As their book title, "Wealth Without Worry," suggests, James Whiddon and Lance Alston are doing just fine, thanks. So are their clients...
As their book title, “Wealth Without Worry,” suggests, James Whiddon and Lance Alston are doing just fine, thanks.
So are their clients.
The two Dallas financial planners are the prime movers of JWA Financial Group, a small, fee-only financial-planning firm.
While most advisory firms promise careful security selection, unrelenting attention to economic events and high fees for their sublime foresight about future events, Whiddon and Alston are different.
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Their goal: a “market return portfolio,” no more, no less.
In their book, they point out that a simple diversified index portfolio consisting of four basic index funds (20 percent S&P 500, 20 percent Russell 2000, 20 percent MSCI EAFE and 40 percent Lehman Intermediate Government indexes) would have returned 12.7 percent a year during the 25 years from 1979 through 2004.
That’s a pretty good return.
How good? Try these examples. Dodge and Cox Balanced, a fund frequently mentioned in this column and now closed to new investors after years of stunning performance, clocked in at “only” 11.4 percent over the same period.
Vanguard Wellington, another top performer, returned “only” 10.4 percent over the period. And Fidelity Puritan, another stalwart, returned “only” 10.04 percent.
Basically, the index-fund portfolio blew away the very best managed funds and did it with less risk. The index-fund portfolio returned that 12.7 percent, while the S&P 500 was returning about 12 percent.
Whiddon and Alston say they can beat simple indexing by using institutional asset class index funds from Dimensional Fund Advisors.
This research shows that it is possible to increase portfolio returns by investing in small-cap stocks and “value” stocks with low price-to-earnings and price-to-book value ratios.
The financial planners’ 80:20 Market Return Portfolio consists of seven asset class funds, including small-cap, real estate and emerging market indexes. Only 20 percent is committed to fixed income.
While the simple index-fund portfolio crushed the returns earned by active managers, the Whiddon/Alston model portfolio was returning a whopping 14.3 percent. And it did it with less market risk.
How can this happen?
Whiddon attributes the superior performance to several factors: relatively low costs, asset class funds that contain more than 15,000 securities — compared with fewer than 4,000 securities for a typical index-fund portfolio — and such broad diversification that downside risk is muted.
During a recent interview, he called it “super-diversification.” He said that, in practice, portfolios were constructed with 12 to 14 asset classes.
This is important.
One of the dramatic exercises in their book is a simple probability question. “What are the odds that an active manager can select a portfolio of funds that will do better than a portfolio of index funds?”
If only 30 percent of active fund managers beat the “U.S. large blend index,” 26 percent of the managers beat the “U.S. large value index,” 39 percent beat the “U.S. small value index,” and 29 percent beat the “large international index,” the probability of a portfolio (or wrap account) manager picking index-beating funds is only 0.88 percent.
That, of course, doesn’t mean that a managed portfolio can’t beat an index portfolio. One outperformer can raise the overall average.
When I pointed this out to Alston, he had a quick response: “With one-quarter of the portfolio in one asset class, you might have a chance to outperform with one good fund. But with 15 asset classes, it simply can’t happen.”
In other words, the same major diversification that works to reduce portfolio risk also makes it a near mathematical certainty that a portfolio of managed asset classes will underperform a portfolio of indexed asset classes.
Whiddon put it in broader terms: “The idea with the Market Return Portfolio is that you own the market. You own the entire casino. You own capitalism, which has been successful since it was created.”
In managed investing, Wall Street owns the casino. Wall Street sets the “vig.” And Wall Street invites us to play at its many tables.
And “the house” always wins.
Questions about personal finance and investments may be sent to Scott Burns at The Dallas Morning News, P.O. Box 655237, Dallas, TX 75265; by fax at 214-977-8776; or by e-mail at email@example.com. Questions of general interest will be answered in future columns.