Allan Roth, an investment advisor at Colorado Springs, Colo.'s Wealth Logic, which has more than $1.5 billion of assets under advisement, is also known for his blogging acumen on DareToBeDull.com. The Northwestern University graduate is a big proponent of broad asset allocation that resists any urge to surrender to the bells and whistles associated with more niche strategies.
The beauty of Roth's unequivocal message that he shared with IndexUniverse Correspondent Cinthia Murphy recently is that he manages to make Vanguard founder John Bogle's "humble arithmetic" of investing seem quite compelling. And anyone who has tried to convey the obvious advantages of indexing over traditional active management will instantly recognize Roth's gift as a rarity.
IU.com:What do you think is the biggest mistake investors make?
Roth: Expenses and emotions. The market is almost 90 percent professionally advised; so to pay one professional a lot of money to outsmart another professional is statistically very unlikely to work. I'm a believer in indexing-I'm agnostic whether it's a mutual fund or an ETF-but as long as it's broad and low cost, it's good. That's the expense mistake.
And then the emotion mistake is, well-we all tend to think we can take a ton of risk. In 2007, when the market was up, we were heavily into the market, then 2008/2009 comes along and we find out we're not such risk takers. We believed then we were going into the Great Depression ahead, so we got out of the market, and of course, we missed the recovery. Emotions get the best of us.
IU.com:Is that why you're such an advocate for broad asset allocation; diversification for the mitigation of risk?
Roth: Yes. Thirty years ago, I got my MBA at Northwestern thinking I was a logical, rational being, not biased by the herd. And I don't know how I could have been so stupid. Along came the whole subject of behavioral finance, and then suddenly:"Ah-ha! That's me, that's everyone, that's all of us."
Broad asset allocation minimizes the risk. It certainly doesn't eliminate it, but by owning a total U.S. fund, I'm not going to have security-selection risk. If I pick one stock, I may get lucky-you could've picked Apple a few years ago and gotten lucky. But you could've picked Lehman Brothers. It can go both ways.
The second thing I try to do is I guarantee I will beat the average dollar invested in the U.S. stock market by staying broadly diversified in the long term. Study after study shows that investors earn less than a [fund's performance] because we move into something after it's done well. In other words, we move into gold after it's done well; we move into utilities just in time to see it do poorly.
IU.com:Well, if you're going to follow the market, you necessarily have to be behind it, right?
Roth: Well, yes. I can't predict what the market will do, but I can predict investors, and I have to say that advisors probably performance-chase as much, if not more, than an individual without an advisor. We need to add focus and discipline to investing.
IU.com:So investors should go with broad asset allocation, and should go low cost. But is there room for some more tactical asset allocation? When does that make sense?
Roth: Only for a gambling portfolio. Tactical asset allocation is a fancy name for performance chasing. In the long run, value will beat growth.
IU.com:Value always beats growth?
Roth: In general, the expectations of growth are very high, and the expectations of value are very low. For example, Apple can have some really stellar increases in sales, and the stock plummets because it wasn't as high as investors expected. So people will move their money, and these moves are almost always exactly at the wrong time.
IU.com:So if an investor is to own a very broad-based portfolio, does he or she have to supplement it with anything? Does it make sense to have any other more specific or niche-y strategy, if you will, on the fringes to supplement that broad exposure?
Roth: I think there are a couple of cases for that. Most alternatives deliver low correlation to the stock market, but unfortunately have negative returns. So the way to diversify is to have lower correlations but positive expected returns, and the way to go about it is to stick with low-cost alternatives, but you have to be committed to it.
I think there's a case for a REIT index fund, even though REITs are in the Total Stock Market Index. REITs can have low correlations to stocks. I also think there is a case for having very, very tiny amounts of precious metals and mining stocks. And one has to be committed to it because those stocks make the stock market look boring-they're volatile as heck. Again, they have a lower correlation to the stock market.
And I think there's an argument for a slight tilting towards small-cap value. But that's for a different reason:It's extra-expected return for extra volatility.
IU.com:Do you recommend investors embrace fundamental indexing as another alternative?
Roth: I think fundamental indexing, alternative weighting and economic weighting are viable active strategies. They are not indexing. By design, they have a small-cap and value tilting, and I think one can get the small-cap-value tilting more efficiently by buying a total U.S. fund and then buying some small-cap value on the side.
But I have some clients who want to do some of that. It's less tax efficient, for sure. But the nice thing about a total index fund is that when, say, Apple surges, it doesn't have to rebalance. When Apple tanks, it doesn't have to rebalance. The market-cap weighting does it for it. But when you're starting to weight with alternative mechanisms, you've got to buy some, sell some-if you're doing it off of revenue, if you're doing it off of book value, if you're doing it off different measures, when those change every year, you've got to change the weightings, which passes through capital gains and the like.
IU.com:So your message, again, is "the more boring the better"?
Roth: Yes:Dare to be dull. It's not such an easy thing to own the broad market. And the daring part is-the toughest thing I ever had to do was to buy stocks in October '08, look pretty stupid and have to buy more stocks in March '09. Setting an asset allocation is the second-most important thing investors have to do. Committing to and sticking to it is the most important.
It sounds funny, but I mean it dead seriously. If you can't be right, at least be consistent. Right now when markets are again at an all-time high, I'm trying to talk new clients down off of the asset allocation that they say they want. I'm pointing out that we get twice as much pain from losing a dollar as we do pleasure from gaining a dollar, and in good times, we all think we can take a lot of risk.
The truth is that we tend to think markets are so much more volatile now than they were 20, 30 years ago, but it's just not true. We've always had uncertainty; we always will have uncertainty. Often times when stocks are going up, it's hard to get a client to rebalance to sell. Investors need to stick to the asset allocation, rebalance and when they get that irresistible urge to do something, letting it pass is key.
One of the things I've discovered is, if you make a move that feels good, it's probably going to be bad for you. And if it hurts, it's probably a good sign. In other words, it felt good to buy the precious metals in mining-it felt good to buy (NYSEArca:GDX) three years ago. It would feel bad to buy it now. I can tell you, I don't know how it's going to do next year, but I could tell you it's a better deal today than it was three years ago.
IU.com:You must be very popular with your clients.
Roth: Well, I don't know the future, but humans can't accept randomness. It's very counterintuitive to say, "I don't know how the market's going to do next year." We've got to say, "Well, we've got the sequester coming up. Housing is coming back." And the media merely predicts the past. During good times, they say, "Stocks are going to go up. Things are good." And in bad times, "We're going into the Great Depression ahead."
But neither good times nor bad times last forever, which is an argument for rebalancing. And rebalancing is the one contrarian view. It can make you buy when people are selling, and it can make you sell when people are buying.
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