Become A Wise Index Investor

by: Lowell Herr

"What distinguishes index funds is that they don't presume to have greater wisdom than the collective market, but instead try to channel its wisdom to your advantage." - Zack O'Malley Greenburg, a financial journalist.

Daniel R. Solin writes in his recent book, The Smartest Portfolio You'll Ever Own, "I am frequently invited to talk to investment clubs. I have a standard response: You don't want me because I will tell you either to disband your group or to call it a social club because that's what it is." Having been involved in two investment clubs, Solin has it right.

To back up my contention, here is the current performance data that sums up the performance of hundreds of investment clubs. From 12/31/2000 through 9/8/2011 the average return of investment clubs was -3.0% annually vs. 2.1% for the VTSMX index. That is a difference of 5.1% annually. Using data from the site ( providing this information, the dollar difference is an astounding 72% in favor of the total stock market index.

Investment clubs are set up to teach individuals how to analyze individual stocks. If clubs perform so poorly, what is the alternative? Permit me to digress and tell a short story.

About eleven years ago, I was asked to evaluate a small endowment fund for a non-profit organization. The fund was managed by a well-known national bank. For their services, the bank was charging the institution 1% point to invest in actively managed mutual funds. These funds were adding an additional 1% point to manage the money. The two percentage point fees seemed excessive, particularly when all three actively managed mutual funds had below average performance. My advice was to pull the funds from the bank as soon as possible. What to do with the investments was the next question.

My advice was to sell the mutual funds and build a portfolio around ETFs. There were few ETFs in late 2000, but there were plenty to construct a portfolio with worldwide diversification. The following screen shot shows the current portfolio and a few of these investments have been in the portfolio since its inception on 12/01/2000. Included in the list are a number of iShares ETFs that were once part of the portfolio.

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The following screen shot shows the asset allocation plan of the portfolio, and this has changed little since its inception. International REITs and Commodities were added in recent years and the allocation to bonds increased. Otherwise, the asset allocation plan looks much as it did ten years ago. Over time, assets were moved from a few iShares to Vanguard ETFs to reduce expenses. Using a threshold or target limits of 20%, the portfolio rarely requires rebalancing. Right now a sale of bonds and commodities would make sense.

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How well has this passively managed portfolio performed? That question brings the discussion back to investment clubs. The duration of operations for this endowment fund, composed of index ETFs, is almost identical to the data from the investment club site. Since inception, the index oriented endowment fund has an Internal Rate of Return (IRR) value of 4.3% or 7.3% (annualized) above the average investment club. The endowment fund tops the VTSMX benchmark by 2.2% points on an annual basis, and does it with a Sortinio Ratio of over 18. In other words, the risk is quite low.

Investors interested in tracking this endowment portfolio need only search for the Schrodinger Portfolio on this site. While the Schrodinger is not a perfect allocation plan, it serves as a model for diversification, and above all, use of index ETFs as investment vehicles.

Disclosure: I am long VEU, VWO, HYG, GSG, RWX, VNQ, VOT, VOE, VBR, VBK, VO, VB, SLV, IEF, TIP.

Additional disclosure: I use almost every ETF that shows up in this portfolio. While this is not my personal portfolio, I do watch it carefully for the non-profit organization.