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An Index Overview (Part IV)

June 1st, 2017 Posted by Asset Allocation, Financial Education, Foreign Investing, Investment Strategy, Investment Vehicles, Uncategorized 0 thoughts on “An Index Overview (Part IV)”

Part IV: Index Investing – Opportunities and Obstacles

Legend has it, a pharmacist named John Pemberton was searching for a headache cure when he tried blending Coca leaves with Cola nuts. Who knew his recipe was destined to become such a smashing success, even if Coca-Cola® never did become the medicine Pemberton had in mind?

In similar vein, when Charles Dow launched the Dow Jones Industrial Average (the Dow), his aim was to better assess stock prices and market trends, hoping to determine when the market’s tides had turned by measuring the equivalent of its incoming and outgoing “waves.” He chose industrials (mostly railroads) because, as he proposed in 1882, “The industrial market is destined to be the great speculative market of the United States.”

While the actively minded Dow never did achieve market-timing clairvoyance (and neither has anyone else we’re aware of), he did devise the world’s first index. We’d like to think his creation turned into something even greater than what he’d intended – especially when Vanguard founder John Bogle and other pioneers leveraged Dow’s early work to create among the most passive ways to invest in today’s markets: the index fund.

Bogle launched the first publicly available index fund in 1976. Initially dismissed by many as “Bogle’s folly,” its modern-day rendition, the Vanguard 500 Index Fund, remains among the most familiar funds of any type.

Index Investing Is Born

In defense of Dow’s quest to forecast market movements, it’s worth remembering that his was a world in which electronic ticker tape was the latest technology, there were no open-ended mutual funds or fee-only financial advisors, and safeguards and regulations were few and far between. Essentially, speculating was the only way one could invest in late-nineteenth century markets.

Compared to actively managed funds that seek to “beat” the market by engaging in these now-outdated speculative strategies, passively managed index funds offer a more solid solution for sensibly capturing available market returns. As the name implies, an index fund buys and holds the securities tracked by a particular index, which is seeking to represent the performance of a particular slice of the market. For example, the Vanguard 500 Index Fund tracks the popular S&P 500 Index, which in turn approximately tracks the asset class of U.S. large-company stocks.

Compared to actively managed solutions, index funds lend themselves well to helping investors more efficiently and effectively target these three pillars of sensible investing:

  1. Asset allocation – How you allocate your portfolio across various market asset classes plays a far greater role in varying your long-term portfolio performance than does the individual securities you hold.
  2. Global diversification – Through broad and deep diversification, the sum of your whole risk can actually be lower than its individual parts.
  3. Cost control – The less you spend implementing a strategy, the more you get to keep.

Index Investing: Room for Improvement

As we’ve described throughout this series, indexes weren’t specifically devised to be invested in. There’s often a lot going on underneath their seemingly simple structures that can lead to inefficiencies by those trying to retrofit their investment products on top of popular indexes.

Index Dependence – Whenever an index “reconstitutes” by changing the underlying stocks it is following, any funds tracking that index must change its holdings as well – and relatively quickly if it’s to remain true to its stated goals. In a classic display of supply-and-demand pricing, this can generate a “buy high, sell low” environment as index fund managers hurry to sell stocks that have been removed from the index and buy stocks that have been added.

Compromised Composition – Asset allocation is based on the premise that particular market asset classes exhibit particular risk and return characteristics over time. That’s why your investment “pie” should be carefully managed to include the right asset class “slices” for your financial goals and risk tolerances. As we described in Part III of this series, if you’re invested in an index fund and you aren’t sure what its underlying index is precisely tracking, you may end up with off-sized pieces of pie. For example, the S&P 500 and the Russell 3000 are both positioned as U.S. stock market indexes, but both also track some real estate. If you don’t factor that into your plans, you can end up with a bigger helping of real estate than you had in mind.

Introducing Evidence-Based Investing

So, yes, index investing has its advantages … It also has inherent challenges. No wonder academically minded innovators from around the globe soon sought to improve on index investing’s best traits and minimize its weaknesses. In fact, many of these thought leaders were the same early adapters who introduced index fund investing to begin with. Building on index investing, they devised evidence-based investment funds, to offer several more advantages:

Index-independence – Instead of tracking an index that tracks an asset class … why not just directly capture the asset class itself as effectively as possible? Evidence-based fund managers have freed themselves from tracking popular indexes by establishing their own parameters for cost-effectively investing in most of the securities within the asset classes being targeted. This reduces the need to place unnecessary trades at inopportune times simply to track an index. It also allows more patient trading strategies and scales of economy to achieve better pricing.

Improved Concentration – Untethering themselves from popular indexes also enables evidence-based fund managers to more aggressively pursue targeted risk factors; for example, an evidence-based small-cap value fund often has more flexibility to hold smaller and more value-tilted holdings than a comparable index fund. This provides more refined control for building your personal investment portfolio according to your unique risk/return goals.

Focusing on Innovative Evidence – Evidence-based investing shifts the emphasis from tracking an index, to continually improving our understanding of the market factors that contribute to the returns we are seeking. By building portfolios using fund managers who apply this same evidence to their funds, you can make best use of existing academic insights, while efficiently incorporating credible new ones as they emerge.

An Index Overview, Revisited

From describing an index’s basic functions, to exploring some of the intricacies of their construction, we’ve covered a lot of ground in this four-part series on indexing. To recap, indexes can help us explore what is going on in particular slices of our capital markets. In the right context, they also can help you compare your own investment performance against a common benchmark. Last but not least, you can invest in funds that track particular indexes.

Equally important, remember that indexes do not help us forecast what to expect next in the markets, nor do high-water markets such as “Dow 20,000” foretell whether it’s a good or bad time to buy, hold or sell your own market holdings. And, while low-cost, well-managed index funds may still play a role in your overall investment portfolio, it’s worth ensuring that you select them when they are the best fit for your evidence-based investment strategy, not simply because they are a popular choice at the time.

What else can we tell you about indexes or index investing? Let’s take a look at your unique financial goals, and see how indexing fits into your globally diversified world of investments. To learn more, please get in touch with us at OpenCircle Wealth Partners, 203-985-0448.

[Photo curtesy of ekta kapoor]


An Index Overview (Part II)

May 9th, 2017 Posted by Financial Education, Investment Strategy, Investment Vehicles, Uncategorized 0 thoughts on “An Index Overview (Part II)”

Part II: A Few Points About Index Points

As we covered in our last piece, indexes have their uses. They can roughly gauge the mood of a market and its participants. If you’ve got an investment strategy that’s designed to capture that market, you can see how your strategy is doing in comparison … again, roughly. You can also invest in an index fund that tracks an index that tracks that market.

This may help explain why everyone seems to be forever watching, analyzing and talking about the most popular indexes and their every move. But you may still have questions about what they are and how they really work. For example, when the Dow Jones Industrial Average (the Dow) exceeded 20,000 points last January, what were those points even measuring?

An index’s total points represent a relative value for the market it is tracking, calculated by continually assessing that market’s “average” performance.

If that’s a little too technical for your tastes, think of it this way: Checking an index at any given time is like dipping your toe in the water to see how the ocean is doing. You may have good reasons to do that toe-check, but as with any approximation, be careful to not misinterpret what you’re measuring. Otherwise, you may succumb to misperceptions like: “The Dow is so high, it must be in for a fall. I’d better get out.”

With that in mind, when it comes to index points, we’d like to make a few points of our own.

Indexes Are Often Arbitrary

It helps to recognize how popular indexes become popular to begin with. In our free markets, competitive forces are free to introduce new and different structures, to see how they fly. In the same way that the markets “decided” that the iPhone would prevail over the Blackberry, popular appeal is effectively how the world accepts or rejects one index over another. Sometimes the best index wins and becomes an accepted reference. Sometimes not.

Measurements Vary

Different indexes can be structured very differently. That’s why the Dow recently topped 20,000, while the S&P 500 is hovering in the 2,000s, even though both are often used to gauge the same U.S. stock market. The Dow arrives at its overall average by adding up the price-weighted prices of the 30 securities it’s tracking and dividing the total by a proprietary “Dow divisor.” The S&P 500 also takes the sum of the approximately 500 securities it’s tracking … but weighted by market cap and divided by its own proprietary divisor.

With mysterious divisors, terms like “price-weighted” and “market cap,” and additional details we won’t go into here, this probably still doesn’t tell you exactly what index points are.

Think of index points as being like thermometer degrees. Most of us can’t explain exactly how a degree is calculated, but we know hot from cold. We also know that Fahrenheit and Celsius both tell us what the temperature is, in different ways.

Same thing with indexes. You can’t directly compare an S&P 500 point to a Dow point; it doesn’t compute. Moreover, neither index adjusts for inflation. So, while index values offer a relative sense of how “hot” or “cold” a market is feeling at the moment, they can’t necessarily tell you whether a market is too hot or too cold, or help you precisely predict when it’s time to buy or sell into or out of them. The “compared to what?” factor is missing from the equation. This brings us to our third point …

Models Are Approximate

There’s an important difference between hard sciences like thermodynamics and market measures like indexes. On a thermometer, a degree is a degree. With market indexes, those points are based on an approximation of actual market performance – in other words, on a model.

A model is a fake copy of reality, with some copies rendered considerably better than others. Here’s what Nobel Laureate Eugene Fama has said about them: “No model is ever strictly true. The real criterion should be: Do I know more about markets when I’m finished than I did when I started?”

Your Take-Home

According to Professor Fama’s description of a model, indexes have long served as handy proxies to help us explore what is going on in particular slices of our capital markets. But, they also can do damage to your investment experience if you misinterpret what they mean.

For now, remember this: An index’s popular appeal is the result of often-arbitrary group consensus that can reflect both rational reasoning and random behavioral bias. Structures vary, and accuracy is (at best) approximate. Even the most familiar indexes can contain some surprising structural secrets. In our next post, we’ll unlock some of them for you. Ask us a question at (203) 985-0448.


[photo curtesy of ACSM_1954]


Building an Evidence-Based Plan — April 2017

April 27th, 2017 Posted by Investment Strategy, Uncategorized 0 thoughts on “Building an Evidence-Based Plan — April 2017”


“Control what you can control.” —David Butler, co-CEO, Dimensional Fund Advisors

By following the above five words from Butler, investors can help simplify their complex financial lives. Out of thousands of pages of scientific research, a cornerstone of evidence-based investing emerges: Control what you can control. Control the fees you pay and your trading costs. Control your tax efficiency and your asset allocation. Control how closely your emotions are tied to an up-and-down market. Bigger picture, you can take better control of your entire financial experience.

This article looks at foundational tenets of evidence-based investing, as practiced by OpenCircle, to give you confidence when you think of where you are and where you want to go.


“Diversifying your wealth across a variety of market risks helps you remain on course and in the driver’s seat, even when the road ahead is uncertain.” —Manisha Thakor, director of wealth strategies for women, the BAM ALLIANCE

For an example of why we stress the importance of having an internationally diversified portfolio, just go back a few weeks. The first quarter of 2017 closed strongly for developed international and emerging markets (up 7.4 percent and 11.5 percent, respectively). This came when many investors had cooled on international stocks after they significantly underperformed U.S. markets from 2008-2016. But not so long ago (2002-2007), the MSCI World ex USA Index returned 128.7 percent compared with 42.5 percent for the S&P 500 Index. Diversifying your portfolio so it has exposure to both U.S. and global equity markets allows you to capture market upswings and withstand its downswings over the long haul.


Click here or the image to see the up-and-down nature of various asset classes on a year-by-year basis from 1992-2016 as well as their 20-year annualized averages and the single best and worst years of these classes from 1997-2016.

All of this underscores the importance of being diversified and — the topic we’ll address next — being disciplined.


“Inactivity strikes us as intelligent behavior.” Warren Buffett

Buffett is really smart and really good at making money. But he makes an important point when it comes to someone having the ability to outsmart the market. “Success in investing doesn’t correlate with IQ. Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people in trouble investing.”

Too many investors buy stocks during upswings when all feels good and sell during downward spirals when uneasiness seeps in. This lack of discipline can cause investors to be on the sidelines when markets rebound, causing missed opportunities. Click here or the image to see the cost to investors when they miss the best one, five, 15 and 25 days of market performance during a 45-year period.


Patience and prudence are central to an evidence-based strategy. Stay true to your well-devised plan while rebalancing periodically. Doing so will keep your portfolio in line with your target allocations and will enable you to capitalize on buy-low/sell-high opportunities.


“The makeup of your portfolio depends entirely on your unique ability and willingness and need to take risk.” Larry Swedroe

Swedroe, a prolific author and the director of research for the BAM ALLIANCE, says the ability to take risk is largely defined by the investment horizon, the stability of an investor’s income and the need for liquidity. Swedroe says the willingness to take risk can be succinctly summed up through the “stomach acid” test. Can you stick to your plan even when the market goes down for an extended period? This includes rebalancing — selling what has done relatively well or held its value and buying what has done worse. The need to take risk is determined by the rate of return that is needed for you to reach your financial goals.

Picture3Of course, the word unique is critical as well. The ability, willingness and need to take risk are highly personal decisions. They vary for each investor’s specific circumstances. However, you can view general guidelines for prudent asset allocation decisions by clicking here or the image.


“It’s just fun to do research, learn new stuff, and potentially have an impact on the way other people are thinking about the world.” Kenneth French, professor, Dartmouth College

No room for speculation, prognostication or hunches, the evidence-based world is rooted in decades of objective research on the long-term behavior of financial markets. We use that evidence to tilt portfolios toward the asset classes that have delivered the highest returns over the long haul and should continue to do so. Click here or the image to see the return profiles of distinct asset classes during the period of 1931-2016.


This research leads to plans that keep costs low, minimize risk and implement tax-efficient strategies. The evidence results in portfolios that are diversified domestically and internationally. Those same portfolios use fixed income to dampen volatility and address the risk tolerance of each investor.

To learn more, please be in touch with us at OpenCircle, 203-985-0448.