July 28, 2020
My Dear Reader,
Earlier this week a story caught my eye in the Institutional Investor that I felt should be brought to your attention. It may seem at first to be a simple spat between two conflicting Financial ideologies, but there is valuable knowledge that we can glean from this story. Writer Leanna Orr details the argument and lawsuit in her article about the situation.
“Clarence Herbst, a prominent donor to and alumnus of the University of Colorado, has sued the school’s foundation over its investment strategy and so-called “abysmal” returns. But the UC Foundation — which holds nearly $2 billion for the public university — has outperformed most of its peers over short and long-term horizons, according to the mainstream NACUBO benchmark.
Herbst is a longtime and vocal advocate of passive investing. He has donated about $5 million to his alma mater and received various honors and officials [sic] designations from the university, including the chairmanship of its investment committee in the 1990s.”
Hurst has argued that the endowment should have been invested more heavily in Vanguard funds over the past decade. Clarence also argues that the endowment would have gained an additional five and a half percent over their current mark if they would have used his strategy. I’m not sure exactly where she is getting those numbers, but I am sure he is bringing this suit in good faith and truly believes that the endowment of the University of Colorado would have been much larger under his stewardship. However, as detailed in the article, it does not appear that the current managers of the Colorado University’s endowment have done anything wrong. When a large company invests, they balance their portfolio and manage the complexities of a large count through many different aspects. This can be done for the purchase of natural resource production, investment in apartment complexes, and other tangible, non-speculative assets. Many companies also invest in bonds.
But I believe that for our purposes we must understand that just because something has a name brand, like Vanguard, it doesn’t necessarily mean that they will be the best in a vacuum. I’m not questioning nor am I suggesting that Vanguard has failed their investors in any way, but their use in mutual funds and 401ks should be open to questioning, like any other fund.
In my book smoke and mirrors, I spoke with my good friend Jerry Fetta about mutual funds and how their rate of return is calculated.
Mutual funds are advertised as a way to diversify to avoid market risk, while also having the ability to earn high rates of return. Financial pundits will even advertise these products as a way to safeguard and expand your savings. But if you found out today that the 12 percent that was advertised by pundits and some financial advisors turned out not to be true, would that bother you? It bothered me so much, I decided to ask other financial professionals for help. After nearly a decade of declining returns, we all wish we could see those 1980s-esque double-digit returns, but those won’t be back for a long time, if ever. So why do financial pundits still claim that you can get 12 percent in a mutual fund? I felt as though a proper answer could be gained by asking someone who formally based their life on them. I turned to budding Alaskan superstar Jerry Fetta, owner of Wealth Dynamix and Wealth Dynamix University, to ask him this very question, among others. He explained:
“Mutual funds are reported with what is called average annual return, when, in reality, investments should be reported by compounding annual growth rate.”
To put the financial jargon aside, what Fetta describes is exactly what I feared. The problem with math is that you can virtually make numbers say anything. So, by reporting the rate of return as an average, which does not translate to an actual return, those who push mutual funds are able to make their funds look more attractive in a sales pitch. Fetta is of the belief, as am I, that investments in nearly any market or industry should be calculated by an annual growth rate. In other words, how much more do I have in my pocket today that I didn’t have yesterday? Fetta goes on to explain that “[a] mutual fund can show mathematically the percentage went up over time. But again, if you measure ‘what did I start with versus what did I finish with,’ and I annualize that return and find out how much it was per year, [I] actually make significantly less money than I show on my return.” I began to understand how these funds are sold. They are not inertly wrong, but what I don’t understand is why they are marketed so heavily to the “blue-collar worker.” I decided to look harder at the kinds of fees that were attached to these funds. Perhaps there is an ulterior motive for promoting these funds.
As I explained earlier, Jerry Fetta used to heavily pro-mote mutual funds. I began to wonder, what makes them so bad, to the point where he won’t even promote them at all now? I confronted Fetta on this and he replied, “[I did promote] mutual funds for a long time, and don’t promote them at all now. The reason [is twofold] because of the taxes and the way the returns are reported.” We just went over the returns, but Fetta decided to dive deeper into this subject. “[The problem is] how the fee structures are set up. I’ve never seen a client that, after you take out all those factors, actually makes money inside of a mutual fund. It’ll show on their statement that they’re going to have positive returns, it’ll show that they’ve had them in the past, but the reality is when you measure the return in dollars, they have less than what they started with.”
I believe I can see how many moving parts there truly are in order to build a complex Investment Portfolio, and my question is why are we trying to bring the same kind of mathematics and complexities to Grandma and Grandpa? Shouldn’t we give them a simple strategy in which they can understand what they’re doing and why? But then, of course, I fear there might not be nearly as much money in that.
To Your Creation and Potential,