Cost Matters Hypothesis

Two Investment Gurus: Index Funds are Path to a Winning Investment
By Bonnie Bauman
September 30 , 2005


Investors should steer clear of actively managed mutual funds, hedge funds
and ETFs. The best path to take is the one that leads them to a globally
diversified portfolio of index funds. So said Mark Hebner, author of Index
Funds: the 12-Step Program for Active Investors and Vanguard founder and
author of a number of books on index fund investing, John Bogle. (Bogle
reiterated his views in a speech he delivered at the American Association of
Individual Investors in May 2005.)

"The all-market index fund and the Standard & Poor's 500 Index Fund are far
better ways to invest than searching through a seemingly-endless list of the
products of the marketing-driven, asset-gathering machine that today's
mutual fund industry has become," said Bogle.

Hebner, for his part, directs investors to a more globally diversified
portfolio of index funds, including 15,000 stocks and a tilt toward small
value stocks from 35 countries.

In his speech, Bogle laid out what he calls the central fact of investing:
"As a group, investors never- never! -enjoy the gross return that the
markets deliver." That's because at the end of the day, what investors walk
away with are net returns after costs, he said.

"Thus, just as gambling in the casino is a zero-sum game before the
croupiers rake in their share.and a loser's game thereafter, so beating the
stock and bond markets is a zero-sum game before intermediation costs, and a
loser's game thereafter," Bogle said.

Bogle outlined the "huge sums" mutual fund advisors rake in: the annual
costs incurred by investors in the average equity fund include: a management
fee of 0.9%, plus other expenses 0.6%, for a total expense ratio of 1.5%;
hidden portfolio transaction costs of at least 0.8%; and sales commissions
on load funds, about 0.7% (a 5% commission, spread out over, say seven
years). The total sum equals a whopping 3% per year!

"Most of you are familiar with the EMH- the Efficient Market
Hypothesis -that suggests that most stocks are fairly valued, most of the
time," Bogle said.

"But," he continued, "the relentless rules of humble arithmetic remind us of
something both more certain and more profound than the EMH. I call it the
CMH- the Cost Matters Hypothesis -the iron rule that investors as a group
must always lose to the stock market by the amount of the costs they incur."

Meanwhile, Hebner points out in his book that the Fama/French Five Factor
Model helps investors identify the stocks and bonds risk factors that best
correlate to long-term historic returns, and therefore provide foundations
for the best index funds. The application of these factors add about a 3%
per year return at the same risk level as a U.S. total market index fund.
This is after an investment advisor fee and an index fund fee. Taxes in such
portfolios are also kept very low due to the use of tax managed index funds
from Dimentional Fund Advisors.

In his speech, Bogle turned to "simple arithmetic" to prove the advantage of
investing in passively managed index mutual funds versus actively managed
mutual funds. For one thing, over the past 20 years, a simple, low-cost,
no-load stock market index fund delivered an annual return of 12.8%, while
the market's return was a close 13%. Meanwhile, the average equity mutual
fund delivered a return of just 10%, less than 80% of the market's annual
return. Hebner's book shows that a lower risk global portfolio returned
15.32% after fees.

Bogle indicated that "each $1 invested in the U.S. total market index fund
grew to $10.12-the magic of compounding returns -while each $1 in the
average fund grew to just $5.73, not 80% of the market's return, but a
shriveled-up 57%-a victim of the tyranny of compounding costs . The magic,
alas, is overwhelmed by the tyranny."

And that's all before taxes, pointed out Bogle. Due to the "astonishingly
high" portfolio turnover of the average managed equity fund, another 2.2% is
knocked off of the return-that equals only 41% of the market's annual
return. For their part, index funds relinquished only 0.9% in taxes.

The "simple arithmetic" of hedge funds and ETFs is equally as bleak, Bogle
said. In the case of hedge funds, Bogle pointed to a recent study that
showed that the average hedge fund earned a return of about 9.3% per year in
1995 to 2003, slightly less than the stock market return of 9.4%.

Those who invest in ETFs, which Bogle described as "low-cost index funds
that can be traded in the stock market just like regular stocks," don't fair
much better. ETF investors for the most part are short-term investors. Said
Bogle, "Only long-term holders are certain to benefit from the glitteringly
low expenses of most ETFs."

In conclusion Bogle outlined four "Essential Rules" of Investing:

One, pare costs to the bone. "Realize that in investing you get what you
don't pay for. Whatever future returns the stock and bond markets are
generous enough to deliver, few investors will succeed in capturing 100% of
those returns, simply because of the high costs of investing-all those
commissions, management fees, investment expenses and taxes."

Two, diversify. Own American business and hold on to it. "Not one company of
industry, but a broadly diversified portfolio of lots of companies and
industries. Buy such a portfolio, never sell, and hold it forever. No one
knows what stocks will do tomorrow, or even what they'll do over the next
decade, but over the long pull the dividends and earnings growth of American
business will be reflected in rising stock prices."

Three, don't forget to allocate your assets prudently between stocks and
bonds. "As the years roll on, we have more wealth at stake, less time to
recoup losses, and begin to rely on our investments to provide income. Each
of these critical factors suggests that, as investors age, we should own
even larger bond portions."

Four, don't do something, just stand there. Stay the course. "Once you get
your costs down, your stocks and bonds diversified, and your stock/bond
balance right. Not only expenses, but emotions, are the investor's greatest
enemy." In his book, Hebner reminds investors that an investment advisor can
help control these emotions that are so destructive of investor returns.

Hebner's book points out a fifth "essential rule" Bogle has left out.
Investors who invest in index funds add substantial value to their
investments by signing on with a registered investment advisor (RIA) that
maintains the discipline of exclusively using index funds. RIAs are
registered with the Securities and Exchange Commission and provide valuable
ongoing advice and education.

Indeed, RIAs that specialize in indexing help investors to stay the course
by encouraging long-term buy and hold and rebalancing strategies. On top of
that, they advise prudent investing through ups and downs of the market.
Furthermore, a few RIAs provides access to Dimensional Fund Advisor's low
cost institutional-style index funds, which are based on the highly regarded
Five Factor Model.

For example, Index Funds Advisors (IFA) works to make sure investors are
matched with a risk appropriate portfolio of index funds by carefully
qualifying and quantifying the investors risk capacity and matching it to a
portfolio's risk exposure. This strategy ultimately results in higher gains
for investors.

As is shown in the table below, from January 1985 to December 2004, IFA's
Portfolio 100, pulled in an annualized return of 15.32%, whereas the S&P 500
trailed behind at 13.23%, the Russell 3000 Index was at 12.96%, and the CRSP
Market 1-10 Index was at 12.94%.

It should be noted that the IFA index portfolio's annualized returns are
calculated after the IFA and DFA fees are subtracted. By signing on with a
fee-only investment advisor who sells only index funds, investors can be
assured that the advisor does not receive compensation contingent on the
purchase or sale of any investment products.

See the chart below to see how IFA's Portfolio 100 risk and return compared
to three well-known indexes. At a lower risk and after DFA and IFA fees, it
obtained about a 3% per year higher return over the 20 year period ending
Dec. 2004.


Portfolio 100
S&P 500 Index
Russell 3000 Index
CRSP Market

1-10 Index

Annualized Return
15.32%
13.23%
12.96%
12.94%

Growth of $1
$17.31
$12.01
$11.44
$11.39

Annual Standard Deviation
16.46%
17.05%
16.88%
17.34%


Source : ifa.com/btp

Re: Cost Matters Hypothesis

"NoEd" <> wrote

> Bogle outlined the "huge sums" mutual fund advisors rake in: the annual
> costs incurred by investors in the average equity fund include: a
> management
> fee of 0.9%, plus other expenses 0.6%, for a total expense ratio of 1.5%;

I don't think I own any funds with expenses of 1.5% or higher, but I might.
Bogle never talks about the "huge sums" that Vanguard rakes in. Wonder why?

Re: Cost Matters Hypothesis

"NoEd" <> wrote

> In his speech, Bogle turned to "simple arithmetic" to prove the advantage
> of
> investing in passively managed index mutual funds versus actively managed
> mutual funds. For one thing, over the past 20 years, a simple, low-cost,
> no-load stock market index fund delivered an annual return of 12.8%, while
> the market's return was a close 13%. Meanwhile, the average equity mutual
> fund delivered a return of just 10%, less than 80% of the market's annual
> return.

Over the last five years, 47% of large blend fund beat VFINX.
Almost a 50/50 chance of beating it by throwing a dart at the list.

Re: Cost Matters Hypothesis

Where are you getting your statistics? As of June 15, 2005, it was 64.39%.
See the reference below. Ed, you don't have the facts in your favor; you
only have your beliefs.








"Ed" <> wrote in message
news:
>
> "NoEd" <> wrote
>
>> In his speech, Bogle turned to "simple arithmetic" to prove the advantage
>> of
>> investing in passively managed index mutual funds versus actively managed
>> mutual funds. For one thing, over the past 20 years, a simple, low-cost,
>> no-load stock market index fund delivered an annual return of 12.8%,
>> while
>> the market's return was a close 13%. Meanwhile, the average equity mutual
>> fund delivered a return of just 10%, less than 80% of the market's annual
>> return.
>
> Over the last five years, 47% of large blend fund beat VFINX.
> Almost a 50/50 chance of beating it by throwing a dart at the list.
>

Re: Cost Matters Hypothesis

All money market funds beat VFINX over the past 5 years.




"NoEd" <> wrote in message
news:
> Where are you getting your statistics? As of June 15, 2005, it was
> 64.39%.
> See the reference below. Ed, you don't have the facts in your favor; you
> only have your beliefs.
>
>
>
>
>
>
>
>
> "Ed" <> wrote in message
> news:
>>
>> "NoEd" <> wrote
>>
>>> In his speech, Bogle turned to "simple arithmetic" to prove the
>>> advantage
>>> of
>>> investing in passively managed index mutual funds versus actively
>>> managed
>>> mutual funds. For one thing, over the past 20 years, a simple, low-cost,
>>> no-load stock market index fund delivered an annual return of 12.8%,
>>> while
>>> the market's return was a close 13%. Meanwhile, the average equity
>>> mutual
>>> fund delivered a return of just 10%, less than 80% of the market's
>>> annual
>>> return.
>>
>> Over the last five years, 47% of large blend fund beat VFINX.
>> Almost a 50/50 chance of beating it by throwing a dart at the list.
>>
>
>
>

Re: Cost Matters Hypothesis

Another "blank out."


"Ed" <> wrote in message
news:
> All money market funds beat VFINX over the past 5 years.
>
>
>
>
> "NoEd" <> wrote in message
> news:
>> Where are you getting your statistics? As of June 15, 2005, it was
>> 64.39%.
>> See the reference below. Ed, you don't have the facts in your favor; you
>> only have your beliefs.
>>
>>
>>
>>
>>
>>
>>
>>
>> "Ed" <> wrote in message
>> news:
>>>
>>> "NoEd" <> wrote
>>>
>>>> In his speech, Bogle turned to "simple arithmetic" to prove the
>>>> advantage
>>>> of
>>>> investing in passively managed index mutual funds versus actively
>>>> managed
>>>> mutual funds. For one thing, over the past 20 years, a simple,
>>>> low-cost,
>>>> no-load stock market index fund delivered an annual return of 12.8%,
>>>> while
>>>> the market's return was a close 13%. Meanwhile, the average equity
>>>> mutual
>>>> fund delivered a return of just 10%, less than 80% of the market's
>>>> annual
>>>> return.
>>>
>>> Over the last five years, 47% of large blend fund beat VFINX.
>>> Almost a 50/50 chance of beating it by throwing a dart at the list.
>>>
>>
>>
>>
>
>

Re: Cost Matters Hypothesis

All money that was placed in glass jars and buried near a tree beat VFINX
over the past 5 years!

Re: Cost Matters Hypothesis

If you put $5,000,000.00 into VFINX five years ago, my paperboy made more
money than you did on your investment. Paperboy's cost, 80%, he has to pay
$0.40 for each $0.50 paper he delivers.

Re: Cost Matters Hypothesis

"Ed" <> wrote in message
news:
> If you put $5,000,000.00 into VFINX five years ago, my paperboy made more
> money than you did on your investment. Paperboy's cost, 80%, he has to pay
> $0.40 for each $0.50 paper he delivers.
>

A sawbuck says he still doesn't get it.

(I know ... a sucker bet)

Re: Cost Matters Hypothesis

"Gary C" <> wrote in message
news:xaz0f.2048$
>
> "Ed" <> wrote in message
> news:
>> If you put $5,000,000.00 into VFINX five years ago, my paperboy made more
>> money than you did on your investment. Paperboy's cost, 80%, he has to
>> pay $0.40 for each $0.50 paper he delivers.
>>
>
> A sawbuck says he still doesn't get it.
>
> (I know ... a sucker bet)

You know these cult guys, my info can't be correct.

Re: Cost Matters Hypothesis

I know that VFINX lost money the last 5 years. But it still outperformed
60% percent of the other large blend funds. I will ask you again what will
be one of the top 5 performing funds in the next three months, why do you
think this, and do you own it now? We need to know this information IN
ADVANCE. Even your drunk sidekick understands the importance of these
questions.


"Ed" <> wrote in message
news:
> All money that was placed in glass jars and buried near a tree beat VFINX
> over the past 5 years!
>
>
>
>

Re: Cost Matters Hypothesis

"NoEd" <> wrote in message
news:

> Even your drunk sidekick understands the importance of these questions.
>

Hey Mac, are you going to let him call you a sidekick?

Re: Cost Matters Hypothesis

I lit cigars with $5 bills every friday for 5 years and didn't lose as much
as VFINX.

Re: Cost Matters Hypothesis

"Gary C" <> wrote in message
news:2CF0f.459$
>
> "NoEd" <> wrote in message
> news:
>
>> Even your drunk sidekick understands the importance of these questions.
>>
>
> Hey Mac, are you going to let him call you a sidekick?

Don't be offended, he's just angry because he has most of his money in
VFINX.

Re: Cost Matters Hypothesis

"NoEd" <> wrote

> I will ask you again what will be one of the top 5 performing funds in the
> next three months, why do you think this, and do you own it now?

Go back and look for the answer I gave you last time you asked, it hasn't
changed.
You know which funds I own, I've posted them here.

Once again:
FLPSX PRWCX TRMCX PRNEX TRIGX TBGVX VGSTX OAKBX

In my brokerage account:
AAI* EFJI* EWH LDF* LU MSFT PFE
*these have all past my price targets but I haven't sold any of them yet.
MSFT & PFE have been disappointments so far, large cap dividend paying
stocks are the way to go, phooey. I was hoping for a stronger Hong Kong but
EWH is in the black, just not exciting.


In all of my accounts:
Plenty of $$$$, getting more bearish all the time.

Re: Cost Matters Hypothesis

Let see how these perform over the next three months.



"Ed" <> wrote in message
news:
>
> "NoEd" <> wrote
>
>> I will ask you again what will be one of the top 5 performing funds in
>> the next three months, why do you think this, and do you own it now?
>
> Go back and look for the answer I gave you last time you asked, it hasn't
> changed.
> You know which funds I own, I've posted them here.
>
> Once again:
> FLPSX PRWCX TRMCX PRNEX TRIGX TBGVX VGSTX OAKBX
>
> In my brokerage account:
> AAI* EFJI* EWH LDF* LU MSFT PFE
> *these have all past my price targets but I haven't sold any of them yet.
> MSFT & PFE have been disappointments so far, large cap dividend paying
> stocks are the way to go, phooey. I was hoping for a stronger Hong Kong
> but EWH is in the black, just not exciting.
>
>
> In all of my accounts:
> Plenty of $$$$, getting more bearish all the time.
>
>

Re: Cost Matters Hypothesis

"NoEd" <> wrote

> Let see how these perform over the next three months.

Took profits on some of these so the portfolio has changed.

Re: Cost Matters Hypothesis

LOL.


"Ed" <> wrote in message
news:
>
> "NoEd" <> wrote
>
>> Let see how these perform over the next three months.
>
> Took profits on some of these so the portfolio has changed.
>

Re: Cost Matters Hypothesis

"NoEd" <> wrote
> LOL.

NoEd, that money you've been losing over the last couple of days, sorry but
I didn't participate in a lot of that. LOL.



> "Ed" <> wrote in message
> news:
>>
>> "NoEd" <> wrote
>>
>>> Let see how these perform over the next three months.
>>
>> Took profits on some of these so the portfolio has changed.
>>
>
>

Re: Cost Matters Hypothesis

You poor man.


"Ed" <> wrote in message
news:
>
> "NoEd" <> wrote
>> LOL.
>
> NoEd, that money you've been losing over the last couple of days, sorry
> but I didn't participate in a lot of that. LOL.
>
>
>
>> "Ed" <> wrote in message
>> news:
>>>
>>> "NoEd" <> wrote
>>>
>>>> Let see how these perform over the next three months.
>>>
>>> Took profits on some of these so the portfolio has changed.
>>>
>>
>>
>
>

Re: Cost Matters Hypothesis

I don't have a reference for you but I read a piece that said something
about the S&P500 having a negative ten year average annual total return. The
index is off to a good start. It started 2005 with 5 year negative numbers
and it's going for 6. I think the story said that it will be a first if it
happens.

I'm trying to decide on a few diversified or even index funds for next year
and I don't see the S&P500 or the Wilshire 5000 as candidates.

I'm sure you know what Select Sector SPDR's are. In case you aren't sure,
they are 9 sector indices that split the S&P500 into 9 groups.

Vanguard Prime Money Market Fund is yielding 3.45% and that should go up a
little more by year's end. Year to date, 9/30/05, only 3 of the SS SPDR's
have done better than the MM fund. They are health care +4.92%, energy
+42.91%, and utilities +23.24%. With the exception of health care I don't
see much here that will challenge the MM fund in 2006, maybe consumer
staples.

It really looks like foreign will be the place to be next year once again,
foreign and individual stocks.

What are your thoughts going forward.








"NoEd" <> wrote in message
news:
> You poor man.
>
>
> "Ed" <> wrote in message
> news:
>>
>> "NoEd" <> wrote
>>> LOL.
>>
>> NoEd, that money you've been losing over the last couple of days, sorry
>> but I didn't participate in a lot of that. LOL.

Re: Cost Matters Hypothesis

I overload mid and small value, acknowledging this is a more risky
proposition. I think I will increase my FXI holding. I don't do sectors.
My time frame is 5 years minimum.


"Ed" <> wrote in message
news:
>I don't have a reference for you but I read a piece that said something
>about the S&P500 having a negative ten year average annual total return.
>The index is off to a good start. It started 2005 with 5 year negative
>numbers and it's going for 6. I think the story said that it will be a
>first if it happens.
>
> I'm trying to decide on a few diversified or even index funds for next
> year and I don't see the S&P500 or the Wilshire 5000 as candidates.
>
> I'm sure you know what Select Sector SPDR's are. In case you aren't sure,
> they are 9 sector indices that split the S&P500 into 9 groups.
>
> Vanguard Prime Money Market Fund is yielding 3.45% and that should go up a
> little more by year's end. Year to date, 9/30/05, only 3 of the SS SPDR's
> have done better than the MM fund. They are health care +4.92%, energy
> +42.91%, and utilities +23.24%. With the exception of health care I don't
> see much here that will challenge the MM fund in 2006, maybe consumer
> staples.
>
> It really looks like foreign will be the place to be next year once again,
> foreign and individual stocks.
>
> What are your thoughts going forward.
>
>
>
>
>
>
>
>
> "NoEd" <> wrote in message
> news:
>> You poor man.
>>
>>
>> "Ed" <> wrote in message
>> news:
>>>
>>> "NoEd" <> wrote
>>>> LOL.
>>>
>>> NoEd, that money you've been losing over the last couple of days, sorry
>>> but I didn't participate in a lot of that. LOL.
>
>

Re: Cost Matters Hypothesis

"NoEd" <> wrote in message
news:
>I overload mid and small value, acknowledging this is a more risky
>proposition. I think I will increase my FXI holding. I don't do sectors.
>My time frame is 5 years minimum.

You're just too funny.
Why FXI?
Did you know that 70% of the holding in FXI are controlled by the Chinese
government?
The same Chinese government that tried to buy Unocal. They might find out
that you hold shares in that puppy and freeze your assets.

If you were smart you would buy EWJ and EWY instead.

I try so hard not to buy anything that's made in China, it's getting worse
and worse.

I have a Samsung laser printer and a Nikon camera, both were made in f'n
China.
I have a Linux T-shirt that was made here, Penguin on the back "opening new
frontiers with Linux" on the front. The shirt was free.

Re: Cost Matters Hypothesis

"NoEd" <> wrote in message
news:

> I think I will increase my FXI holding. I don't do sectors.

Oxymoron .... or just moron?