This could be you: 3 things that nearly all hometown millionaires share in common

When the father of a friend was in college, he lived in a bunker on campus for part of the time and shivered through one winter for lack of a coat. He was determined, though, and despite his lack of money, he made it through Eastern New Mexico University and eventually got a Master’s degree in geology from the University of New Mexico.
Geologists are not known for their lavish earnings. Even still, he lived frugally and saved and invested his money, so when it came time to retire, he has done so quite comfortably. You wouldn’t know it to look at him; he drives a 1983 Blazer to the greasy spoons where he eats breakfast several times per week and shops the sales at our local grocery stores like some sort of coupon ninja.
This friend’s father is, in short, a hometown millionaire.
The habits and values of wealthy Americans like him are fairly ordinary: They call for 1) hard work, 2) saving money toward financial goals, and 3) keeping a close eye on tax liabilities and portfolio risks. What’s extraordinary, though, is the consistency with which they apply these practices. Most of the multi-millionaires polled in the 2016 edition of U.S. Trust’s Insights on Wealth and Worth, a survey that shares characteristics of nearly 700 Americans with $3 million or more in investable assets, got off to an early start. On average, they began saving money at 14; held their first job at 15; and invested in equities by the time they were 25.
Most of them have invested conventionally. Eighty-three percent of those polled by U.S. Trust credited buy-and-hold investment strategies for part of their wealth. Eighty-nine percent reported that equities and debt instruments had generated most of their portfolio gains.
Fifty-five percent agreed with the statement that it is “more important to minimize the impact of taxes when making investment decisions than it is to pursue the highest possible returns regardless of the tax consequences.” In a similar vein, 60% said that lessening their risk exposure is important, even if they end up with less yield as a consequence.1
Worth noting: According the high-net worth surveyor Spectrum Group, 78% of millionaires turn to financial professionals for help managing their investments.
Just how many millionaires does America have? By the latest estimation of Spectrem Group, a surveyor that follows high-net-worth people, the country has more than ever before. In 2015, the U.S. had 10.4 million households with assets of $1 million or greater, aside from their homes. That represents a 3% increase from 2014. Impressively, 1.2 million of those households were worth between $5 million and $25 million.2
According U.S. Trust, 77 percent of the survey respondents reported growing up in middle class or working class households. When asked, the multi-millionaires said the three values that were most emphasized to them by their parents were educational achievement, financial discipline, and the importance of working.
The Spectrem Group reports finds that millionaires and multi-millionaires come from all kinds of career fields. The most commonly cited occupations? Manager (16%), professional (15%), and educator (13%).3 
Is education the first step toward wealth? Ninety percent of those polled in a recent BMO Private Bank millionaire survey said that they had earned college degrees. (The National Center for Education Statistics notes that in 2015, only 36% of Americans aged 25-29 were college graduates.)4
Interestingly, a lasting marriage may also help. Studies from Ohio State University and the National Bureau of Economic Research (NBER) both conclude that married people end up economically better off by the time they retire than singles who have never married. In fact, NBER finds that, on average, married people will have ten times the assets of single people by the start of retirement. Divorce, on the other hand, often wrecks finances. The OSU study found that the average divorced person loses 77% of the wealth he or she had while married.

Citations.
1 - forbes.com/sites/maggiemcgrath/2016/05/23/the-6-most-important-wealth-building-lessons-from-multi-millionaires/ [5/23/16]
2 - cnbc.com/2016/03/07/record-number-of-millionaires-living-in-the-us.html [3/7/16]
3 - cnbc.com/2016/05/05/are-you-a-millionaire-in-the-making.html [5/5/16]
4 - businessinsider.com/ap-liz-weston-secrets-of-next-door-millionaires-2016-8 [8/22/16]
 

Postcards from Paris

Brandon was featured on the front page of the Courier on June 24, 2017 talking about how he uses financial planning to help our clients achieve their retirement dreams. Here's the lead:

If your retirement dream is to sip a French roast coffee and savor a baguette from a sidewalk shop on the Champ Elysees peering at the Eiffel Tower, Brandon Montoya would welcome a postcard.

The independent financial planner and owner of Montoya Wealth Management in Prescott is a believer that retirement offers limitless possibilities for even the not-so-wealthy — be a European vacation or buying a getaway cottage to entertain grandchildren. All it takes is blending one’s long-term goals with proper money management, he said. 

Read the rest of the article here.

We're really proud to be recognized for the work we do helping our clients live well and grateful to the reporter, Nancy Hutson, for doing such a great job on the story. Thanks Nancy!

 

Podcast: Listening to our clients

Brandon recently had the opportunity to sit down to a discussion with Cadu Medina, of Smart (Small) Business Coaching. Over the course of half an hour, they talked about Brandon's client approach, our firm's approach to continuous improvement, and the importance of community in building a small business here in Prescott.  Give it a listen below.

Life after work: Designing a retirement lifestyle that works for you

Terry_Lamb_JaysBIrdBarn

When Terry Lamb (pictured) and her husband retired to Prescott 12 years ago, the transition was harder than she expected. After spending a decade and a half working at an electrical company, surrounded by a close-knit staff, she was starting over. “I found myself in Prescott knowing no one,” she said.
She liked to quilt, though, and so she decided to go looking for other quilters. In short order, she found herself a part-time job at a quilting store and was thriving in her new community.
Terry’s experience is far from unique. The transition from career to retirement can offer a welcome opportunity for retirees to follow their bliss. But it can also leave people adrift without their routines, social networks, and workplace identities. Here are several questions you can ask yourself to navigate the pitfalls and opportunities of retirement and create an ideal-for-you post-career life. 

What things do you plan to do to create your identity and meaning in retirement?
For many new retirees, a meaningful retirement will center on the things they already enjoy – traveling, golf, gardening, grandkids, and meaningful engagement with the community. Creating simple routines like walking the dog, or having coffee with your morning paper, can be immensely satisfying, as can trying out new pursuits. Prescott resident Ann Sult, for example, became an accomplished painter only after retiring. “It was an ability I had no idea I had, something I never knew was there,” she said.
Whatever you decide to do, it’s important to remember is that a successful post-work life that captures your dreams isn’t one size fits all. Find what works for you, even if that means experimenting some. 

How do you want to spend your money and time in retirement?
Depending on what your plans are, you may need to do some budgeting: Big trips, boats and trailers can cost a lot, and so can gifts for grandkids, so make sure you talk to your financial planner about the best way to fund them so they don't derail your retirement. Time and energy are considerations, too. Volunteer work can be immensely rewarding, but as you're adjusting to a new set of routines, it can be helpful to start with small commitments to avoid feeling overwhelmed. 

Are you planning to retire gradually or all at once? 
George Ryberg, a Prescott-based consulting geologist (who happens to also be my father), eased into his retirement from his career so gradually that he is still accepting field jobs at age 78. Ann Sult, likewise, continues to teach classes part-time. Their approach has several benefits. It allows you to maintain your work identity and a bit of structure while opening up more free time.
“It’s just enough to keep me feeling like I’m doing something worthwhile,” Ann told me.
Easing into retirement can also give you more time to build the routines of a post-work life without the blank slate of endless free time.
Even if you do retire all at once, though, you can still begin to explore post-work activities in order to have a structure – and identity -- waiting for you when you get your gold watch. For example, you can add a volunteer position while you’re still working or take a community college class for painting or writing. One Prescott resident, Gary Cassidy, went as far as to get his MFA well before his retirement from the Army as a colonel.

Who makes up your community? 
When you leave the workplace, you will inevitably lose part of your social circle. It may be worth looking into enjoyable activities to help replace lost connections. Increasing your engagement in church, joining a book or service club, or signing up for social dancing classes are a few of the many options you can consider. Here in Prescott, we have some unusual opportunities, such as the Over The Hill Gang, a group that gets together to build and maintain local hiking trails and the Prescott Tea Society, whose members revel in the pleasures of the high tea.

How much time will you spend with your significant other? What will that time look like? 
It may be helpful to have a discussion with your significant other about how you'll spend the extra time you have together (assuming you’re both retired). Some couples plan to spend their retirement working closely together, while others are interested in maintaining their individual pursuits. Either way, it's important to find your way to a shared vision of how you'll spend retirement, both together and apart. 

Do you want to get another job when you retire?
A part time job in retirement can be a great way to supplement your retirement income, and it can also be a meaningful way to show up in the community.  After the quilting store shuttered, Terry Lamb didn’t work for a while. But she felt unfulfilled. “I found out I’m not a retiree-type of person,” says Terry. “I need to work, but I work for love.”

When she did go back to work, Terry went an entirely new direction with a position at Jay’s Bird Barn. Learning new systems, not to mention the ins and outs of birding, felt intimidating at first, but she’s glad she did it, both because of the connections she’s making in her new position, and because she likes the challenge. “I don’t care how old you are,” she said. “There’s always room to learn.”

Additional Resources
http://www.everydayhealth.com/news/how-live-purposeful-life-after-retirement/ 
https://hbr.org/2013/02/a-new-vision-for-retirement-pr 
http://www.nextavenue.org/can-find-meaningful-work-retirement/ 

Helping clients retire with peace of mind: our approach

While investing our clients’ money is important work, it isn’t where we spend most of our time. Every investment client arrives on our doorstep with a distinct set of concerns and hopes for their financial lives and for each of those, we go beyond merely picking stocks to take steps that set their minds at ease.
As it turns out, this is the most satisfying part of our jobs. Ensuring that our clients can go about living their best lives – lives that center on the simple pleasures of roly-poly grandkids and tomatoes in the garden, on the satisfaction of civic and community engagement, and on the fun of a Sunday golf game – is at the heart of everything we do for them.
What does this look like? A lot of it has to do with figuring out our clients’ concerns and getting out ahead of them with proven, stress-free solutions. Here are some of the concerns we hear most frequently along with how we address them.
 
“I worry I won’t have enough money to live on” or, relatedly, “I worry that while I might be able to live on what I have, it won’t be enough to enjoy life.”
This is our clients’ top concern and so we spend a lot of time putting the pieces into place to ensure they feel comfortable with where their retirement is headed. To get there, we interview them to assess their total financial picture and to gain a thorough understanding of their values, dreams, and desires. Then we build and deploy an effective, easy-to-understand financial plan for drawing down their nest egg in a way that leaves plenty of room to enjoy life. This process often produces a lot of relief for our clients. For example, we were able to give one of our clients a wonderful surprise when we told him that he had enough money saved that he could quit his job right now if he wanted. He took us up on that!
 
“I worry that market volatility is going to cripple my nest egg.”
Investing in the markets can feel uncertain and that’s where we step in. With a customized investment plan in place that we monitor against market movements, our clients can rest easy.  Regardless of how the markets are performing, they have the confidence and peace of mind to focus on the things that really matter most to them, whether it’s eating an ice cream cone with a special grandson, walking the dog around Goldwater Lake, or taking a cruise around the world.
 
“All of this financial stuff makes my head hurt. I wish it were simpler!”
Our financial lives can be complex. One of our clients, a recent widow, came to us overwhelmed. Her husband had taken care of their financial lives for years and when he died, he left behind accounts at multiple financial institutions. She told us she didn’t know where to start.
Part of our job is to take the reins to sort out finances as much as possible and simplify our clients’ role to the parts they like and enjoy. We do this in several ways: by being as available as our clients need us to be, by staying on top of their accounts and investments, and by coordinating among their providers, including accountants and trust attorneys, as needed. When our clients express that they feel they have a trustworthy team supporting their financial lives, we know we’re doing our jobs right.
For our widowed client, taking over the coordination of her finances allowed her to spend more with her daughter’s family, who lived several states away.
 
“I worry about what life might be like for me as I get older.”
A less well-known role of a financial advisor is to serve as part of our clients’ social safety net. We have a strong commitment to look out for our clients’ interests. For example, we watch for irregularities that might mean fraud or abuse and take steps to safeguard our clients. We also serve as a safety net for widowed spouses. Several clients of ours have expressed a tremendous sense of relief in knowing their wives will have a good financial team if they pass away. We consider it a privilege to have that trust; in fact, it’s at the heart of what we do.
 

Could Financial Reform Be Scuttled?

The president orders a reevaluation of Dodd-Frank regulations.
Major legislative changes may soon impact the financial industry. On February 3, President Donald Trump signed two executive orders authorizing reviews of some key industry regulations – the Dodd-Frank Act, and an upcoming Department of Labor rule requiring financial professionals offering retirement planning advice to serve as fiduciaries.1   
 
Passed in 2010, the Dodd-Frank Act was a response to the 2008 financial crisis. To this day, parts of the law have never been carried out. Its goal was to put safety measures in place to prevent further bank bailouts. Dodd-Frank sought to limit risk exposure for big banks by limiting certain speculative forms of investment, setting tighter mortgage lending standards, and establishing greater transparency.2
 
The critics of Dodd-Frank have contended that its hundreds of regulations hamper banks and investment firms. Some feel that Dodd-Frank makes it harder for small and mid-sized businesses to obtain loans, hindering the nation’s economic growth. According to the New York Times, House Republicans are advancing legislation to “repeal and replace” Dodd-Frank as a complement to the executive order.1 
 
The DoL had planned a spring 2017 rollout of the fiduciary rule, with a gradual path toward full implementation. By executive order, President Trump has instructed the DoL to postpone the April 10 debut of the rule by at least 90 days, during which a review of the rule may be conducted.3
 
The regulation was first announced in 2010 and its introduction has been delayed by a number of lawsuits. Proponents believe the rule will help investment professionals to reduce the potential for conflict of interest as they counsel investors. Detractors say that such directives are already in place, and argue that the rule will make it tougher for such professionals to consult lower-income retirement savers.2,3

Citations
1 - nytimes.com/2017/02/03/business/dealbook/trump-congress-financial-regulations.html [2/3/17]
2 - tinyurl.com/j3wse2l [2/3/17]
3 - cnbc.com/2017/02/03/trump-expected-to-delay-rule-giving-savers-greater-protections.html [2/3/17]

Deriving income from your nest egg: One approach

Part of living in retirement is figuring out how to fund your expenses from year to year. There are any number of strategies that you can employ to draw from your nest egg, ranging from applying the rule of using 4% of your portfolio per year to multi-dimensional strategies that rely on actuarial projections of market behavior and life expectancy.
While it should come as little surprise that the mono-dimensional 4% approach doesn’t stand up to research1, that still leaves many complex alternatives to sort through. At Montoya Wealth, our solution employs a three-part approach for our clients where we evaluate their income needs, assess their risk tolerance, and deploy a segmented investment strategy. We’ll use a hypothetical couple in their mid-sixties, John and Patricia Rich, to illustrate.

Understanding our client’s whole financial picture
When working with our clients to design a drawdown strategy, we like to have as much financial information as possible to ensure the strategy is appropriate to the overall financial plan. Some of our clients, for example, are interested in leaving at least part of their retirement to their children while others are perfectly content to pass on no legacy at all. But even clients in the latter group might choose to end their retirement with a large portion of their principle intact in order to ensure they don’t spend down their retirement prematurely.
In the case of John and Patricia, their children are comfortable, but they’re interested in leaving money to help with their grandchildren’s college funds. Still, they’re not intensely worried about outliving their nest egg, which is valued at around $1,500,000 and would rather optimize how they spend it down so they can use their nest egg enjoy life. We use this information as a starting point.
From there, we assess how much income our clients are receiving from fixed sources and how much they need from their investments. We also look at whether that income is likely to vary throughout their retirement as they take fewer vacations or start drawing from other income sources. In the Riches’ case, they have money coming in from John’s pension and will use a 66/70 strategy2 to maximize their Social Security benefit: Patricia took her benefit at 66 and John is receiving a spousal benefit until he starts taking his full retirement at 70.
One we have an understanding of our clients’ income needs and have optimized fixed sources of income, we move on to conduct a three-dimensional risk assessment with our clients – how much investment risk can they tolerate, how much risk their portfolio can actually withstand, and how concerned they are about outliving their investments. The Riches have expressed they feel comfortable assuming a moderate amount of risk in order to be in a position to continue growing their portfolio. Their portfolio and time horizon, likewise, are both robust enough to withstand that level of risk. In addition, the Riches have long-term care insurance, which eliminates one very real source of risk of draining their income sources. What they don’t have is supplemental insurance to Medicare. We address that in their financial plan before moving on to their drawdown strategy.

Generating income throughout retirement
Once we have a good idea of our client’s financial picture and drawdown needs, it’s time to put together an investment strategy in support of those needs. In the Riches’ case, they have expressed that they would like to draw a total of $100,000 while living in retirement. With a pension that pays $10,200, rental property that yields $10,000 per year, as well as Patricia’s social security benefit of $31,200 and $15,600 for John’s spousal benefit, that leaves $33,000 to bridge using their retirement funds until John receives his full social security retirement benefit in another four years.  
We favor an approach of pursuing investment strategies in several different “buckets” based on fixed time frames. The first bucket is highly liquid and contains about a year’s worth of living expenses and, if the client desires, emergency funds for home repairs or other unplanned expenses. For the Riches, that amounts to $73,000: $33,000 plus a robust $40,000 emergency fund for things like rental improvements.
The second bucket contains five years’ worth of projected expenses, invested in lower-risk, medium-term income-producing equities like bonds and preferred stock. As these equities produce income, we move it the first bucket to keep it funded. We’ve invested around $165,000 of the Riches’ portfolio into a laddered bond strategy for this bucket.
The third bucket contains the balance of the portfolio, invested in equities. In this hypothetical scenario we have invested in low-cost index ETFs, with about 30% in bond ETFs of a lower grade (and therefore higher yield) than we used in bucket two. Because we ensured that our clients had six years’ worth of resources available in the first two buckets, we can deploy more aggressive strategies in the third bucket in order to attempt to capture market upside without putting our clients’ retirement at risk. For example, recovery from The Great Recession was complete in three years; this bucket strategy gives our clients plenty of breathing room if they need it while the economy recovers from a downturn. Adding in a sell strategy allows us to monitor specific sectors within the portfolio and realign to others or, in the event of a significant downtown in the broad market, we can also align to cash for a period of time.

Maintenance and adjustment
Even with a plan in place, drawing down can be tricky business. Income needs change as time goes on, and tax issues crop up every year. We meet with our clients quarterly to stay abreast of tax issues, including harvesting, and update our bucket strategy as their income needs change. Because the second bucket is built around laddered bonds, we also continue to make bond purchases with the potential to shift our strategy in response to issues like rising rates or inflation factors. Taken as a whole, the financial plan, investment plan and drawdown strategies we employ for our clients typically offer them peace of mind. There is no one size fits all and it’s important to make sure that your drawdown strategy aligns with your investment profile, your liquidity needs, and your long term goals. In the case of our hypothetical couple, they’re now able to travel and enjoy their grandchildren without worrying if they’re doing so at the expense of their later retirement.

1 - https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2201323
2 - http://www.forbes.com/sites/baldwin/2016/03/29/the-6670-social-security-strategy-for-married-couples/#208da142407b

Disclosure
This material has been prepared by Montoya Wealth Management Group, LLC.. This document is for information and illustrative purposes only and does not purport to show actual results. It is not, and should not be regarded as investment advice or as a recommendation regarding any particular security or course of action. Opinions expressed herein are current opinions as of the date appearing in this material only and are subject to change without notice. Reasonable people may disagree about the opinions expressed herein. In the event any of the assumptions used herein do not prove to be true, results are likely to vary substantially. All investments entail risks. There is no guarantee that investment strategies will achieve the desired results under all market conditions and each investor should evaluate its ability to invest for a long term especially during periods of a market downturn. No representation is being made that any account, product, or strategy will or is likely to achieve profits, losses, or results similar to those discussed, if any. No part of this document may be reproduced in any manner, in whole or in part, without the prior written permission of Montoya Wealth Management Group, LLC., other than to your employees. This information is provided with the understanding that with respect to the material provided herein, that you will make your own independent decision with respect to any course of action in connection herewith and as to whether such course of action is appropriate or proper based on your own judgment, and that you are capable of understanding and assessing the merits of a course of action. Montoya Wealth Management Group, LLC. does not purport to and does not, in any fashion, provide tax, accounting, actuarial, recordkeeping, legal, broker/dealer or any related services. You may not rely on the statements contained herein. Montoya Wealth Management Group, LLC. shall not have any liability for any damages of any kind whatsoever relating to this material. You should consult your advisors with respect to these areas. By accepting this material, you acknowledge, understand and accept the foregoing.

Is a Roth conversion right for you?

As you head into retirement, it’s a good idea to start thinking about how you plan to manage the tax consequences of accessing your nest egg. If you have money in a traditional IRA, the IRS will require you to start taking distributions starting when you’re 70 ½ to ensure it gets its fair share of the money you’ve been growing tax-free up to that point. Instead of allowing IRS rules to be your default tax strategy, it may be worth looking at whether converting some part of your traditional IRA to a Roth IRA will allow you to come out ahead.

As a refresher, traditional IRAs are tax-deferred. That’s income you’ve never paid taxes on that will be taxable as soon as you withdraw it. Roth IRAs, by contrast, are made up of post-tax dollars. Both the principle of Roth IRAs and their gains will never again be liable for income tax.

Deciding whether to make the conversion, hence, is a matter of timing when you want to pay your tax bill: Now with a Roth conversion, or later, with a traditional IRA. If you are earning a lot of money now, it’s probably best to sit tight with your traditional IRA. But if you are in an acceptably low tax bracket, paying those taxes now means you can access a suite of benefits going forward:

A tax-free income source. Once you are age 59½ and have owned a Roth IRA for five years, both the principle you contributed to your Roth and its gains aren’t taxable. This means that you’ll be all set if you need additional funds in a given year but don’t want the tax liability.

Tax-free capital gains. One of the primary benefits of converting to a Roth IRA is that because you pay tax on your conversion, you don’t have to pay taxes on the money ever again. This means you can watch your IRA funds grow indefinitely without ever paying taxes on withdrawals.

The ability to keep contributing. You can contribute to a Roth IRA as long as you live, unless you lack earned income or make too much money to do so. The 2016 contribution limit is $5,500, with an additional $1,000 “catch-up” contribution allowed for those 50 and older.

No more mandatory distributions on that money. Since you’ve already met your tax obligation on Roth money, the IRS doesn’t care when you decide to take distributions. This means you have more control over your tax-bill, and, by extension, over how much money you hand to Uncle Sam.

A tax free-legacy. Roth IRAs can prove to be very useful estate planning tools. Roth IRA heirs can end up with a tax-free inheritance, paid out either annually or as a lump sum. While your heirs must take annual RMDs, they won’t be subject to any federal taxation on those withdrawals if the account has been opened for at least 5 years. In contrast, distributions of inherited assets from a traditional IRA are routinely taxed.

Deciding how (and when) to proceed

The first consideration of a Roth conversion is whether you’re prepared to pay the taxes of a conversion this year. When you add the taxable income from the conversion into your total for a given year, you could find yourself in a higher tax bracket. One way you can offset the tax impact of is by doing partial conversions from year to year instead of one big conversion. This could be a good idea if you are in one of the lower tax brackets and like to itemize deductions.

Another consideration is whether any of the drawbacks of Roth IRAs will impact you. For example, you will generally be hit with regular taxes plus a 10% penalty by the IRS if you withdraw Roth IRA funds before age 59½ or you haven’t owned the IRA for at least five years. Two, you can’t deduct Roth IRA contributions on your 1040 form as you can do with contributions to a traditional IRA or the typical workplace retirement plan. Three, you might not be able to contribute to a Roth IRA as a consequence of your filing status and income; if you earn a great deal of money, you may be able to make only a partial contribution or none at all.

Fortunately, if you find that the conversion hasn’t benefited your portfolio as planned, you can undo it by “recharacterizing” the conversion. If a newly minted Roth IRA loses value due to poor market erformance, for example, you may want to do it. The IRS gives you until October 15 of the year following the initial conversion to “reconvert’’ the Roth back into a traditional IRA and avoid the related tax liability.

As always, when making the decision whether to move forward with a Roth conversion or with any other tax move, it’s a good idea to coordinate with your tax and financial professionals.

When investing, the fees matter as much as the returns

Investment fees, even those that seem relatively low, have a way of taking a bite out of your long-term gains. The reason? Compounding. For example, a yearly fee of 1.5% on a $25,000 investment earning 7% will net out to $163,000 in 35 years. Drop that fee to .5% a year and your take is $227,000.
While clearly, driving down fees will have a huge impact on any portfolio you plan to hold long-term, doing so can be difficult, especially if your portfolio is made up of mutual funds, whose fees typically range from 1 to 2%.
Because some of those fees pay for managers to buy and sell strategically, one way to drive down fees is to focus on index investing. For example, The Investment Company Institute reports that average cost of an index-tracking mutual fund is .74%. Compare this to the 1.22% Morningstar reports as the average annual fee charged by the more than 1,500 large cap funds it and the savings are clear.  
As it turns out, indexing may not just offer savings; it may actually give you better returns. Indexing as a form of passive investment has been championed by the likes of Warren Buffet, John Bogle (founder of Vanguard), and David Swensen (Chief Financial Officer of the Yale Endowment Fund)1. More importantly, the research also supports pursuing passive strategies. The SPIVA scorecard, an effort by the S&P Dow Jones Indices, measures the performance of actively managed funds against their relevant indices. Its results suggest actively managed funds frequently fail to deliver – over any time horizon.
“During the one-year period, 84.62% of large-cap managers, 87.89% of mid-cap managers, and 88.77% of small-cap managers underperformed the S&P 500, the S&P MidCap 400®, and the S&P SmallCap 600®, respectively. The figures are equally unfavorable when viewed over longer-term investment horizons. Over the five-year period, 91.91% of large-cap managers, 87.87% of mid-cap managers, and 97.58% of small-cap managers lagged their respective benchmarks. Similarly, over the 10-year investment horizon, 85.36% of large-cap managers, 91.27% of mid-cap managers, and 90.75% of small-cap managers failed to outperform on a relative basis.”2
Once you decide to make the switch to index funds (or even if you don’t) there’s another step you can take to drive down fees: replace your mutual funds with exchange-traded funds (ETFs). ETFs, the mutual fund’s more tax-efficient and user-friendly cousin, charge a single transparent fee that is often less than half that of a similar mutual funds. For example, in a comparison among three S&P 500 based index funds that strive to mimic the broad S&P 500 Index, the Vanguard S&P 500 Growth Index Fund ETF Shares (VOOG), USAA S&P 500 Index Fund Member Shares (USSPX), and Great West S&P 500® Index Fund Initial Class (MXVIX), we see a $7,000 spread in the final earnings on a $100,000 investment over a ten-year holding period, even though the estimated return, 5%, was the same in each case (see Table 1).
Table 1

  VOOG USSPX MXVIX
Fund type ETF Mutual Fund Mutual Fund
Estimated return 5% 5% 5%
Operating expense .15% .26% .60%
Fees after 10 years $1917.99 $3,304.68 $7488.27
Total profit $60,464.51 $58,709.18 $53,404.60
 
With such a strong case for using index-tracking ETFs, it might be tempting to dive right in. Just pick an index fund that matches your risk tolerance, sit tight and watch your portfolio grow, right? Not so fast. There are many more variables to manage in a successful index investment strategy than simply measuring risk tolerance and buying the corresponding ETFs.  Utilizing ETFs in a way that fits your overall portfolio objectives is also important. As J.J. Zhang of MarketWatch noted, index funds are “…not a panacea or an excuse for ignoring investing fundamentals.”3 When in doubt, talk to your advisor before embarking on a new investment strategy.

Citations:
1. David Swensen, Unconventional Success: A Fundamental Approach to Personal Investment (New York: Free Press, 2005)
2. SPIVA® U.S. Scorecard, mid-2016.
https://us.spindices.com/documents/spiva/spiva-us-mid-year-2016.pdf
3. http://www.marketwatch.com/story/the-downsides-to-indexed-investing-2013-06-19