, but give you lower long-term returns.

This post is about performance. How to get the maximum reliable long-term return. It is not about risk-adjusted returns. It is an apples-to-apples comparison with people that consider themselves index investors. It’s about getting a high enough return to achieve your life goals in your Financial Plan.

Most popular all-in-one ETFs: 25% bonds, 25% Canada, 25% US, 25% International.

• This should lag the world index by about 2%/year.
• Asset allocation loss ratio (AALR) of 2%. Loss because of poor asset allocation.
• 25% bonds = 1.25%/year loss in long-term return.
• Dramatically overweight Canada, despite 1-3%/year lower returns than global stocks.
• Dramatically underweight US – highest growth country.

Popular ETFs often have bonds, such as VGRO.

The goal is to get the full index return less a small tracking error (about .5% for global equity index ETFs).

One broad index might be smart (global or US). But few index investors do this.  You would expect an index investor to invest entirely in 1 or 2 broad index ETFs, such as MSCI World, MSCI ACWI (all-cap), or S&P500 to get the index return. This is probably maximum diversification and pure indexing. Instead, most invest in a few indexes that are usually a more conservative or non-optimal asset allocation.Adding more ETFs is over-weighting some areas, not more diversification.

Almost all index investors have 3 or more ETFs, or an all-in-one ETF, with a sub-optimal allocation and lower long-term return.

I often talk with index investors. They like the lower MER, but don’t realize AALR is much larger than their fee savings. The Asset Allocation Loss Ratio (AALR) is the difference between the expected return of a portfolio and a broad index.

It is EASY to outperform index investors because they buy more than 1 or 2 ETFs, or they are not 100% equities.

Just get the return of the global or US equity index and you outperform index investors. Just use one broad index ETF. That’s all it would take. Or invest with fund managers that you expect will match or beat the index after fees over time.

We invest for “above index returns” with an elite portfolio manager that finds the world’s best investors that all have 15 to 30-year track records beating the index after all fees. Most fund managers lag, but just like any field, there are some amazing people that outperform. We try to beat the global equity index after all fees, including ours, so that our fee-for-service financial planning advice is purely value-added.

Index investors cannot beat the index, but we are confident our portfolio manager will match or beat the index over time. 100% of my personal investments are with the same portfolio manager and same All Star Managers as our clients.

Don’t invest for: “Reasonable return with less risk”. Invest for maximum reliable long-term total returns.

#1 blog in Canada for a financial planner. If you are interested in talking with us, go www.edrempel.com/talk

Ed