#171: Index Funds: The Smarter Way to Invest
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Welcome to another episode of the Richer Geek Podcast! Join us as Mark Hebner, founder and CEO of Index Fund Advisors, Inc. (IFA), presents a comprehensive 12-step guide to mastering index fund investing. Explore the benefits of passive investing, pitfalls of active trading, and the significance of diversification and risk management. Gain insights on aligning your portfolio with long-term financial goals using Nobel Prize-winning research and practical advice to optimize your investment strategy. Ideal for individuals seeking to shift from speculation to education in their investment journey.
In this episode, we’re discussing…
Understanding Index Funds: Learn how passively managed index funds outperform speculative investments over time by optimizing risk-adjusted returns.
Investing Philosophy: Discover Mark Hebner's mission to replace speculation with education in investing, emphasizing the importance of benchmarking performance against index funds.
Risk Management: Gain insights into the Nobel Prize-winning research that shows diversification through index funds reduces risk while maintaining expected returns.
Challenges of Active Investing: Explore the pitfalls of active investing and day trading, likening it to gambling, and understand why a long-term, passive approach is more effective.
Role of Brokers: Uncover the tactics used by brokers that prioritize their earnings over client returns and why working with a fiduciary advisor is crucial.
Historical Performance: Understand the long-term performance of various indexes, including the S&P 500, small-cap, and value companies, and their implications for future returns.
Behavioral Finance: Recognize the psychological aspects of investing, including the addiction to trading and how to overcome it by adopting a structured, educated approach.
Practical Advice: Practical steps for investors to determine their risk tolerance and align their portfolio with long-term financial goals using index funds.
Resources from Mark
LinkedIn | Index Fund Advisors | Index Funds: The 12-Step Recovery Program for Active Investors
Resources from Mike and Nichole
+ Read the transcript
Mike Stohler
Hey everybody. Welcome back to another episode of The Richer Geek Podcast. Today we have Mark Hebner, he is the Founder and CEO of Index Fund Advisors, Inc. , is on a mission to change the way the world invest by replacing speculation with education. And actually the investing company, Acorns was inspired by his methodology. How're you doing, bud?
Mark Hebner
Acorns.
Mike Stohler
Acorns.Yeah.
Mark Hebner
Yeah. Acorns is an app that helps people kind of save and invest.
Mike Stohler
So we're going to get into a little bit of what we think the stock market is, and the traditional advisors tell us to believe, give us a little bit about your background, how you got started and where you're at now?
Mark Hebner
Sure, so I started this company 25 years ago, on March 5th of 2024, it would be 25 years. We'd been planning our big celebration of that. I started with the idea that most of my friends and relatives had been essentially gambling in the market. And we're not aware that a passively managed index fund actually does better on a risk-adjusted cost, adjusted basis than people sort of gambling among different types of stocks. So you have to benchmark their performance. If they're buying large stocks, gambling and the S&P 500 stocks, then you compare that to the S&P 500. If they're buying technology, stocks, you want to compare it to NASDAQ and different benchmarks out there that are available. And most people didn't really understand, and probably even today, don't understand this concept of benchmarking their returns against an alternative investment, which would be these passively managed index based funds. So anyway, so we started 25 years ago, we were really an internet-based investment advisory business with investment advisors on the phone and doing webcasts, way back then and 1999. We were trying to do that with clients. We had all the tools, but most clients didn't. But after COVID, it works great now, because everybody knows how to use Zoom. Anyway, we started basically with zero and today we have 5 billion in assets under management as of the year end of 2023. We've obtained about, I don't know, 2400 clients, and help them manage their wealth in what we like to call the most optimized way that's optimized between the risks they take and the return they expect to earn. Did it help you?
Mike Stohler
Yeah, it does. You're speaking about index funds. What is an index fund, compared to all the other stuff that you can do out there?
Mark Hebner
Sure. The most famous of them is the S&P 500 fund, though, there's 500 stocks. And when you invest in them, they put the most money of your investment in the largest company, they call it a market cap weighted index based on the market capitalization of a stock. So Apple, Microsoft are going to get the most amount of money of all the of your investment, maybe it's I don't even know what it is today, five 6% goes into those stocks, and then it goes down. And so the smallest company in the S&P 500 gets the least amount. But that's just one index. I think there's literally hundreds of 1000s of indexes today. If you look at all the different companies doing index creation, and there's even indexes created by academics, they call them research indexes. Among the most famous there are a couple of guys, Eugene Fama and Kenneth French, they're the Fama French indexes. And they slice up the market to value companies and growt h companies and large companies, small companies, and they do that international us emerging market. So there's all kinds of ways you can slice and dice markets. But I like to say an index fund is a set of rules of ownership that are held constant, regardless of the market condition. That last part is the hard part for people. They think, oh my gosh, it's 2008 2009 I've got to change my investment strategy, something went wrong with the market, what have you and or whatever it might be COVID, you know, and March of 2020 market takes a big dump people get scared want to sell, but you don't want to do that you want to basically bear the risk to capture the return. That's what returns are tied to it's basically the risk you expose your assets to.
Mike Stohler
Do you feel that the index is probably the most cautious part instead of going out on your own or saying "Hey, you know this EV stock kind of tanked today."
Why not put some money into it? Should we diversify some of that? Or just say, you know what? The S&P, this index, they've given you 10 plus percent? Just stick with what you know.
Mark Hebner
I think the beginning of your question had to do with the risk of them, right?
Mike Stohler
Yeah.
Mark Hebner
So risk can be quantified with basically the variability of the return of that investment over some reasonably long period of time. And if you look at the risk of one stock, versus the risk of 500 stocks, it's a little more than double. Okay, so what that means is the ranges of outcomes, both on the negative and the positive side, are twice as much as you would expect from owning 500 stocks. So from that perspective, it's less risky. But here's the key, the expected return of one stock is the same as the expected return of all 500 together. And that's because on average, those 500 stocks earn that 10% a year, and you just don't know people think they know, but you don't know which stock is going to get 100% return or go bust. Okay. So this is a Nobel Prize for Harry Markowitz, that the expected return of one stock and 500 stocks is both 10% a year. But when you buy all 500, you basically double the certainty of getting that return. And they call that the only free lunch in investing, because you've improved your expectation of getting that return by diversifying.
Mike Stohler
Yeah, that does make sense. And that's probably why it's big news when a stock falls out of the S&P or a company, because now they're not part of that index. I know, Tesla goes in and out in and out, as just one example. And other big companies fall in and out, is that why it's such a big deal, all of a sudden, they're not available in those big indexes anymore?
Mark Hebner
It can be a big deal to those individual stocks. But I wouldn't say over the long term, that's a short term, maybe opportunity to kind of gamble on those. But you'd have to be so careful, that price adjusts immediately, that the information is known to traders, this is a real problem for investors is they read news, and they haven't quite appreciated the fact. But by the time they've read it, the price is already adjusted to it. And so you're too late, virtually all the time is the way you should at least perceive it. The probability that you know, something that's not already embedded in the stock price is virtually zero.
Mike Stohler
Yeah.
Mark Hebner
The goal of most investors is to discover a security that's undervalued or overvalued. If it's undervalued, that means, you know, the market hasn't quite appreciated what you know, then you should back up the truck and load up on those stocks. And if it's overvalued, you shouldn't be selling them and getting them out. But the real problem is, instead of that all securities are fairly valued all the time. And why is that because we have 10 million traders, half of them buyers, half of them, the sellers, they're trading 10 billion shares a day, at through this huge processing machine, if you will, of all these sub 40 publicly traded markets all over the world, we arrive at the fair market value of all of these securities virtually all the time. And so you should just give up on this idea of speculating on mispriced securities, and just accept them as being the fair price. And instead of having speculation as the reason for your return. Think of it as basically capturing the cost of capital of those firms. That's a little bit difficult. But every person who gets capital has some costs something they have to give up to get that cash, right. And all sellers of securities give up their future return. If I sell you Tesla today, I think "Oh, maybe in the next 12 months, it's going to make 10%." And so I want to price that free compensates me for the probability of getting that 10%. That's what investing is about is it's basically capturing the cost of capital of the seller of whatever security you're buying. But the other way you can think about this, as you just said, 10% for 95 years now, those large companies have earned about, it's about 9.8, I think percent per year for 95 years, that should tell you something, but if you invested in smaller companies, those are riskier, have higher cost of capital, it's more like 12%. And then if you look at value companies, it's also in that 12, maybe a little excess, and these numbers are all based on indexes. You know, we have indexes for that long for a period of time, that's the other reason to use an index is you have more data about the risks and returns of those stocks that have those characteristics. They're large, they're small, their value their growth.
Mike Stohler
Yeah. What do you say about you know, some of us have been burned by our brokers, because they get perhaps, something on the front something that they steer you. How does that work? And what are some of the tactics that you know, I love this little blurb that you have? It's, they have tactics that are cleverly designed to make your broker rich, and not you.
Mark Hebner
Exactly. As in most business transactions, you want to follow the money, okay? How is somebody else making money off of you. And in the brokerage business, their model is to make money on transactions almost in all cases, it's a transactional business, right? We call that the broker deal dealer world, there's another classification of investment advice through registered investment advisors, and registered investment advisors have a fiduciary duty, while brokers don't one's regulated by FINRA and one's regulated by the SEC. But the way you get around that, is you work with an advisor who just takes a percentage of your assets. So they're not motivated to get you to trade, or get you all emotionally excited about buying or selling, and basically creating transactions. The short answer, I hate to say it, but brokers are not the best place for investors because they encourage this trading. And we've now through all this research that I've mentioned to you, we've concluded that the more you trade, the worse off you are not the better off you are. We'd like to say, you know, why they call brokers is when they're done with you, your broker?
Mike Stohler
Well, I haven't heard that one. That's very true. For instance, I remember back in the day, I wanted to spend x amount of 10s of 1000s of dollars on gold when it was $100 announced. Sure, and the guy goes, no, no, no, there's a fund out there, or there's a something American fund that has gold mines. And that's what they want to do, instead of put money on gold, because he got 5% on the front, he got whatever on the back.
Mark Hebner
Right.
Mike Stohler
And I missed out on gold being $100 an ounce, you know, so that's sort of the cleverly designed stuff that...
Mark Hebner
I want to just give you a few seconds. I know we're running short on time about gold and virtually all commodities, okay. The value of a company is basically the present value of their future earnings. Gold has no earnings, a Bitcoin has no earnings, all commodities are not profit generating investments, okay. So their value just as a speculation, based on future supply and demand, which really, nobody knows, I mean, this whole thing about 21 million Bitcoins, and you know, the bid demands gotta go up, and blah, blah, blah. But there's really no foundational earnings tied to any of these commodities, I would avoid them like the plague. I've got the data right here, the long term return of gold is about 4%, which is about the same as inflation, except for gold has this huge volatility of about 18% standard deviation, that's a measure of risk. That's one of the things that investors want to try to pay attention to. They want to see how much return they're getting for the risk, they're exposing their assets to. And that's the Nobel Prize for this guy named Harry Markowitz. He went back and looked at the returns and the basically the variability of return the uncertainty of return. And when you do that, it gives you a set of investments that have maximize the return given the risk, historically speaking, and if you have a really large sample size, I'd say 30, 40, 50 years, then that gives you a better estimate of what you could anticipate literally every year going forward. That's the application of statistics to the market. And statistics works as long as these prices are fair, so that there's not opportunities to sort of outsmart the market. And that's basically what we've concluded. And that's all in my book, Index Funds. And we call it The 12-Step Recovery Program for Active Investors because that's sort of modeled after gamblers anonymous, they actually have a brochure about stock market gamblers. And so I just kind of use it as a rough framework for the design of my book and providing this education so that people will not engage in speculation, as you said at the front.
Mike Stohler
Yeah, so let's talk about that. I never thought about this, that there are people out there that are day trading and they can't get off the computer. That's right and If it's almost like playing poker or going to the casino.
Mark Hebner
It is like, it's not almost it is the same.
Mike Stohler
It is the same. So it's just another, it's money. Right? So this is the 10th edition of the 20th anniversary of your book Index Funds: The 12-Step Recovery Program for Active Investors. Let's talk a little bit about that. And what's in it, how do you even say, "Hey, yeah, I'm an addict."
Mark Hebner
So we actually have a list of things. And this is what actually gamblers anonymous does. Also, I think they have 10 items, 10 things that would give you an indication that maybe you have a some level of addiction to gambling. And it's things like as the first thing you think about in the morning, is where's Tesla stock going to be the day, and I should run to my computer and still look at the charts from the last three days is or last three hours, and tried to decide what I should be doing. And are your thoughts consumed with the market, as you mentioned, these day traders, I guarantee you, a large percentage of their thinking is dedicated to the next trade. And there is the real of the big return. And the regret of the loss that is constantly nagging at them. Gamblers anonymous, calls each trade an action. And it's like a hit of adrenaline, when they actually make this decision to buy to sell. This is what is the addiction, like it is for drugs, and smoking and alcohol, so many other things. It's basically becomes addictive. As you said, very few people recognize that as an aspect of investing. But I assure you it is there's there's been brain studies where addicts have been shown cocaine, and then they've been shown a way to get rich quick, this is the real issue here, people think they're going to cheat risk, and get rich really quick instead of slow. Basically, money comes slowly, it doesn't come fast. And so what that does is it lights up the same component, same areas of our brain, that are tied to our addictive behaviors. My book covers all of these in step one about basically, are you an active investor. And then in the traditional 12 steps, they want to come up with something that will be more important to you than your addiction, right. And so traditionally, they come up with some god or some religion that gets you away from your addiction. And what occurred to me is the academics and in particular, those who won Nobel Prizes, for their work on how investing works should be your investing gods, not just somebody who had a great return last year or last three years or whatever, what you want to see is independent, peer reviewed empirical research. And in particular, that research that was so good, a bunch of other academics voted on it to get the Nobel Prize. And that's what my step two is about, we list all these various Nobel prizes that lead to this basically a portfolio of index funds type of strategy for investing.
Mike Stohler
So instead of saying, "Stop doing this," and maybe stop doing the daily trading and things like that, you try to get them to change their mindset and say, hey, look, you can still invest, but do it the smart way. Do it the proven way, is that correct?
Mark Hebner
That's right. I like to think of it as given them an education, you know, just like anytime you go to school, you might walk into some class with some preconceived notions about a topic. But then as the professor starts laying out the facts for you, you're going Oh, okay. I mean, you might think of it as a doctor or a lawyer, you know, anything like that, where there's a certain expertise to be known. In investing, there is a huge body of research and academic papers that I almost guarantee you very few investors paid any attention to. So I mentioned a couple of Nobel Prizes for you. Some of them have to do with this risk of return. The other Nobel Prize I talked about with where the prices are fair, and a third Nobel Prize. Well, it's actually a component of prices being fair, but small companies have done better than large and values done better than growth. There's a lot of Nobel prizes have been thrown around here that people basically aren't aware of. And once they know these ideas, have that sort of Nobel seal on them, then maybe they'll pay a little more attention to them, as opposed to their broker who probably didn't even graduate from college. I hate to say this doesn't take a lot to get a brokerage license, they send you to a review course. And then you take a test and you're out giving an investment advice to people. It's kind of scary.
Mike Stohler
Yeah, it is scary. You know, every time I walk into my bank, there's a 27 year old kid say, "Hey, you know, yeah, let me talk to you about retirement fund 2036 or something like that." And I'm like, "No, that's okay."
Mark Hebner
Because you need some help. Mike, you can call me.
Mike Stohler
There you go. I appreciate it. Everybody, we're talking about book Index Funds: The 12-Step Recovery Program for Active Investors, and Mark Hebner. So what do you see Mark? We're in an election year.
Mark Hebner
Yep.
Mike Stohler
The stocks always respond, usually, this time of year, are people going to be relieved? Or do you still see some volatility? What do you see 2024? And then maybe the end of 2024 to 2025? What are your thoughts?
Mark Hebner
So listen carefully. Nobody knows, including me.
Mike Stohler
Good answer.
Mark Hebner
Stocks follow basically a normal bell curves and their monthly returns. And the reason is, those forecasts that you just said, are all in the minds of the 10 million traders today. They're all thinking about that. And as they go to place their trades, they embed their knowledge, the current surveys, and the polls of all the experts or whatever, all the things that they know, one group of people think that's a buy and other group, people think it's a sell. And they kind of go almost negotiate to get to the just the fair price, given all that information. So you know, it's kind of interesting, when you look back over time, the returns of the market are almost precisely the same for Democrats as they are for Republicans. And I've know both sides might like to say, hey, the market is going to do better under this or that. But just like I told you before, this news and information gets embedded in the price so quickly, it's too late for you to benefit based on your idea or your forecast. Yeah, we used to joke that people would read the Wall Street Journal as if they were the only ones reading it. And then they would go and place their trades. First of all, by the time it's getting printed in the Wall Street Journal, it's really old. It's the Bloomberg Terminal. And that's why Michael Bloomberg is so wealthy, that scrolls that news for the whole world through all these Bloomberg terminals all at the same second. And even there, half the people think it's a buyer and have them think it's a sell, and they come together and come up with a fair price. So the answer is, and let me just add the record of these forecasters are horrible. Who monitors these forecasts of all these people walking across the stage on CNBC? They ought to introduce that. Okay, what's been your accuracy over the last 100? Forecast? Okay, well, I can tell you, it's pretty low. The accuracy needed is 74%. And there is no long term record like 100 forecasts or more that exceeds 74%. Let me explain that really quick. Because that 10% return you mentioned. Turns out it's only about three or four days a year that make up that 10%. So a big day is like two and a half 3%. Right? So let's just say it's two and a half, four of those big equal your 10% return. So if you weren't there weren't invested when those big days came along, then you missed out on your 10%. And this is why it's so difficult to forecast in a way that would allow you to do better than just buying and holding that is sort of the benchmark, if you will, the buy and hold index have a similar risk. All speculators should hold themselves accountable to that, but they don't.
Mike Stohler
Yeah, that's fascinating, you know, hearing it that way, because it's the same thing in real estate by the time it gets to an MLS or listing.
Mark Hebner
Right.
Mike Stohler
No one else wants it. Because all the big guys turned it down. And now that you get to see it.
Mark Hebner
I mean, they're the whole pocket listing, right, they get right in there. There's phone calls made before it even gets in there. They put it on there for we might call the newbies.
Right.
Mike Stohler
Exactly. That's exactly. Let's give it a shot. Mark, it's been a pleasure having you on where can people find you? What's the website's LinkedIn?
Mark Hebner
So the websites ifa.com That's india, frank, alpha dot com. It stands for Index Fund Advisors. And all of our information is there. We have incredible charts and videos and articles that were considered one of the top resources for investing I would say in the world are what I'll call proper investing, and not speculation. And hopefully, your listeners will be sobered up by this information. So you don't want to continue to gamble in the market, like they are probably doing now I guess you have a lot of tech listeners, I think you might have said. So you know, those people like to maybe gamble within their industry. But I can assure you, even though they work in those companies, all the analysts and all the other people that are trading those securities combined, are going to know more than you. So let it go. So we have a little questionnaire. So what do you do with your investment, you take this questionnaire to find out how much risk is right for you. And then there's a portfolio of index funds that we show on our website, that we can now show historic data for 95 years because there are indexes. And that's all spelled out my 12 steps to in my book. There's also an audio book, which is kind of nice. I know a lot of tech listeners are probably more into an audio book, just like they might be listening to this podcast, right. And those with a Kindle or any device pretty much can do a Kindle, you can also get that.
Mike Stohler
Well, there you go. Well, thank you Mark. And again, everybody it is Mark Hebner, ifa.com His book, go to Amazon, and it's Index Funds: The 12-Step Recovery Program for Active Investors. Mark, it's been a pleasure having you on The Richer Geek Podcast. Have a wonderful day.
Mark Hebner
Yeah. You're doing good work there, Mike. Thank you.
Mike Stohler
Thank you.
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ABOUT MARK HEBNER
Mark Hebner is the founder and CEO of Index Fund Advisors, Inc. (IFA), renowned for his groundbreaking book "Index Funds: The 12-Step Recovery Program for Active Investors," which has garnered acclaim from financial luminaries like John Bogle and Nobel Laureates Harry Markowitz and Paul Samuelson. With a mission to revolutionize investing by promoting education over speculation, Mark's 12-Step Program elucidates the pitfalls of active investing and champions evidence-based strategies. A respected speaker and authority in the field, Mark holds an MBA from the University of California, Irvine, and a Bachelor’s in Nuclear Pharmacy from the University of New Mexico. Prior to IFA, he co-founded Syncor International, later acquired by Cardinal Health for approximately $850 million.