Want to beat the Wall Street pros? Listen to this guy
Investing legend Charley Ellis was one of the earliest and most vociferous advocates for passive investing, making the case for “indexing” before it drew heavy cash flows and fawning headlines.
For his latest of 17 books -- “The Index Revolution: Why Investors Should Join It Now” -- the Yale professor, founder of Greenwich Associates and investment committee member at Rebalance IRA argues that virtually every American should invest in low-cost index funds.
CBS MoneyWatch chatted with Ellis about his case for indexing, what’s the best investing advice he has received and his outlook for markets as the presidential election looms. Following is a transcript, lightly edited for length and clarity.
CBS MoneyWatch: You’ve been doing this investing thing a long time. Your message has been pretty consistent over the years. I’m wondering whether, as you see more people take your advice on index funds, is that a heartening development?
Charley Ellis: It sure is. It’s a very sensible thing for almost everybody to be doing. I recognize there’s some people with extraordinarily high levels of mathematical skills who can do better, and there’s some people who are really serious about doing long-term, careful investing, and they can do better.
But for most of us, it’s really hard to compete with a market that’s filled with professionals who have fabulous competitive advantages. And if we pay attention to the realities, most of us would say we shouldn’t be competing with them any more than I should be getting on the field with NFL football players.
MoneyWatch: To continue your metaphor, is this latest book sort of an end-zone dance for you?
Ellis: I see it as part of a continuation. As the world kept changing, I’ve been changing my degree of confidence. I’ve gone from, gee it looks like a serious problem. When I started out originally, I thought active investing was the right thing to do, the people doing it were really smart and the clients ought to catch on to it.
I believed that at the time, and the data really supported it, but that was 50 years ago. Think of all the changes in the last 50 years. I don’t think it makes any sense for individuals and most institutions to be trying to beat the competition, beat the market.
MoneyWatch: Index funds certainly have grown in popularity. Do you think it’s possible for indexing to get too big, to the point where there are downsides? Players potentially taking advantage of the credibility behind the word “index”?
Ellis: No. 1, it’s always possible for people to exploit and take advantage of the word “index” and charge a high fee instead of a low fee. That has gone on in the last 10 years, and we’ll likely see more of it. The second part of the question -- is there a time when there’s so many people doing indexing that so much money is not active in the market, and therefore we’ve got a problem with pricing? Honestly, I don’t see that.
To get to that stage, you’d have to have large numbers of people leaving active investment management. I don’t think there’s ever been a line of work as interesting for as many people. And there certainly hasn’t been a line of work that’s as well paid as investment management.
Could it happen in 50 years or 100 years? Yeah it could. But people still go to Las Vegas in pretty large numbers. The reason they go is they see the chance they might be successful. It’ll be a long time before active investing cuts down.
MoneyWatch: For nonprofessional investors, is it possible to do a one-and-done index portfolio, or do you advise a basket of index funds?
Ellis: I think you could do a one-and-done: Pick an index fund that’s a global fund and covers a wide spectrum of the market. That would make a lot of sense for anyone. That’s the easiest answer.
Many people don’t feel comfortable with international investments. They can invest very substantially in the U.S., and because we’re such a large economy and so diversified, and the companies in the American market do so much international business, you’ve really got most of the international diversification right there. You could claim that to be done.
If people get comfortable with indexing and realize how easy it is, and [especially if they have a really long time horizon], they should add small companies or emerging markets.
MoneyWatch: Changing gears a little, what’s your confidence level in the target-date funds class? Are those funds going to perform as the promise is being sold?
Ellis: Let’s be careful. The promise as it’s intended to be made, I do think they will perform. The promise as it’s heard might be a little too optimistic, so there could be some disappointment.
One of the problems with target-date funds is people say 65 is your retirement age. First of all, most of us better learn pretty soon the benefit of staying at work is so large. Most of us should stay at work until we’re at least 70.
The second thing is if you do retire at 65 or 70, what’s your reasonable life expectancy? Well, at that age, your life expectancy is late 80s. So you’re talking about a pretty long period of time, and it might be better to have your target date centered somewhere in the middle of your retirement.
MoneyWatch: So the product itself is sound, but you’d recommend looking under the hood and adjust the year of fund you choose if necessary?
Ellis: The hood I’d most want to look under is mine. Who am I? What are my objectives? If you don’t have external wealth, you might not view a target fund the same way.
MoneyWatch: How is your own money invested?
Ellis: Index funds. More importantly, my wife’s money is in index funds. My two sons are in index funds.
MoneyWatch: You’re a chef who eats what you serve.
Ellis: That’s fair to say.
MoneyWatch: What’s the best and worst investment advice you’ve ever received?
Ellis: The best, easy story. I was young and hardworking and very keen to persuade a particular organization to be a client of the firm I was working with in financial services. I was taken to lunch by a very good guy at a good firm, who said on the elevator going up that they weren’t going to be a client.
I swallowed my breath, and we got off the elevator, and we sat down. He said what would you like me to tell you about? I asked for his best investment idea. For the next half-hour, he told me about Berkshire Hathaway.
It just happened that my partners and I had a small amount of surplus cash available for investment. I went back to the guys and told them “I’ve just heard the most sensible argument for a sound investment for the long, long, long term. We should put the money into Berkshire Hathaway.”
It’s gone up 100 times since then. (The guy, incidentally, was Sanford “Sandy” Gottesman, a Warren Buffett friend and billionaire several times over.)
MoneyWatch: And the worst?
Ellis: Also easy. I had a classmate in college who got involved in venture capital. And I knew he was really smart, so I sat down with him, and he talked about what he was doing. It just sounded like exactly what I should do with a small part of my own investments. A little bit spicy, but I thought I could handle a moderate amount.
It was a dreadful mistake because he was a salesman, not an investor. He didn’t know how to use the money sensibly, and most of it went to smoke. Fortunately, it was a small amount.
MoneyWatch: I’d be remiss not to ask you about the election. Do investors have a reason to worry?
Ellis: Yes. I think very definitely so. It would do this nation grievous harm in so many ways if Hillary Clinton does not get elected.
MoneyWatch: What kind of harm in terms of markets and investing?
Ellis: First of all, we’d have a remarkably judgmental but not well-informed individual at a very powerful position that could affect the economy. He could also very powerfully affect the climate of confidence people have. Those two together could cause, inside the U.S., tremendous difficulty.
It also would be very high probability that he would cause real difficulty with international relationships, and it could lead to threats or even risks of war. He’s too quick-spoken, not well-enough informed, doesn’t understand how to deal with complex issues that you need to be president of the United States.
MoneyWatch: Does Trump represent the kind of threat that even an index-fund investor should be worried about, or think about getting out of those funds?
Ellis: I’d be worried about anything were he to be in office. I’d worry about investments particularly. The safest investment I could imagine would be to do indexing, so I didn’t get caught in individual stocks getting slammed by screwball things happening out of the blue.
There’s a nice defensive characteristic of indexing, two different kinds. One wonderful advantage is diversification. The second thing is you don’t get anxious or nervous about individual stocks, allowing you to be cool, calm and collected as markets go up and down.
MoneyWatch: Anything else to add? Takeaways from the book?
Ellis: One of the things I think is really interesting is that the fees for investment management have gone up and up and up. And most people think no, that’s not serious, fees are low. You ask them what are the fees, and they say “only” and usually say “1 percent.”
We all know it’s a little more than 1 percent of the assets. But you’ve already got the assets. What is it as a return of what you’re going to get from the manager? Well, 7 percent returns are what people expect on the optimistic side these days. If you take a 1 percent-of-assets fee, as a fraction of 7 percent returns, you’re talking about a fee of 15 percent. That’s pretty high.
You can get a commodity product called an index fund for one-tenth of one-percent. Candidly, the fee on actively managed funds is larger than the incremental return.