Passive Investing Wisdom from Taylor Larimore

By Murray Coleman

Taylor Larimore is co-author of "The Bogleheads Guide To Investing" and retired chief of the Federal Small Business Administration's finance division in south Florida.

The former Internal Revenue Service officer is also a frequent contributor at the popular Bogleheads' indexing forum.

Index Universe caught up with him recently to find out his views from a passive investor's perspective in these days of $4 per gallon gas prices and a slowing economy.

IU: In these trying times, do you think it's reasonable to make tactical allocation changes?

Larimore: You are younger than I am or you might not call these "trying times." I have endured at least 10 bear markets when the S&P 500 declined 20% or more. I was eight-years-old when the Dow plunged 89%. My dad's restaurant failed for lack of customers, and we had to move into my grandparents Florida home. Later, there were: World War II, the cold war, the Cuban missile crisis, President Kennedy's assassination, the Vietnam War, the Korean War, 15% inflation, hostages in Iran, Y2K and dozens of other crisis situations. Each time, the financial pundits were forecasting gloom and doom. But you know what happened? The Dow climbed from 235 in 1950 to about 12,000 today -- and that does not include dividends. So, to answer your question about "tactical allocation changes" (which is really market-timing), I think the best strategy is simply to hold a broadly diversified portfolio and stay the course.

IU: Critics argue that buy and holders are simply sticking their heads in the sand as risk rises in the marketplace. How do you respond to those views?

Larimore: No one can forecast what the stock market is going to do. Mr. (John) Bogle has stated that he never met anyone who can time the stock market successfully and consistently. Research confirms the futility of trying. There is always risk in securities markets. The way we manage risk is to diversify among different types of securities - including bonds - and then stay the course. That doesn't mean do nothing forever. We still need to rebalance and make necessary adjustments based on our own personal situation -- not on market forecasts.

IU: Do you see investors going to extremes in overweighting portfolios to take advantage of the so-called value and small-cap premiums? What are your suggestions?

Larimore: I have been investing for more than 50 years, which is about average for most investors during their working and retirement lifetime. If there is one thing I have noticed, it is that investors tend to invest in what's doing well during the past few years. Morningstar has a tic-tac-toe style box of nine asset classes. In 1999, large-cap growth stocks had the best 15-year returns and investors shunned small-cap value stocks, which had the worst 15-year returns. Today, if you look at the tic-tax-toe box you will find that investors are loading up on small cap value stocks, which now have the best 15-year returns. It's the same chase-the-hot-stock behavior in reverse. Instead of jumping in and out of different asset classes, I think it is better to hold them all in a broad market index fund and stay the course.

IU: Is Vanguard leading investors astray by also offering actively managed funds?

Larimore: Although I prefer index funds, well-diversified and low-cost managed funds can be a fine investment -- certainly better than buying individual stocks.Vanguard must meet investor demand if it is to grow. Indexing takes time and education to understand. Most investors rely on Wall Street's marketing machine for advice instead of independent academic research. This is why I think that IndexUniverse.com, the Bogleheads.org and Morningstar.com are such valuable resources for individual investors.

IU: How does a longtime index funds enthusiast like yourself view exchange-traded funds?

Larimore: I have mixed feelings. Exchange-traded funds are relatively new. They're being heavily promoted with their benefits heavily exaggerated -- particularly by brokers who have been losing business to no-load mutual funds. Exchange-traded funds are a type of index fund which, in some cases, can be an improvement over conventional index funds. The lower cost structure of an ETF is a plus. Unfortunately, most ETFs are being used for trading and speculative purposes. Turnover for NASDAQ Qubes is reported to be over 6,000% a year. Although I prefer the simplicity of holding a few index mutual funds directly with one low-cost company, I can appreciate the benefits of diversified ETFs for investors making few transactions.

IU: You used to invest in high-cost actively managed funds, didn't you? What led to your conversion?

Larimore: I was worse than you describe. Not only did I invest in high-cost managed funds, I was also a market-timer. I even wrote a monthly market-timing newsletter. It was an early edition of Burton Malkiel's, "Random Walk Down Wall Street" that first made me realize how stupid I had been with our investments. The classic book "Bogle on Mutual Funds" completed my conversion to indexing with its advantages of: lower-costs, higher long-term returns, greater diversification for lower risk, better tax-efficiency, no manager changes, no style drift, never below-average performance, simplicity and greater peace of mind.

IU: You have made more posts on Morningstar forums than any other contributor. What message would give to IndexUniverse.com readers?

Larimore: The easiest way to beat the average investor, professional or otherwise is to: save regularly, avoid mistakes, have an asset-allocation plan, diversify with broad market index funds, keep costs low (including taxes), strive for simplicity, and stay the course.

Comments

[Panskeptic:]

Welcome to Jurassic Park!

"Mr. (John) Bogle has stated that he never met anyone who can time the stock market successfully and consistently."

I'm sorry he's never met George Soros, Paul Tudor Jones, Julian Robertson or any other of several hundred private investors and hedge fund managers who have done just that. Mr. Bogle should get out more.

Even people who say they don't market time, like Warren Buffett, wind up timing their entries and exits anyway.

Mr. Larimore's quasi-religious claptrap is utterly useless. Blind repetition of slogans doesn't make them true, but I suppose if you don't want to worship a tree or a rock, you can worship Mr. Bogle instead. And Mr. Malkiel's orthodoxy has a tough time explaining exactly what happened in the markets this year. "Random" it was not, and hasn't been for a long time.

For a 25 year period not so long ago, the markets had virtually zero return. We're just coming out of what many are calling "A Lost Decade." If you've got 10 or more investing years to waste doing nothing while the market vainly searches for a trend, good for you, but those of us with realistic actuarial estimates aren't limited to passive buy-and-die. "Stay the course" as a piece of advice has a well-deserved reputation of being utterly disastrous.

Do many people overtrade? Sure, without a doubt. Is this particular set of mantras a recipe for success? Hell, no.

P.S. The astronomical turnover in Cubes comes from institutional investors, the ones Jack Bogle has never met, not from individual white-shoe'd retirees in Florida.

2008 Jun 16 10:53 AM

[Skjellifetti:]

Neither George Soros nor Julian Robertson have been able to time the markets both successfully and consistently. They have done better than most, but they have also had blowups that cost their funds billions.

2008 Jun 16 12:36 PM

[Alpha Seeker:]

This is the worst article on ETFs and investing in general.
Just because the guy is old and retired, I would not waste time taking him seriously.

2008 Jun 17 03:42 PM

[bongo_dongo:]

The comments show the that lack of sophistication of the writers. They obviously haven't heard of modern portfolio theory or the efficient frontier. This is what Taylor is advocating. Ignorance has a price and you will pay it. He wised up. if you listen and learn you may also.

2008 Jun 19 08:51 PM

[User 437423:]

Мery interesting

Jun 27 03:02 AM