THE BLOG

It's So Easy, Your Broker Could Do It!

05/25/2011 12:10 pm ET
  • Dan Solin Author of the Smartest series of books

Last week, I described six deadly investing myths. It's easy to be negative, since most investors chase returns, following the advice of their brokers or advisors who tell them that they can "beat the market" by picking "good" stocks or "the best" mutual funds.

So, if I have convinced you to refuse to be a lamb being led to slaughter, how exactly should you invest your hard earned money?

When The New York Times reviewed The Smartest Investment Book You'll Ever Read, the headline was "A Stubborn Insistence On One Way To Invest." The reviewer went on to somewhat begrudgingly concede that "it is clear he is on to something."

Actually, I am only partly guilty. I do not believe there is only one way to invest. I do believe there is only one way to invest intelligently. Here it is:

1. Determine your asset allocation. You can do this by taking a free risk capacity survey. There are many of them on the internet. I admit to a bias for the one at the web site for my book.


And the one at the web site of Index Funds Advisors (with whom I am affiliated):

2. Buy three low cost index funds from Vanguard.

* The Total Stock Market Index Fund (VTSMX). Put 70% of the amount allocated to equities in this fund.

* The Total International Stock Index Fund (VGTSX). Put 30% of the amount allocated to equities in this fund.

* The Total Bond Index Fund (VBMFX). Put 100% of the amount allocated to bonds in this fund.

3. Rebalance your portfolio once or twice a year to keep your asset allocation intact or to change it if your investment objectives or tolerance for risk have changed.

That's it. You are done.

Depending on your asset allocation, the long term average annual returns of these portfolios have ranged from 9.06% to 10.86%. The portfolios with the highest allocation of equities have yielded the highest returns.

Other fund families, like Fidelity and T. Rowe Price, offer similar funds.

You would think that following this advice would be very simple. The basic principles are endorsed by hundreds of academic studies, the views of virtually every Nobel Prize winner in economics, Warren Buffet, Peter Lynch and $4 trillion of the smartest, most sophisticated pension, trust and endowment money invested in this country. So, what's the catch?

The securities industry. They can't make any money giving you this advice, so they belittle it. They will tell you that it is fine for "novice investors." Or that it produces only "average returns".

This is complete nonsense. What they mean is it produces below average fees.

Trust me, if index funds were high commission products (like variable annuities -- but that is another story), every broker in this country would be extolling their virtues.

If you follow my advice, you are guaranteed to make the market returns for your particular asset allocation, net of fees, because you are investing in the market.

When your broker disparages this advice, ask him or her to take the Solin Challenge:

Will you guarantee me in writing, that my returns will equal or exceed market returns, net of fees, for my particular asset allocation?

I can assure you that you will never receive this letter -- and for good reason.

Studies indicate that most investors, following the advice of their brokers or advisors, significantly underperform market returns. And that the mutual funds recommended by these brokers and advisors cost more and perform worse than funds selected by investors on their own.

Other studies show that over 95% of mutual funds that have as their goal exceeding the returns of the S & P 500 index, fail to do so over a 10 year period.

It follows that investors who followed the simple portfolios I recommend would have been in the top 5% of all professionally managed money. Does that seem like "average" performance to you?

To be fair, there are reasons why some investors should not follow my advice. Here they are:

You like to gamble.

You confuse activity with progress.

You like the thrill of the chase.

You have an addictive personality.

You believe that the overwhelming academic data does not apply to you and your broker.

Notice that obtaining superior returns is not on this list.

Following this advice is responsible and intelligent investing. It's so easy, a broker could do it.

But she won't.