how not to invest Archives - Page 2 of 3

December 29, 2014December 29, 2014

Not A Fan Of Socially Responsible Funds

A version of this post ran in the San Antonio Express News.

I want to be wealthier. I also want to be a good person.

A friend – someone who also wants these two things – recently asked if I could recommend a good, reasonable-cost, ‘socially responsible’ mutual fund.

My answer: Nope. I can’t.

Greatest of All Time (and I will not argue this)

Now, I know this makes me a 42-year old Grumpy Cat of the investment world. Also, while I’m not a fan of socially responsible mutual funds, I respect people who disagree with me on this topic.

Unlike some topics – (Greatest Of All Time status in their respective categories go to Tom Brady, The Wire, and Rihanna, and I will not argue this) – I’m not hopelessly dogmatic about socially responsible investing.

However, I’d like to make the case against socially responsible mutual funds because of:

Costs
Endlessly arguable selection criteria
Lower returns
There’s a better way to be wealthier and a good person.

I’ll take these one at a time.

Costs

Most socially responsible mutual funds – not all, but most – charge above-average management fees when compared to other actively managed mutual funds. This makes sense partly because of the additional layer of ‘screening’ or selection that a socially responsible manager theoretically does.

This also makes sense because an investor in socially responsible funds has already agreed – silently, implicitly – to the idea that she’ll buy a premium product at higher costs because it suits her values.

My analogy here is to the buyer of an organic or farmer’s market tomato: The buyer agrees to pay $4.50 for a tomato, because those big, red, tasteless $0.75 things are an abomination. In the case of tomatoes, I get it.

In the case of mutual funds – as an ardent index fund believer – it’s really hard for me to endorse 1.25% fees rather than the 0.25% fees of an equity index fund.

Selection Criteria

Fine, call me Grumpy Cat, but I just don’t know how to get precisely the values I want when I buy public company stocks.

grumpy_cat_investor — I know this whole post makes me a Grumpy Cat

Socially responsible filters vary widely by fund, but many apply both an ‘eliminate the negative’ and ‘accentuate the positive’ filter to their stock selection.

Can you avoid the ‘negative’ companies in industries you oppose? Like…

Oil and gas drillers and refiners? (Exxon)

Saturated fat pushers? (McDonalds)

Gun manufacturers? (Smith & Wesson)[1]

High-fructose corn syrup dealers? (Coca Cola)

Tobacco companies? (Philip Morris)

Beer producers? (Anheuser-Busch)

Weapons manufacturers (Lockheed Martin)

Subprime mortgage CDO structurers? (Goldman Sachs)

Casinos? (Las Vegas Sands)

Union-busting retailers (Wal-mart) or offshoring manufacturers (Apple) that don’t care to pay workers a living wage?

Incidentally, those companies above represent some of the most successful stocks of all time.

Those are the easy ones to eliminate, I suppose, but where do I draw the line? Am I ok with plastic bag manufacturers? Styrofoam cup producers? Battery makers? Animal-testing pharmaceutical companies? When I looked at the portfolios of social responsible mutual funds, many of the companies above filled their portfolios. It all depends on what one deems ‘socially responsible,’ which can vary widely from fund to fund, and individual to individual.

If I kept applying filters like this, I’m afraid my universe of acceptable companies shrinks almost to zero.

On the other hand, would it be possible to only invest in ‘positive’ companies?

Companies engaged in sustainable energy manufacturing? Sustainable agriculture? Microcredit lenders?

The list of public companies truly engaged in only, pure, ‘positive’ activity, untainted by greed and potential harm is pretty slim. Unless you are willing to be fooled by green-washing.[2]

Overall, though, what’s my problem? My big problem is that mutual fund investing would be an extremely blunt, imprecise expression of my values. Do I really trust that the mutual fund managers can engage in ‘positive’ investing while eliminating the ‘negative’? According to me?

No, I really don’t.

Of course I could invest in individual companies, but that would violate other investment rules of mine, regarding individual stock picking.

Lower returns

In addition, am I willing to receive a lower return on my money by filtering out all of the companies in certain industries? Especially some of the spectacularly profitable ones listed above?

Implicitly, I think most socially responsible investors would say they are willing to receive a lower return on their money as a result of their selection criteria.

For the most part, I’m unwilling to do that.

Is there a better way?

My own preference is to try to make the most money I can through ordinary – in my case, index – investing. I own none of those companies I named above directly but I’m pretty sure they’re all tucked away in my retirement account through a broad market index I own.

With more money in my account – admittedly made from investments in companies engaged in the broadest range of moral, immoral, and amoral activities – I’ve got more money available for expressing my personal values.

When I give money philanthropically, I much more precisely express my values with a philanthropic contribution. I’m not willing to give up money – through fees and underperformance – that would leave me with less to contribute philanthropically.

At least, that’s what I tell myself, when I want to be both wealthier and feel like a good person.

Starbucks, you are a greenwashing drug dealer. (And I love you!)

[1] I recommend this New York Times’ article on socially responsible investing, highlighting the profitability of gun-manufacturing stock Smith & Wesson and the ‘greed v. values’ dilemma this creates for people opposed to investing in gun makers.

[2] Oh, what’s green-washing? When a rapacious capitalistic conglomerate posts pictures of happy Guatemalan coffee pickers smiling in their huipiles, so that I go ahead and buy their product every morning at the drive-through partly because I’m a hopeless addict and partly because I’m mistakenly comforted in the belief that I’m buying a “fair-trade” product safely on the side of the angels – that’s me being green-washed. And also, hopelessly addicted. Damn you Starbucks! But I digress.

Please see related posts:

Book Review of A Random Walk Down Wall Street by Burton Malkiel

The Simplest Way to Invest by Lars Kroijer

Ask an Ex-Banker: Algorithmic Trading

A version of this post appeared in the San Antonio Express News

Dear Mike,

I spotted something on algorithmic trading on your blog, and finance and investment are a bit of a hobby of mine. I am sending you a press release about a Canadian trader who has worked out a successful trading technique based on an algorithm, and a new trio of former Harvard fellows have made an app allowing you to do it yourself.

Here’s an excerpt from the link he sent me:

AlgoTrades, the leading provider of automatic investing systems for individual investors, and EquaMetrics Inc., the leading provider of algorithmic trading systems and their Intuitive, drag-and-drop interface that lets you quickly build and edit complex algorithms – in a matter of minutes, today announced a strategic partnership that will arm both active traders and investors with the ability to have the AlgoTrades investing system traded for them, and build trading systems of their own[…]
Algotrades is seeing increased demand for its existing automated trading systems. The Algotrades futures system is hitting at 100% accuracy for the first 6 months of this year with a ROI of 12.3% to date. Max peak-to-valley drawdown is 2.4% and many of our clients are asking for more diverse and active automated trading solutions to expand their portfolios.

This intrigues me: My question is: What is your gut feeling about this? Apparently some of the big news journals like Barron’s and the Wall Street Journal gave this coverage, so it might be something, or not? Any ideas about it?

–Willem from the Netherlands

Dear Willem,

You probably saw on my site that I’ve written reviews of three books on this topic: Rishi Narang’s Inside the Black Box and Michael Lewis’ Flash Boys, as well as a review of a book by a friend from a high frequency trading firm who says Lewis got it all wrong, Flash Boys: Not So Fast.

As for the opportunity described in that announcement:
I would run, not walk, away from anything like that.

I have a long list of reasons for this advice, but I’ll just name a few.

1. Algorithmic trading typically involves high volume trading activity. For an individual investor the trading costs and – equally importantly – the tax bill make this extremely tax and cost inefficient. Brokers and certain types of professional institutional investors get trading costs lowered dramatically, and are not subject to the same capital gains tax laws as individuals (at least in the US) based on high volume buying and selling of stocks, so they don’t have that inefficiency problem. But for you, high volume trading is likely deathly to your individual account, due to costs and taxes.

2. The ROI (Return On Investment) claim in that press release makes me very wary. Even assuming its true, this is an extremely short time horizon, and barely tells us anything, except the juicy part, namely 12.3% ROI in just 6 months’ time.

In my experience, professional investors who can consistently achieve 12.3% ROI over 6 months (24.6% per year, annualized) never, ever, (ever!), seek to share that technology with others. They don’t market secrets like this. Why should they? Instead, they just quietly compound 24.6% per year for a few years and they can get extremely wealthy all by themselves.

3. Be skeptical of groups or strategies that claim high returns over short time periods, and market their services and technology to the general public. Many strategies can make (or lose) impressive amounts of money over a short time frame. If the strategy could – reliably, provably – earn that kind of return over 10 years, now I might be interested. But again, see point #2 above, because those folks wouldn’t be interested in sharing the strategy with you or me if they had a 10 year track record of 24.6% annual returns. They’d already be extraordinarily rich without us.

4. The successful institutional algorithmic and high frequency traders that make money have extraordinary advantages over individuals trying to mimic their techniques. The kind of traders described in Michael Lewis’ Flash Boys for example, invest tens to hundreds of millions of dollars in software and hardware to give them every technological advantage over the kind of individual traders targeted in this press release. I simply do not believe this ‘algorithmic app’ for individuals could possibly compete with the knowledge, technology, and capital of established firms in this competitive space.

In sum, and to recap: Don’t walk away.

Run!

Please see related posts:

Book Review of Flash Boys by Michael Lewis

Book Review of Flash Boys: Not So Fast by Peter Kovac

Book Review of Inside The Black Box by Rishi Narang

As well as:

Would You Like to Understand High Frequency Trading?

The Rise of the Machines

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November 2, 2014

Guest Post – Annuities Are Expensive

Annuities are an important and sometimes dominant part of the investment portfolio for millions of savers. While in certain instances there is a requirement for pension scheme participants that they put a part of their pension savings into an annuity, others decide to have them because they find great comfort from having a secured cash flow until they die (some annuities continue payments for dependants).

I certainly don’t have a problem with annuities. There is great intangible value to be had in knowing that you are going to be ok in your old age, regardless of how old you become. Particularly if you have an annuity that is adjusted for inflation (some adjust for changes in the retail price index), you have a very good picture of your spending power in retirement, without worrying about the oscillations of the markets or dying with a lot of money that you may have no use for (you’ll be dead…).

But there are a couple of things I would encourage you to think about when purchasing an annuity.

Who guarantees your payment in the future and what is their credit quality?

Keep in mind that you will be expecting payments many years into the future. If you buy an annuity at age 50, with some luck you’ll be looking for a payment half a century into the future, and at that time your quality of life may greatly depend on actually receiving that payment. In most cases annuity providers are insured by a government backed scheme, but you want to make absolutely sure that this is the case. You certainly don’t want to be in a case where a Lehman style bankruptcy means that you are left with nothing in retirement when your earnings potential has greatly diminished (keep in mind that annuity providers are likely to be struggling exactly when markets are tough and you probably need them the most).

The price of the annuity may be very high – be sure you need it!

You are essentially lending money to the insurance company for a very long time. You can try to figure out at what rate the following way for a standard (non-inflation adjusted) annuity:

Figure out your life expectancy. There are many life expectancy calculators on the internet[1] – it will be more accurate if you can incorporate where you live, etc. This will give you a good idea of how long the insurance company expects you to pay your annuity for (make sure you tell them all the bad health stuff – as morbid as it sounds in this case you want them to think you are going to die soon). I was surprised by how long I can expect to live, which according to a friend in insurance is a common reaction.
Search around for the best annuity and be sure that the payments are in fact guaranteed by someone other than the annuity provider’s general corporate credit. Assume we are doing an annuity that you buy for £100; what will your yearly payments be?
Figure out the internal rate of return (IRR) on your payment. Your IRR is the rate that the insurance company effectively borrows from you at. So year zero: -£100, year 1: +3.75, year 2: +3.75, etc. You can do this in excel. Keep in mind that unlike a bond you don’t get the principal back at the end (there are annuities that do this, but the interim payments are just lower to reflect this).
Figure out the average time to future payments (the duration – also use excel); depending on your circumstances it will perhaps be 15-20 years. If you start receiving the annuity payments now this will be half the years you are expected to have left to live.
Compare your IRR to a government bond of a maturity similar to the duration and in the same currency (your average time to payment in 4 above).
Apply some sort of discount to the annuity IRR to reflect the inflexible nature of the product and perhaps stiff penalties if you try to get out of the annuity. Depending on the policy these penalties can very stiff and you should discount the value of the annuity accordingly.

Consider any tax advantages of the annuity; these are at times significant.

As an example, when I did the above exercise as a potential annuitant, the IRR I received on my investment was slightly lower than the equivalent UK government bond. So I essentially would be lending money to the annuity provider decades into the future at a lower rate than I would the UK government, ignoring the flexibility I would have in trading the UK government bonds if my circumstances changed. In other words, the insurance I received from the annuity provider against running out of money in very old age was very costly.

It is not surprising that the IRR for your annuity is not great. Annuity products are expensive to manage, and not necessarily great business for the insurance companies, as you deal with the administration of cash transfers to thousands of annuitants, in addition to marketing, overhead, re-insurance that the annuity provider will be able to pay you, and their profit and capital requirements of the annuity provider. Just think that it costs money every time someone calls up to complain that they have not received their £300 and multiply that by a million customers – even if you are not the costly customer you share in paying for those costs by being on the same annuity platform.

My conclusion on annuities is that if you don’t have a lot of savings and worry about having enough into old age, annuities are well worth the poor return they promise on your investment. If you don’t have a lot there is great value in knowing exactly what you have and that it will be enough. An annuity can give you that.

If you have more assets and are highly likely to leave an estate for your descendants then perhaps reconsider annuities. After adjusting for potential tax or other benefits the return on the assets you put into an annuity is mostly quite poor and you could make more money investing on your own. You will of course not have the guarantee of additional payments if you live beyond your life expectancy, but considering your other assets you will be fine even without those additional monies. Also annuity providers make large sums from the hefty penalties from changing or cancelling annuities and if there is any chance that you may be doing that do consider that in evaluating an annuity (a lot can change in decades ahead so even if you consider that unlikely now that may change in the future). This could include if you wanted out because you no longer considered the future annuity payments secure. Just imagine how you would feel if your old age living cost was promised by a Greek insurance company that was backed by the Greek government in case it defaulted. You would hopefully have run for the hills a long time ago.

As evidenced by the IRR on the annuity the return profile is extremely low risk/return and that may not suit your risk profile – if you can afford greater risk in pursuit of greater returns in your portfolio an annuity may lock you in to lower return expectations for decades ahead.

[1] I used a couple including one from University of Pennsylvania: wharton.upenn.edu/mortality/perl/CalcForm

Editor’s note: I like annuities even less than Lars. For example, please see my related posts on annuities:

Ask an Ex-banker: Annuities!

Using Discounted Cash Flows to Understand Annuities

And please see related posts by or about Lars Kroijer:

Book Review: Investing Demystified by Lars Kroijer

Podcast with Lars Kroijer on Having an ‘Edge’ in Markets

Podcast with Lars Kroijer on Global Diversification

The Simplest Investment Approach Ever, by Lars Kroijer

Don’t Buy Too Much Insurance, by Lars Kroijer

Agnosticism Over Edge Can Earn You 7 Porsches, by Lars Kroijer

[1] I used a couple including one from University of Pennsylvania: wharton.upenn.edu/mortality/perl/CalcForm

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October 27, 2014October 27, 2014

Rebalancing, Explained

Editor’s Note: A version of this post appeared today in the San Antonio Express News:

A former student at Trinity sent me a Facebook message recently. He linked to an advertisement message for an investment advisory company that emphasized the importance of ‘rebalancing’ one’s investment portfolio every quarter or every year.

I realized I had not taught that principal at Trinity in our personal finance course last Spring. When the link came in on Facebook with the simple query from my student: “What is rebalancing?” I thought “Uh-oh, I missed that one.”

To make it up to that student, as well as to anyone else who might have the same question, here’s the quick explanation of rebalancing.

Rebalancing is one of those investment things you should do regularly, like brushing your teeth (only less frequently) or going to your college reunion (only more frequently). Once a year rebalancing is fine.
The point of rebalancing is to avoid two big No-Nos of investing:
1. Overexposure to one particular type of risk; and
2. The “Buy-high, Sell-low” investment behavior that everybody unwittingly does.
I’ll illustrate the simplest form of rebalancing with an example, assuming you have just two types of investments in your portfolio: a stock mutual fund and a bond mutual fund.
Let’s say you and your investment advisor agreed that you needed the 60/40 allocation to stocks and bonds that 98.75 percent of all investment advisors inevitably urge on their clients.
[Quick aside: I totally disagree with this allocation, and I’m not an investment advisor, so for both reasons please don’t think I’m recommending this for you. In fact I wouldn’t recommend it for the vast majority of people, but that’s a whole other column – or series of columns to come – in the future.]

Ok, back to my example, which will happen to match up – by pure coincidence! – with how 98.75 percent of your investment advisors have set up your portfolio.]

After one bad year in the stock market in our example here, let’s say stocks have dropped by 12 percent and bonds have returned a positive 5 percent, and now your portfolio allocation has shifted due to the market.
The new portfolio at the end of Year 1 now has a 56 percent stocks to 44 percent bonds allocation.

Here’s where the rebalancing part comes in.
When rebalancing at the end of the year you would sell some of your bonds – in my example 9.6% of your bond allocation so that it only makes up 40 percent of your portfolio again. With the proceeds of the bond sale you would purchase stocks, also returning stocks to just 60 percent of your portfolio. You would now begin Year 2 with your previously agreed-upon 60/40 asset allocation.
Next year, let’s say the stock market rebounds, returning a positive 18 percent, while bonds return just 1 percent overall.
Using numbers from my example, you end up with a 0.66% larger portfolio at the end of Year 2 through rebalancing. That may not seem like much, but those little amounts add up over time. If you have a $100,000 portfolio you would be $660 richer after just one rebalancing.

Let’s extend the example one more year. At the end of Year 2, before rebalancing, you have a 63.6% stocks and 36.4% bond mix. We’ll have to sell about 5.6 percent of our stocks to return to our preferred 60/40 mix.
In Year 3, let’s say stocks return a positive 8 percent and bonds return positive 3 percent. You will now have a portfolio 2.1% higher than if you had never rebalanced, or $2,100 on your original $100,000 portfolio. The math works in your favor this way with any asset allocation in which assets have different returns in different years. It also works just as well with more than two types of assets.

calculating_rebalancing — A screenshot of the spreadsheet I used for calculations

I’d like to list a few more important points about rebalancing, why it works, and also some caveats.

First, the act of regular rebalancing forces you to “Buy-low, Sell-high,” at least on a relative basis. Whichever asset class has outperformed the others will be the one you sell (high) and whichever asset class has underperformed will be the one you buy (low).

Second, while regular rebalancing makes sense, I doubt it makes sense to do this more than once a year. If you have a taxable account (a non-retirement account) then the tax costs of selling winners may outweigh the benefits. Also, frequent trading is always a mistake, so rebalance with moderation.

Third, because of point number two, if it’s possible for you, the best way to rebalance is not through selling existing investments, but rather through new investments. If you regularly contribute to an investment account, you can ‘rebalance’ your portfolio without tax consequences by simply purchasing more of whatever has become underweighted in your portfolio. This has the happy effect of allowing you to buy (relatively) low with your new investments, rather than to do what everybody else does, which is chase whatever hot sector has recently outperformed.
This may seem super-duper obvious and it is indeed super-duper easy to do.

But!
Most people don’t do it. After Year 1 of losing 12 percent in the stock market, for example, few people have the guts, rebalancing discipline, or a nudgy-enough financial advisor to remind them that their allocation is out of whack. Simple rebalancing will help correct that whack.
We get scared to buy something down 12 percent. After Year 2, we also have a hard time selling something that just soared 18 percent in a year. “Ride that winner!” we tell ourselves, to our later regret.

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October 13, 2014October 20, 2014

Do You Need An Investment Advisor? And Why?

A version of this post previously appeared in the San Antonio Express News.

Some friends of mine recently opened up investment accounts with a guy who is a salesman at a national insurance company. My friends also hired a “fiduciary” to review their investment plans. Finally, they consulted me, for free, on what to do with their investments because I’m a friend.

They seek answers to something nobody ever bothers to teach. They need financial advice. Who doesn’t?
Among the three sources they recently contacted, they will certainly hear quite a bit of possibly contradictory advice. In the long run, I got to thinking, do they also need to hire an investment advisor?
“Do you need an investment advisor?” is one of those evergreen questions for people who have managed to accumulate some investments.

The short, albeit possibly contradictory answer — given that I do not have an investment advisor myself — is: “Yes, probably.”
Following on the heels of that question, if the answer to the first question is yes, is: “What do I need an investment advisor for?”

I’m so glad you asked. And you’re not going to believe this, but I have very strong opinions on this question.
A good investment advisor should do two — and only two — things, and then stop.

Number one thing: Set up an investment plan for the client that has a reasonable chance for success at meeting the client’s goals, taking into account the client’s ability to save and invest. The plan should be so simple that all parts can be understood clearly by the client. The plan should run on auto-pilot (probably involving automatic paycheck or bank account deductions), and should rebalance on a low-frequency cycle (probably through new purchases, rather than sales).
All of this should be accomplished within two visits with the investment advisor.

Number two thing: When the market crashes — by the way, the only 100-percent guaranty in an investing life is that the market will crash, probably more than once, in a client’s 30-year investment cycle — the investment advisor is there to prevent the client from selling after the crash. Because when things get cheap you’re supposed to buy more, not sell.
Psychologically speaking, few of us can stomach the nausea of actually buying after the crash.

Ahem. Now, would all those reading this who made stock purchases in March 2009 please raise your hand?
Oh, really? All of you with your hands up are liars.
While we rarely have the sense to buy at the lowest point in the market, realistically a good investment advisor reminds us at least not to sell after the crash happens. The good advisor reminds us that we knew a crash would happen a couple of times in our 30-year investment cycle.
After the crash comes you don’t sell — you just keep on doing what you’re doing. If the advisor can prevent the panicked sale after the crash, the advisor is worth all the money paid to her over the years.

And that’s it. Anything else that an investment advisor does is probably too much, and the client may suffer as a result.

“But, but, but…..” I can already hear all of the investment advisors out there protesting.

But what about tax planning? And estate planning?
What about insurance products? Have you considered whole life versus term life insurance. Or can I interest you in a variable annuity?
But shouldn’t an advisor pre-screen some hedge funds and venture capital funds?
Want to hear about oil & gas leases? Master limited partnerships?
I’m pretty sure there’s real estate and mortgage refinancing to be done, no?
What about picking great stocks for a client?

financial_advisor — If your financial advisor was a stock-photo robot, he should look like this

But what should I know about precious metals, agricultural commodity futures, and that new project finance deal in Ghana?
I also once read something about sector rotation? And then there’s value vs. growth? And biotech, and countercyclical consumer products!
What about anticipating the Fed, trading ahead of new data releases, getting in early on the next hot trend, or black-box trading and currency hedging?
Look, I agree — finance can be endlessly fun and interesting, and these are all great areas for a broker or investment advisor to get into because they produce wonderful opportunities for additional fees, commissions, portfolio churn and opacity. In most cases, however, they just don’t happen to produce wonderful results for clients.
If you need insurance or tax planning, by all means hire an expert. But a good investment advisor does not necessarily serve her client by brokering all these products.

To sum up:
Do you know how to set up what I describe above as “the number one thing” all on your own? If not, you probably need an investment advisor.
Second, do you know — beyond a shadow of a doubt — what you will do when the market crashes? Are you sure? If not, you probably need an investment advisor to hold your hand — that itchy-to-sell trigger-finger hand — to prevent you from selling.

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August 11, 2014August 11, 2014

Driving In Traffic – A Metaphor For Fund Fees And Performance

Editor’s Note: A version of this post appeared in the San Antonio Express News in my brand spanking new “So…Money” column.

My morning commute this summer means driving the two young lovelies to their respective kid camps. I like driving in heavy traffic as much as I enjoy hauling over-heated kitchen garbage out to the brown bin in the garage in August. Which is to say, I often have my crinkled-nose sad face on when commuting.

One benefit of being stuck in 8 a.m. traffic headed north on U.S. 281, however, is the chance to reflect on my favorite analogy about investment fund fees and risky markets.

Picture me in traffic, in my dark red — although for my own pretentious reasons I insist friends refer to the color of my car as “Crimson” — Hyundai Elantra. This hot number accelerates from O to 60 in just under 4.3 minutes.

[By the way, please open and press play on this YouTube link in another browser, as it constitutes the preferred musical accompaniment to this entire post. This is meant to be a multi-media experience. Thank you.]

hyundai_elantra_like_an_index_fund — Hyundai: The “Index Fund” of the Car World

So we’re crawling along around 3 miles per hour, and I glance over my left shoulder at the electric blue Corvette next to me.

A key fact to know, which hardly needs spelling out, is that the owner of that pretty blue Corvette paid approximately three and a half times what I paid for my Hyundai.

I exchange a “Whaddyaknow?” grimace in solidarity with the middle-aged man behind the wheel of his sports car, since we’re both stuck behind a few miles of bumper-to-bumper commuters.

My investment fund fees analogy hinges on the key fact that my crimson Hyundai and my buddy-in-traffic’s electric blue Corvette are in the process of accomplishing exactly the same thing, despite an obvious difference in price — and an obvious difference in status.

Because both of us are moving nowhere fast.

Now, here’s my great traffic and investment fund analogy in full:

With your investments, your primary goal is to get from point A to point B. Specifically, to turn some amount of money you have today into some larger amount of money in the future.

The speed at which traffic flows is the market returns of any given year.

Sometimes you’ll flow along nicely up 281 at 65 miles an hour with not much traffic. That’s like earning a cool 12 percent from the stock market for the year without breaking a sweat.

On other occasions you’ll ease onto the nearly empty Pickle Parkway — also known as State Highway 130 — and legally cruise at 85 miles an hour. That’s what it feels like to earn 20 percent or more from the stock market.

And then, in the worst times, you’re stuck behind a four-car pileup, sweating and swearing and unable to move or even get off the highway. We had that kind of year in 2008, when everyone in stocks lost about 35 percent.

Here’s where my analogy really kicks in, though. For the vast majority of driving situations, like the vast majority of investing situations, we get what everybody else gets and there’s not much we can do about it.

As my daughters’ pre-school teachers like to remind them: The best (investing) attitude is ‘You get what you get and you don’t get upset.’ Maybe you already know this idea, and you set it to good use when you buy an investment fund. But I know most of us don’t act like we know it.

Practically the entire personal investing industry is built on the false conceit that you, the consumer, can buy a financial vehicle that can go faster than someone else’s vehicle — essentially to “beat the market.” In reality, that’s incredibly rare.

Without breaking the law, heading onto the shoulder lane or driving recklessly at an elevated risk of hurting yourself or others, you cannot generally beat the rate of traffic, whether you drive an electric blue Corvette or a crimson Hyundai Elantra.

And the same goes for investment funds. You can pay more for a mutual fund or hedge fund, but almost none of them reliably “beat the market.” Every rigorous academic study of financial funds ever done concludes this way: The difference in market returns between high-cost and low-cost funds is, in aggregate, the cost of the funds’ management fee. The difference in market returns, in aggregate, favors the low-cost fund.

Traditional mutual funds charge between 0.75 percent and 1.5 percent management fees, or between $750 and $1,500 per $100,000 investment per year. If you buy an index fund — the Hyundai Elantras of the investment world — you will pay between 0.1 percent and 0.5 percent management fees, or $100 to $500 per $100,000 in the account.

The entire financial industry would like you to think that the extra cost buys you something, but I’m here to tell you the straight fact that you’re paying three and a half times more to get exactly the same investment performance.

Whaddayaknow?

Please see related Posts:

On Cars Part I – On Avoiding Excessive Fleecing

On Cars Part II – Acceptable Price of a Car

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