Rick Ferri is not sitting on the fence in the active versus passive investing debate. He has both legs firmly planted in the passive camp, as the cover of his new book amply illustrates. Above the title, The Power of Passive Investing, is a picture of a businessman pulling open his jacket to show a Superman-style uniform underneath. In place of the “S” for Superman is a “P” for “Passive”.
The Case for Passive Investing
Ferri, a former Marine fighter jet pilot, had been working at a large financial firm in the mid 1990s when he began to catch the passive fever. Having seen a lot of active managers fall short, passive investing quickly came to make sense to him, and he became a fan of the the teachings of Vanguard founder Jack Bogle, the father of mutual fund indexing. Soon Ferri no longer fit in so well in a world more focused on active-management, and in 1999 he founded his own shop, Portfolio Solutions, a Troy, Michigan-based financial advisor. The firm now has 600 clients nationwide and nearly $1 billion in assets under management, Ferri reports.
To promote his firm and his message, Ferri’s written six books and penned a regular column for Forbes. His writings are assembled at rickferri.com
In The Power of Passive Investing Ferri has gone back in time to test how actively managed funds of all different stripes performed. Basically he found no good argument to change his stance that low-cost, passively managed mutual funds and ETFs are any individual investor’s best bet.
One of this most fascinating findings: the more actively managed funds you hold the worse your portfolio is likely to perform. Owning more individual stocks may increase diversification and increase your chances of a strong investing return, actively managed funds have just the opposite impact, largely, Ferri says because of the compounding of their fees. If you absolutely must own an actively managed fund, Ferri says, be sure you only own one.
Ferri’s no fan of actively managed funds, but he does like Exhange Traded Funds as well as mutual funds. He argues that recent concerns over the disconnect between the prices of some ETFs and the prices of their underlying assets has more to do with mispricing of the assets than of the ETFs.
Ferri’s Core Four Model Portfolio: Mutual Funds or ETFs
Ferri has created a well-known model portfolio called the “Core Four” using both mutual funds and ETFs. For someone with a 60% stock allocation and a 40% bond holding the components would be:
36% VTSMX Vanguard Total Stock Market Index
18% VFWIX Vanguard FTSE All-World Ex-US
6% VGSIX Vanguard REIT
40% VBMFX Vanguard Total Bond Market
36% VTI Vanguard Total Stock Market ETF
18% VEU Vanguard FTSE All World Ex- US ETF
6% VNQ Vanguard REIT ETF
40% BND Vanguard Total Bond Market ETF
Ferri warns that anyone interested in this kind of portfolio has to have a long time horizon:
All of these models are created with 20/20 hindsight. We don’t really know what’s going to happen going forward, they’re our best guess. If you’re going to be in anyone’s model you really have to be in it for 25 years, it’s a life strategy decision and you have to be disciplined about maintaining that or it isn’t going to do what you think it will do. Something as simple as buying four mutual funds and holding on to them sounds easy but is difficult to do, there is too much noise out there.
You need to have no more risk in your portfolio than you can emotionally handle. There’s a neat rule out there – Adrian’s rule. He says don’t put any more stock in a portfolio than you could stand to lose half of. If you put 80% in stock, you have to be able to withstand a loss of 40% of your portfolio.
If you can’t, pare back your holdings, Ferri says. One of the worst mistakes an investor can make is to sell in panic.
Click on the video below to hear Ferri talk more about passive investing, when a mutual fund is a good choice, when an ETF works, and how to build a decent portfolio in your 401(k) even when your investing options are limited.