Imagine we’re on an intergalactic spaceship traveling far away from Earth. It’s a quiet day. There are no meteor storms or alien encounters to contend with. We’re sitting in the Solar Lounge discussing a topic of great interest to both of us – the root elements of investment value. Our dialogue is as follows: What defines investment value? Is it the return of an investment over time? We contemplate this and decide that return cannot be a good definition of value because inflation causes prices to rise, which is not an increase in real value. Then inflation gains are taxed by governments, which reduces real value.
What do 25%, 25%, 25% and 25% have in common? Besides adding up to 100%, it’s a pattern of active fund underperformance versus indexes that consistently occurs in the mutual fund marketplace.
A 401(k) plan is broken when the fund expenses overwhelm the tax benefit of participation. Employer sponsored 401(k) and similar tax-deferred savings plans encourage employees to save for retirement by deferring income taxes on their contributions. However, a recent study suggests that about 1 in 7 plans provide investment options that are so expensive that young workers would be better off not participating. They would be better off paying taxes and investing after-tax in low-cost index funds.
It’s easy to beat the S&P 500. Just hold all stocks in the S&P 500 in an equal amount. This “equal weighted” index would have outperformed the cap-weighted S&P by more than 6% annually over the past five years. What’s the trick? Just ignore risk.
Everything was bionic in the 1970s, even investment strategies. Bionic Beta was the buzz phrase with institutional investors. This wasn’t a strategy that invested in companies that made bionic arms, legs, or eyes — far from it. Bionic Beta was a strategy that is very similar to what is being called Smart Beta today. In a sense, it’s the 1970s all over again.