The Secret of My Investing Success

The most skeptical investors I ever met were Wall Street equity capital market professionals - the ones responsible for pricing initial public offerings. When it came to their personal accounts, they never saw a share they liked.

Their problem? They were the line foremen at the giant Wall Street sausage factory. They knew what went into the sausages, how they were cured, packaged and sold - and wanted no part of it.

I always had a different take. I believed in the promise of the equity markets but not in the hope of anyone to outsmart them. Which is why I turned to index funds and the Vanguard Group, the not-so-secret secret of my investing success.

Since 1991, I have been investing at Vanguard, a $1.3 trillion money manager. Vanguard's specialty is index funds - passively managed funds that mirror the performance of broader stock indexes. Today, I have about a dozen Vanguard funds.

My returns? For the five years ended May 31, my blended Vanguard return is 11.5% annually. Over three years, the same 11.5%. Over the past year, 0.4%. By hedge-fund standards, these are modest returns. But the money outperformed the S&P 500 by 7.2 percentage points over the past year, by four percentage points over the past three years and by about two percentage points over five years. And that was with about 10% always in cash.

The next George Soros? I am afraid not. My investment mix is 70% index funds, a few sector funds and two funds managed for Vanguard by Primecap, a West Coast asset manager.

Some Vanguard investors are fanatical about only indexing. I am an index believer, but not a zealot. A decade or so ago, my wife randomly picked the actively managed Primecap fund. It has outperformed its peers. So far.

How does an active management skeptic like me outperform with index funds? Mostly luck in allocation. There were European and emerging-market index funds that rose as the dollar collapsed. And energy and precious-metal funds that rode the bull commodities market.

Plus, I benefited from an aberration in my own investing behavior. I almost never take profits. But last October I looked at the five-year 25% to 35% annual returns in my 'hot' funds and figured this can't last forever. So I took some money off the table. Common sense, not brilliant insight.

Can it be that easy? Wall Street doesn't want you to think so, but it is. Index funds, sensible allocation, patience, not chasing performance. That is really all it takes. When friends ask me what to do with their money, I point them to Vanguard.com.

On Wall Street, Vanguard isn't popular. Unlike Fidelity and BlackRock Inc., it's structured as an entity owned by the funds themselves. Low costs, no profits. It is an affront to the armies of traders, brokers and fund managers who require high costs for their livelihood.

Many of my Wall Street colleagues would have been embarrassed to admit they invested through Vanguard. It is like a gourmand confessing he loves McNuggets. Most had expensive brokers who disappointed them. Every now and then the broker would serve up an allocation to a hot IPO to justify his services.

Vanguard may be a little too Do-It-Yourself for people who prefer to entrust their money to someone else. Nor is it the place for the sophisticate looking to roll the dice with hedge funds. Of course, Vanguard isn't the only good money manager out there. But wherever you end up make sure you know what you are paying.

A friend of mine uses a large, well-respected money-management firm. I have scrutinized his portfolio statements at length and I still can't figure out his real returns. There is a gobbledygook of buried expenses and fees. Inappropriate benchmarks. Blended returns. Incomprehensible.

Which is what his money manager wants. Then he can't see he would have been better off with index funds.

On Wall Street, this obfuscation of actual performance is an art form. It is called marketing. Next time you see an advertisement promoting a fund's performance, count the asterisks and read the small print. You may go blind, but at least you will understand how the game is played.

There is only one way to beat the market. Buy the market - and get a little lucky.

Evan Newmark
WallStreet Journal 2008-06-10