Investing by the Numbers

The Active vs Passive Approach?

Mark HebnerIndex Funds Advisors, Inc.

19200 Von Karman Suite 500Irvine, CA 92612

888-643-3133

www.ifa.com

Reference sources can be found at www.ifa.com

and the Index Funds: The 12-Step Program

0 Zero: the number of active equity managers left in the

Philip Morris $12.4 billion domestic equity pension fund.

Zero: the number of active equity managers left in the $36.9 billion Washington State Investment Board.

Zero: The mathematical expectation of the speculator is zero. – Louis Bachelier, The Theory of Speculation, 1900

Source: Pension and Investments, Aug 9, 1999; May 2001

1 1 out of 28 professionally managed major

pension funds beat a simple index fund allocation of 60% S&P 500 Equity Index and 40% Lehman Bond Index (1987-1993.)

1 Dimensional Fund Advisors (DFA) ranks #1 of all mutual fund

companies, with strong ties to Univ. of Chicago academics. Eugene Fama ranks #1 out of 44,492 authors of academic

economic research. He is a Univ. of Chicago Economist, CRSP Director, and DFA Director of Research. If you don’t understand his work, someone who does will be taking your money.

Univ. of Chicago ranks #1 in the world for Nobel Prizes in Economics (9.)

Over $1 trillion dollars of index funds are now invested in pension plans.

2 Only 2 out of 71 (3%) mutual fund managers

outperformed the S&P 500 index over 10 yrs in taxable accounts.

3 3 risk factors captured in DFA funds explain 95% of

stock market returns, going all the way back to 1928. 1. Your exposure to the market. Premium = 8% 2. Your exposure to small cap stocks. Premium = 3% 3. Your exposure to value stocks. Premium = 4.5%

4 Over 10 years, 88% of the return of the S&P

500 was contained in an average of 4 days per year.

5 5 year track records of investment managers

offer no useful information for investors. You need 20 years.

12 Over the last 74 years, a Small Cap Value

index had a total return of 12 times the S&P 500. ($27.3 million vs $2.25 million on a $1,000 investment in 1927.)

12 12-Step Program

to Index Funds, the treatment of choice for active investors.

The number of steps used to treat over 31 different addictions.

12 Of the original 500 stocks in the S&P 500 in

1957, 426 were taken off the index and only 12 of 74 remaining ended up with an index beating return. Leaving a 2% chance of picking the stocks in advance that beat the average return.

17 Over the last 17 years, the S&P 500 had a

total return of about 17 times the average equity investor, after inflation. IFA estimates that after inflation, taxes, and all related expenses the average equity investors actually loses* money over 17 years.

*the mathematical expectation of the speculator is zero – before costs.

19 The famous Janus and Magellan funds both

claim S&P 500 beating returns. Since about 19% of their return went to taxes, they both underperformed the index by about 0.5% per year over 15 years, in taxable accounts.

22 Morningstar says you need 20 years of risk and

return data to draw statistically meaningful conclusions about mutual funds. Of their 11,000 mutual funds in their database, only 22 managers have 20 years tenure. Only 2 have a risk-adjusted returns in excess of the S&P 500 over the last 10 years. None beat a global index fund portfolio.

28 Since 1961, 28% of mutual funds became

“dead mutual funds.” From 1970 to 2000, 41% died. Survivorship Bias upwardly skews the results of active management by about 1.5% per year.

30 The first index fund was created 30 years

ago, in 1971, at Wells Fargo Bank for the $6 million Samonsite Luggage Pension Fund.

US pension and public institutions currently index 30% of their US equities.

35 Out of 1,466 large cap mutual funds, only 35 beat the

S&P 500 over the last 10 years. A mere 2.4%. How could anyone identify those funds 10 years ago?

37 The average investor recently scored 37%

correct answers on 20 basic investment questions.

40 There are 40 books in the ifa library that

support the passive indexed strategy of capturing risk factors and their related returns in the most efficient low cost manner.

50 A diversified equity portfolio of DFA index

funds* has earned about 17%/year for the last 25 years or growth of $1 to $50.

S&P 500 was up 15.3% over the same period, or growth of $1 to $35.

*Past performance does not guarantee future performance. See disclaimer and backtested data at www.ifa.com

53 Over a 15 year period, 53% of the total return

of actively managed funds go to your “silent partners.” It is only 13% for a total market index fund.

60 “If I have noticed anything over these 60

years on Wall Street, it is that people do not succeed in forecasting what`s going to happen to the stock market.”

- Graham, Benjamin, Legendary investor and author

95 95% of market timing newsletters went out of

business over a 12.5 year period.

96 Of the dead mutual

funds, the Harwick Fund had the worst record. They had a total loss of 96.5%.

99 "99% of fund managers demonstrate no

evidence of skill whatsoever."

- William Bernstein, The Intelligent Asset Allocator

100 Recent research concluded that stock selection and

market timing contributed nothing to long term returns. 100% of returns are explained by asset allocation to appropriate benchmarks using index funds.

100% of 68 comparable bond funds were outperformed by the Salomon World Government Bond Fund Index.

102 102 years ago, Louis Bachelier wrote the The Theory of

Speculation. 52 years ago, Harry Markowitz wrote Portfolio Selection. 39 years ago, Bill Sharpe wrote Capital Asset Prices: A Theory

of Market Equilibrium Under Conditions of Risk. 12 years ago, Fama/French wrote The Cross-Section of

Expected Stock Returns. These 4 papers explain how the stock market really works. Only

a very small percentage of investors understand them.

250 There are 250 academic research papers

listed in the article database in the library of ifa.com. They support the passive indexed strategy of capturing risk factors and their related returns in the most efficient low cost manner.

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Investing

1. How do I make a return on my capital? Expose it to risk (engage in capitalism)

2. What is risk? The possibility of loss. The degree of probability of such loss is usually specified.

4. Where do I find risk? The most risk and return has been found in small and low priced stocks. (selling close to book value)

Q and A

Q and A

5. How do I get the highest return for a specified level of risk? Diversify and passively hold risk factors captured within multiple index funds.

6. How much risk exposure should I have? Measure your risk capacity with the Risk Capacity Survey.

Investing

Why Index Funds?

Why invest in a portfolio of index funds?

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Because you get… Because you avoid…

Lower portfolio turnover, taxes, fees and expenses

Higher portfolio turnover and the high costs of “silent partners in your returns.

Increased Diversification, reduced risk, higher and more reliable returns

Low diversification, un-rewarded and higher risk, and lower and less reliable returns.

28 yrs simulated risk and return data on risk factors captured by many of the indexes.

Stocks, times, managers and style picking. Highly suspect risk and return data, with very high std error of the mean.

Style Purity, Asset Allocation and risk consistency

Style Drift, Asset Allocation and risk drift

Relaxation Stress