Search Results for: swedroe

Larry Swedroe Personal Portfolio: Small Value Stock Premium Revisited

I’ve written a little bit in the past about including small-value stocks to your investment portfolio. “Small” means companies with a relatively smaller market cap (total market value) – definitions vary from being the bottom 10% by capitalization or being worth less than $1 billion. “Value” stocks are those that tend to trade at a lower price relative to others when measured against markers like earnings, dividend yield, sales, or book value.

This NYTimes article on the portfolio of investment advisor and author Larry Swedroe included some concise examples of how significant this small-value premium has been in the past. For one, small-value stocks outperformed the S&P 500 by about 4% annually from 1927-2010.

Put another way, by making a portfolio using small-value stocks and US Treasury bonds, you could have gotten similar performance to the S&P 500 with much lower risk. Specifically, you could have held 1/3rd small-value and 2/3rd Treasury bonds and had close to the same return as the S&P 500 over a 40-year period from 1970-2010. This chart summarizes:

Source: Buckingham Asset Management, New York Times

Will this “small-value premium” continue to persist? There are a few theories out there. One is behavioral, where small-value companies tend to be the more ignored and unpopular companies and thus are consistently underpriced. Another is based on the fact that small-value companies are simply riskier, and thus investors demand a higher return for holding them.

I happen to believe that there is something enduring about small-value stocks, but the size of my bet on that belief is relatively small – only about 5% of my target stock allocation. But I also know that you need to hold a very strong belief in whatever internal explanation you have for the outperformance. Otherwise, when small-value is the dumps for a while relative to the Current Hot Thing – and it will be, one day – you’ll sell and lose any potential edge.

Wise Investing Made Simple by Larry Swedroe

I’ve been getting back into reading financial books, but am really behind in writing reviews for them. One book I finished last month was Wise Investing Made Simple by Larry Swedroe, which promises “Tales to Enrich Your Future”.

The key word is “tales”, because this is not a book with complex mathematical formulas or lots of charts and statistics. (Although I love charts…) It contains 27 short stories using simple concepts like sports analogies to explain the benefits of a long-term, passive approach to investing. Each story includes a quick “Moral of the Tale” summary.

I’ve already written about my favorite tale in Why Sports Betting and Stock Picking Are Similar. But here is my paraphrasing of another good chapter:

The $20 Bill
Here’s is a common story used to poke fun at the Efficient Market Hypothesis. An economist who believes in efficient markets walks down the street with a friend. The friend says “Look, there’s a $20 bill on the ground!” The economist says “No way. If there was a $20 bill on the ground somebody would have already picked it up”, and continues to walk away. This supposedly counters the idea that in a truly efficient market it would be impossible to find an under-priced stock (similar to a $20 bill priced at $10 or even free).

However, this argument is not really correct. What the story eventually explains is that while many passive investors believe that the occasional $20 bill on the ground may exist, spending your time looking for them may not be the most effective way to make money. The same could be said about stock-picking or market timing. Persistence in beating the market (finding $20 bills) beyond the randomly expected is very difficult to find.

For the investor that is already committed to passive investing and fully understands the underlying reasons why they believe that is the best strategy for them, this book probably won’t bring that much new to the table. It won’t help you decide whether to hold 20% International or 45% International stocks, or if you should include exposure to commodities or precious metals. If you are a full-time trader who is adamantly against passive investing, this book probably won’t contain enough hard facts to sway you either.

Instead, I think the sweet spot for this book are those investors that have been told “index funds are great” and may even invest in them but don’t really know why they are so great and don’t have the interest level to read some dry investing book about correlations and standard deviations. The problem with this level of understanding is that when things get tough it can be easy to bail out if you don’t really know why you’re doing something. This book breaks things down into simple, bite-size pieces without being patronizing.

On a personal level, this book might not be the very first book on saving money I’d give someone, or my favorite book about investing, but I am going to keep it in my library because it provided some different ways to explain to others (and myself at times) why I invest the way I do.

Overall Rating: 3 Stars (ratings explained)

Global Asset Allocation Book Review: Comparing 12+ Expert Model Portfolios

gaafaberI am a regular reader of Meb Faber’s online writings, and volunteered to received a free review copy of his new book Global Asset Allocation: A Survey of the World’s Top Asset Allocation Strategies. It is a rather short book and would probably be around 100 pages if printed, but it condensed a lot of information into that small package.

First off, you are shown how any individual asset class contains its own risks, from cash to stocks. The only “free lunch” out there is diversification, meaning that you should hold a portfolio of different, non-correlated asset classes. For the purposes of this book, the major asset classes are broken down into:

  • US Large Cap Stocks
  • US Small Cap Stocks
  • Foreign Developed Markets Stocks
  • Foreign Emerging Markets Stocks
  • US Corporate Bonds
  • US T-Bills
  • US 10-Year Treasury Bonds
  • US 30-Year Treasury Bonds
  • 10-Year Foreign Gov’t Bonds
  • TIPS (US Inflation-linked Treasuries)
  • Commodities (GSCI)
  • Gold (GFD)

So, what mix of these “ingredients” is best? Faber discusses and compares model asset allocations from various experts and sources. I will only include the name and brief description below, but the book expands on the portfolios a little more. Don’t expect a comprehensive review of each model and its underpinnings, however.

  • Classic 60/40 – the benchmark portfolio, 60% stocks (S&P 500) and 40% bonds (10-year US Treasuries).
  • Global 60/40 – stocks split 50/50 US/foreign, bonds also split 50/50 US/foreign.
  • Ray Dalio All Seasons – proposed by well-known hedge fund manager in Master The Money Game book.
  • Harry Browne Permanent Portfolio – 25% stocks/25% cash/25% Long-term Treasuries/25% Gold.
  • Global Market Portfolio – Based on the estimated market-weighted composition of asset classes worldwide.
  • Rob Arnott Portfolio – Well-known proponent of fundamental indexing and “smart beta”.
  • Marc Faber Portfolio – Author of the “Gloom, Boom, and Doom” newsletter.
  • David Swensen Portfolio – Yale Endowment manager, from his book Unconventional Success.
  • Mohamad El-Erian Portfolio – Former Harvard Endowment manager, from his book When Markets Collide.
  • Warren Buffett Portfolio – As directed to Buffett’s trust for his wife’s benefit upon his passing.
  • Andrew Tobias Portfolio – 1/3rd each of: US Large, Foreign Developed, US 10-Year Treasuries.
  • Talmud Portfolio – β€œLet every man divide his money into three parts, and invest a third in land, a third in business and a third let him keep by him in reserve.”
  • 7Twelve Portfolio – From the book 7Twelve by Craig Israelsen.
  • William Bernstein Portfolio – From his book The Intelligent Asset Allocator.
  • Larry Swedroe Portfolio – Specifically, his “Eliminate Fat Tails” portfolio.

Faber collected and calculated the average annualized returns, volatility, Sharpe ratio, and Max Drawdown percentage (peak-to-trough drop in value) of all these model asset allocations from 1973-2013. So what were his conclusions? Here some excerpts from the book:

If you exclude the Permanent Portfolio, all of the allocations are within one percentage point.

What if someone was able to predict the best-performing strategy in 1973 and then decided to implement it via the average mutual fund? We also looked at the effect if someone decided to use a financial advisor who then invested client assets in the average mutual fund. Predicting the best asset allocation, but implementing it via the average mutual fund would push returns down to roughly even with the Permanent Portfolio. If you added advisory fees on top of that, it had the effect of transforming the BEST performing asset allocation into lower than the WORST.

Think about that for a second. Fees are far more important than your asset allocation decision! Now what do you spend most of your time thinking about? Probably the asset allocation decision and not fees! This is the main point we are trying to drive home in this book – if you are going to allocate to a buy and hold portfolio you want to be paying as little as possible in total fees and costs.

So after collecting the best strategies from the smartest gurus out there, all with very different allocations, the difference in past performance between the 12+ portfolios was less than 1% a year (besides the permanent portfolio, which had performance roughly another 1% lower but also the smallest max drawdown). Now, there were some differences in Sharpe ratio, volatility, and max drawdown which was addressed a little but wasn’t explored in much detail. There was no “winner” that was crowned, but for the curious the Arnott portfolio had the highest Sharpe ratio by a little bit and the Permanent portfolio had the smallest max drawdown by a little bit.

Instead of trying to predict future performance, it would appear much more reliable to focus on fees and taxes. I would also add that all of these portfolio backtests looked pretty good, but they were all theoretical returns based on strict application of the model asset allocation. If you are going to use a buy-and-hold portfolio and get these sort of returns, you have to keep buying and keep holding through both the good times and bad.

Although I don’t believe it is explicitly mentioned in this book, Faber’s company has a new ETF that just happens to help you do these things. The Cambria Global Asset Allocation ETF (GAA) is an “all-in-one” ETF that includes 29 underlying funds with an approximate allocation of 40% stocks, 40% bonds, and 20% real assets. The total expense ratio is 0.29% which includes the expenses of the underlying funds with no separate management fee. The ETF holdings have a big chunk of various Vanguard index funds, but it also holds about 9% in Cambria ETFs managed by Faber.

Since it is an all-in-one fund, theoretically you can’t fiddle around with the asset allocation. That’s pretty much how automated advisors like Wealthfront and Betterment work as well. If you have more money to invest, you just hand it over and it will be invested for you, including regular rebalancing. The same idea has also been around for a while through the under-rated Vanguard Target Retirement Funds, which are also all-in-one but stick with simplicity rather than trying to capture possible higher returns though value, momentum, and real asset strategies. The Vanguard Target funds are cheaper though, at around 0.18% expense ratio.

Well, my portfolio already very low in costs. So my own takeaway is that I should… do nothing! :)

Alpha Architect also has a review of this book.

How to Win the Loser’s Game: Free Documentary recently released a free documentary about the fund management industry and the effect of their high fees on the returns of everyday citizens. “How to Win the Loser’s Game” includes interviews with Vanguard founder John Bogle, Nobel Prize-winning economists Eugene Fama and William Sharpe, author and wealth manager Larry Swedroe, amongst many others. While the publisher is UK-based, most of the concepts are widely applicable to all fund management. The film is broken down into 10 different parts, each about 8 minutes long.

If you are a visual learner and rather watch an educational video than read a book, this documentary is definitely for you. The brief episodes gradually cover the benefits of a low-cost, long-term, low-maintenance, diversified investment strategy. Here’s the trailer, which ends with links to all 10 episodes.

Sell in May and Go Away? How About Remember To Rebalance In May and November

“Sell in May and go away” is a rhyming market-timing slogan that may never… go away. Here’s a graphic that seems to support the idea that stocks have historically performed much worse between May and October than the rest of the year. Credit to Reuters/Scott Barber via Abnormal Returns. Data set is the MSCI World Index from 1971-2011.

Meanwhile, The Big Picture shares a bunch of graphs from TheChartStore that don’t make it look so clear-cut. Looking at this one, why shouldn’t just bail out every September? Data set is the S&P 500 from 1928-2011.

Larry Swedroe tests the theory out using 30-day Treasury bonds as the alternative investment in this CBS Moneywatch article:

He looked at returns through 2007 from six start dates since 1950. “Sell in May” beat “buy and hold” if you started investing in 1960, 1970 and 2000, but not if you started in 1950, 1980 or 1990. “It’s pure randomness,” Swedroe says. “How would you ever know when to start?”

Throw in the tax implications of all that buying and selling, and I agree. Do you really want to base your investing strategy on a data-mining result that has no logical explanation behind it? Sounds too much like driving a car using only your rearview mirror.

However, Tadas Viskanta of Abnormal Returns has what I think is a reasonable compromise – what if you just decided to rebalance your portfolio at the very end of April and the very end of October? You should rebalance your portfolio regularly anyway, so why not do it twice a year, six months apart. If your target asset allocation is 70% stocks/30% bonds and now you’re at 80/20 due to the recent run-up, why not go back to 70/30. If things end up at 60/40 in November, then again, go back to 70/30.

You could call it “Remember to Rebalance in May and November”. It even rhymes! If “sell in may” really works, you’ll get some benefit from this mean reversion wackiness. If it’s just noise, you portfolio shouldn’t theoretically be hurt any more than picking other months.

How Often Should I Rebalance My Investment Portfolio? Updated

Here’s a slightly updated and revised version of an older post I had on rebalancing a portfolio to maintain a target asset allocation.

What is Rebalancing?
Let say you examine your risk tolerance and decide to invest in a mixture of 70% stocks and 30% bonds. As the years go by, your portfolio will drift one way or another. You may drop down to 60% stocks or rise up to 90% stocks. The act of rebalancing involves selling or buying shares in order to return to your initial stock/bond ratio of 70%/30%.

Why Rebalance?
Rebalancing is a way to maintain the risk to expected-reward ratio that you have chosen for your investments. In the example above, doing nothing may leave you with a 90% stock/10% bond portfolio, which is much more aggressive than your initial 70%/30% stock/bond mix.

In addition, rebalancing also forces you to buy temporarily under-performing assets and sell over-performing assets (buy low, sell high). This is the exact opposite behavior of what is shown by many investors, which is to buy in when something is hot and over-performing, only to sell when the same investment becomes out of style (buy high, sell low).

However, in taxable accounts, rebalancing will create capital gains/losses and therefore tax consequences. In some brokerage accounts, rebalancing will incur commission costs or trading fees. This is why, if possible, it is a good idea to redirect any new investment deposits in order to try and maintain your target ratios.

How Often Should I Rebalance?
[Read more…]

Target Asset Allocation for Investment Portfolio

Asset allocation (AA) is an important part of portfolio design, and I like pinning down a target asset allocation for personal reference. This helps keep me focused as my portfolio shifts over time and makes it easy to re-balance back. For some educational posts on this topic, please refer to my asset allocation starter guide.

Below is my updated target asset allocation. Here is my target asset allocation from 2008. It’s not dramatically different, but I’ll try to explain the slight changes below. This is just my own AA, and I think everyone should develop their own based on their own beliefs and learning. If you just copy someone else’s without thinking, when things go awry you won’t have the foundation to stick to your guns. I have been strongly influenced by the writings of Jack Bogle, William Bernstein, David Swensen, Rick Ferri, and Larry Swedroe.


I separate things out first into stocks and bonds, and then later it’s easy to go 60% stocks/40% bonds and so on. Here’s my stocks-only breakdown:

  • I now do a 50/50 split between US and International stocks. In general, I would like to mimic the overall world investment landscape. On a market cap basis, the US stock market is now about 45% of the world, while everyone else takes up 55%. 50/50 is just simpler, with a slight tilt towards domestic stocks.
  • I consider REITs a separate real estate asset class. I used to put Real Estate under US stocks since I only held US Real Estate Investment Trusts (REITs), but in the future I would be open to investing in foreign real estate as property laws improve and investing costs drop.
  • On the US side, I add some extra small-cap value companies. Historically, adding stocks of smaller companies with value characteristics (as opposed to growth) has improved the returns of portfolios while lowering volatility. There is debate amongst portfolio theories as to why this happened and if it will continue.

    If you buy a “total market” mutual fund or ETF, you’ll already own many of these types of companies (although many will not be held due to their small size relative to the big mega-corporations). I feel this adds a bit of diversification.

  • On the international side, I add a little extra exposure to emerging markets. You may be surprised to know that “emerging” countries like China, Brazil, Korea, India, Russia, and Taiwan already make up 26% of the world’s markets when you remove the US. These are countries that have a greater potential for growth, but also lots of ups and downs. I add a little bit more than market weight for these as well.


I try to keep things simple for bonds, partially due to the fact that they are currently a smaller portion of my portfolio.

  • I like a 50/50 split between inflation-linked bonds and nominal bonds. Inflation-protected bonds provide a yield that is guaranteed to be a certain level above inflation. Nominal bonds pay a stated rate that is not adjusted for inflation. I like to balance the benefits of both.
  • Instead of only short-term US Treasuries for nominal bonds, I added some flexibility. I used to invest only in short-term US treasuries, as they provided the best buffer in my portfolio as they were of the highest quality and had a low sensitivity to interest rate fluctuations. Both TIPS and nominal Treasuries did great during the 2009 crash and the subsequent flight-to-quality, but now the yield on Treasuries is just too low in my opinion. There are trillions of dollars from countries and huge institutions around the world that are tucking their money away under the safe Treasury mattress. By venturing into other places they won’t with my tiny portfolio, I feel I can stay relatively safe yet increase my yield significantly. Possibilities include bank CDs, stable value funds, and high-quality municipal bonds.

Want more examples? Here are 8 model portfolios from respected sources, an updated Swensen portfolio, one from PIMCO’s El-Erian, and Ferri’s personal portfolio. Have fun!

Total Stock Returns = Fundamental + Speculative Returns

Another theory of predicting future stock market returns states that there are three main components to long-term stock market performance. Amongst many others, I learned this from authors and investors Jack Bogle and William Bernstein.

Part 1: Dividend Yield
If your stock distributes 2% in dividends each year, then you will have a 2% contribution towards of return. This is what dividend investors love to see coming in each quarter, and is relatively easy to track for a large group of companies. Here it is over time for the S&P 500, courtesy of

Part 2: Earnings Growth
If earnings stay constant, then all other things equal, one would expect the share price of your company to stay constant as well. If the earnings grow by 5% every year, then your share price will grow by 5% per year. Thus, earnings growth rate is a vital component of total return.

If your portfolio was all of the stocks traded in the United States, like that of a broad-based index fund, this would create a connection between the growth rate of the nation’s Gross Domestic Product and the earnings growth rates of all US companies. In other words, the fundamental return is based on GDP growth. In turn, the GDP growth rate is connected to population growth and productivity per person.

These two parts added to together are coined the fundamental return:

Fundamental Return = Earnings Growth + Dividend Yield

Some bad news: Now, from 1950-2000, fundamental returns were 10%: 4% dividend yield and a 6% earnings growth rate. These days, the S&P 500 has a dividend yield of only about 2%. Earnings growth rate estimates are subject to debate, but they hover around 5-6%.

Part 3: Changes in P/E Ratio
The price-to-earnings (P/E) ratio is the price per share divided by earnings per share. In other words, it is how much investors are willing to pay for each unit of earnings. If they are willing to pay 20 times annual earnings, the share price of the stock will be twice as high as if they only paid 10 times earnings. This part is denoted the speculative return, as it has changed throughout history. Here it is again for the S&P 500:

In 1950, the P/E ratio was less than 10. As of right now in mid-2010, it is 20. It is very unlikely that this more than doubling of price-per-share will happen again, with the historical average being around 15. (During the dot-com bubble, the P/E ratio was over 40. In 2008, it was over 25.) This will lead to a zero, and quite possible negative, future speculative return!


When predicting future returns, you have to look at all the sources of those expected returns. Fundamental return is still a solid reason why stock prices will go up on the long-term, especially if you are not investing only in one country or economy. Some people call it a belief in capitalism, that economic growth will continue and GDP will continue to increase. I simply believe in the passion and motivation of all the people out there, from Sweden to China to Brazil. However, there is good evidence that you might not be getting 10% historical returns due to P/E ratio contraction.

In a recent column, Larry Swedroe shares that the forecasts that he has read are predicting a 5% total annual growth in earnings and 2% dividends for a total return of 7% (similar to above). Inflation is predicted at 2.5%. However, he points out the current minimal-risk return is pretty low as well, so you need consider the big picture:

The bottom line is that while the expected nominal return to stocks is lower than the historical return, so is the expected return to Treasury bonds. You should decide if the expected risk premium for stocks is sufficient given your unique ability, willingness and need to take risk.

Tolerable Loss = Half of Equity Allocation Percentage?

There a regular poster on the Bogleheads forum called Adrian Nenu who always posts the following, which is said to have origins with author Larry Swedroe.

Tolerable Loss x 2 = Equity Allocation < 50%

I don’t know if I agree with the last part that says that your equity position should always be less than 50%. However, the first part seems to offer a good rule of thumb when it comes to investing in a target date retirement fund.

Let’s say you have the Vanguard Target Retirement 2050 Fund (VFIFX) and it currently contains 90% stocks. Using this rule of thumb would mean that a possible one-year loss for such a fund is 45%. You should ask yourself – can you handle a 45% drop in the value of your retirement assets, even if you have 40 years before you need it? The good thing about living through 2008/2009 is that you probably have a better idea of the truth. If you’re going to run for cover in cash, only to buy back in later (like now) when prices are 50% higher, then that’s something to avoid.

One thing that I recommend to my more conservative friends who still want a simple investment is to simply buy a different “date”. For example, if you could purchase the Vanguard 2025 Fund (VTHRX) which has 75% in stocks. Who cares if the label is 2025. Meanwhile, I encourage them to continue to learn more about investing so that the can understand the risks trade-offs better and adjust their tolerances accordingly (up or down).

Power Link Dump: Gas Prices, Commodities, Asset Class Forecasts, & More

Here are some neat links from readers and interweb wanderings. I want to expand on them later as well.

Petrofix: Hedge and cap gas prices
A website that will let you control your cost of gasoline in the near future – for a price. If gas prices rise, they pay you the difference. If they fall, you are out the hedge price. The risk? Well, first I haven’t checked out the prices. Also you pay now, but who knows if the company will be around to fulfill their promises in the future. I’d rather hedge against higher gas by buying an oil ETF or use real options with better liquidity. (Disclosure: I did buy some OIL in my fun portfolio at end of 2008.)

The Great Commodities Debate with Larry Swedroe and Rick Ferri
A long multi-part series on HardAssetsInvestor about the role of commodities within a portfolio. Should you add them to your asset allocation? Swedroe and Ferri flesh out their arguments in a moderated battle, and I still don’t know who wins. However, I am glad I didn’t buy commodities the last two years or so when they were in vogue.

Jeremy Grantham / GMO 7-Year Asset Class Forecasts
Each month, Jeremy Grantham and GMO publishes on the web its predictions of the future return for various asset styles over the next seven years. You must register for free on his site to download them. Grantham has gotten increased publicity recently due to how accurate his previous predictions have been. You can read his 2009 Q1 newsletter “The Last Hurrah and Seven Lean Years” without registration. In the end, he’s just another guy with an opinion, but at least he is forthright about it.

Breakdown: The Credit CARD Act of 2009
Cap of StopBuyingCrap has a nice concise list of the changes to credit card laws coming in February 2010, in case you didn’t feel like reading the entire thing. It will be interesting to see how this shakes out. I think that rumors of annual fees or eliminating grace periods for people who don’t carry balances are just scare tactics by credit card lobbyists. They’ll continue to make money from merchant transaction fees, as always.

Google PowerMeter
An online tool that monitors your home’s power usage in real time. Currently only available in very limited areas where people have the right “smart meters” already installed. Sounds even cooler than my Kill-a-Watt energy meter.

Should I Buy Gold Now To Hedge Against Future Inflation?

Due to the current market conditions, many investors are wondering if investments in gold should be added to their portfolios to hedge against future inflation risks. In the video below (direct link), author Larry Swedroe discusses why he thinks gold is not an appropriate hedge against inflation, as well as some alternative investments.

The debate about gold will probably continue on for eternity, but I tend to lean towards his analysis because gold is too volatile for my tastes. I do like the idea of keeping some physical gold bullion as a hedge against economic collapse, but not as ETFs taking up a huge chunk of my portfolio. I would rather have something that would fit into traditional asset allocations plans, providing both stability and a good (but not perfect) hedge against inflation. So let’s explore the recommended alternatives:

In tax-advantaged accounts like IRAs, Swedroe instead recommends Treasury Inflation-Protected Securities (TIPS) which adjust with the Consumer Price Index (CPI). For this, I have bought shares of the Vanguard Inflation-Protected Securities Fund (VIPSX). I could buy individual funds directly from the government at no cost, but for now I like the simplicity. I even increased my allocation recently.

In taxable accounts, he recommends highly-rated municipal bonds with a relatively short average maturity of 3-5 years. For this, I am looking to buy shares of the Vanguard Limited-Term Tax-Exempt Fund (VMLTX). It is currently about 83% AA/AAA rated municipal bonds, and keeps a maturity of between 2 and 6 years (currently 2.8). The yield is currently a tax-exempt 2.12%, and it has a low expense ratio of 0.20%. If inflation does rise, the yield should rise to keep up.

I’m actually surprised he didn’t bring up commodities funds here as well, which I’ve seen him recommend as insurance against unexpected severe inflation.

More Lessons From The 2008 Financial Markets

Larry Swedroe, principal of an asset management company and investment book author, also posted his Lessons That 2008 Taught Us In 2008 on SeekingAlpha. It was a nice compilation that covered a variety of topics from active management to Madoff to your “Plan B”.

Here are some excerpts of a few lessons involving investing and your portfolio:

Don’t forget that companies that managed money themselves were often the victims this year!

Lesson 1: Neither investment banks nor other active managers (including hedge funds) can protect investors from bear markets. […]

If their money managers could protect you, why did firms like Lehman Brothers and Bear Stearns go belly up and Merrill Lynch have to be rescued by Bank of America? It is in the best interest of these firms to manage their risks well. Yet, they have clearly demonstrated that they cannot. As evidence of their lack of ability to forecast events consider that in 2008 Lehman spent $751 million buying back its own stock at an average price of $49.60 and Merrill Lynch spent $5.27 billion buying back its stock in 2007 at an average price of $84.88.(2)

Lots of other historically renowned and recommended active managers had a bad year as well.

Lesson 6: One of the more persistent myths is that active managers can protect you from bear markets. In 2008, the hardest hit sector was financial stocks. Financials comprise a significant portion of the asset class of value stocks. As benchmarks for the active managers we can use the Vanguard Small Value Index Fund that lost 32.1 percent and the Vanguard (Large) Value Fund that lost 36.0 percent.

The following is a list of the returns of some of the actively managed mutual funds with superstar value managers, four of whom were named by Morningstar in June 2008 as their recommendations to run value superstars, their recommendations (those are noted with *): Legg Mason Value Trust lost 55.1 percent; *Dodge & Cox lost 44.3 percent; Dreman Concentrated Value lost 49.5 percent; *Weitz Value lost 40.7 percent; *Schneider Value lost 55.0 percent; and *Columbia Value and Restructuring lost 47.6 percent.

Of course, some actively managed value funds beat those benchmarks. However, how would you have known ahead of time which ones they would be?

Some did guess this would happen. But was it luck or skill?

Lesson 9: There is a great likelihood that each time there is a crisis, some guru will have forecasted it with amazing accuracy. But that ignores two important facts. The first problem is that even blind squirrels occasionally will find acorns. In other words, there are tens of thousands of gurus making forecasts all the time.