Wednesday, October 11, 2017

Why Low-Cost Investing Likely Results in Above Average Returns

Several studies found that only the top 2 to 3 percent of active-fund managers have enough skill to cover their costs. It’s hard enough to save for a house or retirement. So why pay big fees for subpar investment returns? Maybe think about low-cost investing, with an eye toward index investing.

To quote Nobel Prize winning economist Eugene Fama on active managers: “You’re charging people for stuff you can’t deliver.”

We are in the early stages of a move toward low-cost investing as huge sums of money have been flowing out of actively managed mutual funds and into index funds. According to Barry Ritholtz, “we are in the middle of the Copernican Revolution about the proper way to invest or at least the rational way to invest.”

It’s easy to think — by seeing the ads and reading newspaper articles — that if you’re just clever enough, you’re going to win. The delusion comes in the form of how the stock markets actually work.  We don’t understand the negative-sum nature of active investing. Whatever you win, I lose. Whatever I win, you lose, and we both pay to play that game. So the negative-sum nature of investing is one problem that’s often overlooked.

And then there is the second problem, which is, most people suffer from overconfidence, particularly in noisy environments where the feedback is weak. That describes the stock market. It’s incredibly noisy and it’s really easy to misinterpret what the return on your portfolio means.

Simple, perhaps, but elusive. In part because the alternative — the gamble of picking stocks — is so seductive. Which may explain why it took so long for index funds to really catch on. The index fund is more predictable, and boring — which, as Jack Bogle sees things, is its virtue. “It diversifies away the risk of individual investments. It diversifies away the risk of picking a hot manager and diversifies away the idea that you can pick market sectors like healthcare, technology, or whatever it might be.”

And then there’s the cost comparison. According to Vanguard founder Jack Bogle, “They charge a lot for this service. We estimate the average expense ratio is almost one percent for an actively managed fund. Then these active funds, all of them have sales loads. The index funds do not. The active funds further turn over their portfolios at a very high rate and that’s costly. You add that all up and the cost of owning a mutual fund on average is two percent. You can buy an index fund of, an S&P 500 Index Fund, let’s say, for as little as four basis points, four one-hundredths of one percent. In a 7 percent market, you’re going to get 6.96 percent.”

That difference — two percent versus four one-hundredths of one percent — may not sound like a lot. But over time, those numbers are compounded by what Bogle calls the “relentless rules of humble arithmetic.”

Again according to Jack Bogle, “if the market return is 7 percent and the active manager gives you 5 after that two percent cost, and the index fund gives you 6.96 after that four basis point cost — you don’t appreciate it much in a year — but over 50 years, believe it or not, a dollar invested at 7 percent grows to around $32 and a dollar invested at five percent grows to about $10. Think what an investor thinks about when he looks at that number. He says, “Wait a minute! I put up 100 percent of the capital. I took 100 percent of the risk and I got 33 percent of the return.” Well, anybody that thinks that’s a good deal, I’ve got a bridge I want to sell them.”

To paraphrase Bogle, here’s the reality of the actively-managed mutual fund business, you get precisely what you don’t pay for. So, if you pay nothingⁱ, you get everything!

Now there are those who can and some people have and have for long periods of time. Look no further than Warren Buffett. The challenge is being able to identify in advance who will outperform the market, for them to beat the market consistently year over year, and then to do it in excess of costs, fees, taxes, commissions. How can an investor tell when it is luck or skill? 

The bottom line is most people are better off with low-cost indexing for most of their invested money. Active investment management may have a role in asset allocation and portfolio construction, but only when it’s low cost, adds diversification and is not used to exacerbate behaviors detrimental to accumulating wealth.

C. Blakely CFP®, CTFA                        10/2017

- by nothing, I mean almost nothing.

Sources: Bloomberg View - Ritholtz, Freakonomics – Bogle interview, Fama Interview 

Friday, February 17, 2017

Working Past 65 - Considerations for Social Security and Medicare

Living Longer

If you are nearing or at 65 you know there are many decisions you will need to make that will be very important in determining your financial well-being after you stop working. One big consideration that I believe many of us may get wrong is estimating our longevity – we tend to underestimate it.

Case in point, my grandfather lived to be seventy, my father died at seventy two. If I couple that data with the conventional wisdom often cited that states men live into their late 70’s, (and women into their early 80’s) I might expect to make it to my mid 70’s. However, this is mistaken thinking, actual life expectancy is quite a bit longer – the upside! - and it can lead to serious financial consequences – the downside.

The Social Security Administration’s most recent analysis of expected longevity if you’re 50 years old, is 83 years for a woman, and 80 years for a man. This average can be misleading because some will not live to retirement and some will live 30 years in retirement.

In fact, as noted in a recent Wall Street Journal article, 56 percent of all 50-year-old women are expected to live longer than their life expectancy of 83 years and 55 percent of all men are expected to outlive their expectancy of 80 years, according to the Social Security table. This is because the distribution of ages when people are expected to die is a bit skewed with more people living longer than dying early.

So plan to live longer and fine-tune your retirement strategy. This may mean saving more, or for those nearing retirement, reconsidering whether you should work for a few more years and continue growing your retirement accounts.
If you are considering working past 65 there are several very important considerations, although I am only going to touch on two for this post.

When to take Social Security

If you are not planning to live long in retirement then start taking Social Security at age 62. But, if you plan on living into your eighties, consider this, if you defer taking social security until you are 70 ½, the increase in the payout over those eight years is 76 percent – inflation protected! That is a big move up and may make a big difference if you have not been able to save enough for retirement.

What about Medicare

You’re eligible for Medicare at age 65 but what if your desire or need is to continue to work? Hopefully there is someone at work to help navigate this but in many cases you can't rely on your employer for Medicare guidance. Employers frequently provide wrong or confusing advice about when employees should enroll in Medicare.

If you work for a company with fewer than 20 employees, be sure to enroll in Part B during your initial enrollment period. Medicare automatically becomes your primary payer, and your employer's plan is unlikely to pay for any expenses that could be covered by Medicare - even if you forgot to enroll in the government program.

Typically, the insurer will notify you that it will not pay a claim because it should have been submitted to Medicare. If an insurer pays several claims then realizes you are eligible for Medicare -they seek repayment from you. As long as you're still employed, you can enroll in Part B without penalty - and you should do so immediately.

If your employer has 20 or more employees there are different rules. You do not have to enroll in Part B while you're still working. You should** enroll in Part A because it's free for most people, and Part A will be secondary to your employer plan. A spouse who is 65 or older can stay on your company plan and delay Part B until you leave.

If you’re happy with your employee coverage and don’t want to get Part B but are receiving Social Security benefits and automatically received a Medicare card, you can send it back and ask for it to be reissued just for Part A. (You can’t delay signing up for Part A if you are already on Social Security.)

It could make sense to drop your employer coverage if your benefits are inadequate and your premiums, deductibles and other out-of-pocket costs are high. You should compare the benefits and costs of your employer plan with the costs of Medicare, plus Part D and a Medigap policy.

A self-employed person who has an individual insurance policy should enroll in Medicare during the initial enrollment period. Otherwise a policy can coordinate with phantom Part B, meaning that it will pay secondary to Medicare, even if you haven't enrolled.

Once you leave your job, you can enroll in Part B without penalty during an eight-month "special enrollment period," which begins the month after you stop working. To avoid a gap in coverage, be sure to enroll in Medicare a month or two before you leave your job. If you miss this enrollment period, you will need to wait until the next general enrollment period.

**You may run into a bit of a roadblock if you have a tax-free health savings account tied to your employer's high-deductible health plan. Whether you should delay enrollment in Medicare so you can continue contributing to your HSA depends on your circumstances. Employer health care coverage pays primary before Medicare so you effectively don’t need to have Medicare in order to pay your health expenses. This means that as long as you are currently working and you wish to decline Medicare Part B, you can do so and enroll in Part B later when you lose your coverage. However, you cannot decline Medicare Part A, unless, you’re not accepting Social Security benefits. As long as you are not accepting Social Security benefits, you can choose to decline Part A also, which preserves your HSA tax benefit! As soon as you want to stop contributing to the HSA (and if you are still currently working) you can enroll in Part A and get six months of retroactive coverage.
Once you enroll in any part of Medicare, you won’t be able to contribute to your HSA, it’s the law. If you would like to continue making contributions to your HSA, you can delay both Part A and Part B until you stop working or lose coverage from your employer. You will NOT pay a penalty for delaying Medicare, as long as you enroll within 8 months of losing your coverage or stopping work (whichever happens first).

Finding out More
Medicare is a complex service and this post serves only to make you aware of the basics. For more information and help, your state likely offers a free health insurance counseling program (APPRISE in Pennsylvania) designed to help you navigate Medicare. An excellent resource for more information is the Medicare Rights Center's online Medicare Interactive service (, which answers many common enrollment questions. Or you can call the State Health Insurance Assistance Program (find your state SHIP at

CBlakely, CFP®, CTFA                           02/2017

Sources:,, Wall Street Journal