Vanguard "They are the king of the hill," - Buffet Says Buy Index Funds Like Vanguard

Vanguard 'king of the hill' thanks to...Buffett
CNBC.com staff    | @CNBC
Thursday, 21 Aug 2014 | 2:14 PM ET

Investors may be warming up to the stock market, but they're taking the safe way in.

Passively managed funds are all the rage now, with market participants enjoying their low cost, high liquidity and tax advantages.

No outfit has benefited more from that approach than Jack Bogle's Vanguard Group, which has seen its total assets under management swell to nearly $3 trillion thanks to the allure of the firm's funds that track market indexes rather than make individual stock picks, according to a Wall Street Journal report.

That low-risk approach has gotten the imprimatur of none other than legendary investor Warren Buffett, who gave the firm his imprimatur a few months back. In his annual letter to shareholders, he advised them to follow the directions in his will, which mandates that his $66 billion fortune be divided with 10 percent in short-term government debt and the rest "in a very low-cost S&P 500 index fund. (I suggest Vanguard's.)."

Since then, the cash has been rolling in as part of a trend toward index investing that has helped other big names in the field such as BlackRock and Dimensional Fund Advisors.

"They are the king of the hill," Michael Rawson, an analyst at Morningstar, told the Journal, which noted that Vanguard's Total Stock Market Index is the largest mutual fund in the world.
Vanguard also holds a prominent place in the exchange-traded fund space, ranking third in assets with $395 billion, behind BlackRock and State Street, according to ETF.com. Its Vanguard FTSE Emerging Markets ETF ranks fourth largest with just over $45 billion in assets.

How rookie investors can get taken: Roseman

An investment sales pitch by someone in your social network may be seen as more trustworthy. So, keep your guard up when approached by a friend.

How could so many innocent people fall for the outsized promises of convicted fraudsters Earl Jones in Montreal or Bernie Madoff in New York?

“When it comes to having confidence in other people, our group or family affiliations work as a stand-in for family relationships,” says Susan Pinker, a Montreal-based psychologist and author.

“Trusting others who look and sound like us feels natural. There’s a visceral satisfaction that accompanies letting up one’s guard.”

Signs of shared identity and status – accents, tattoos, tight pants or baggy ones, hairstyles, sock colours – are more persuasive face-to-face than they are over the Internet, Pinker says in her new book, The Village Effect.

“That’s why we’re more vulnerable to in-group scammers whom we meet in person than to faceless email scammerswho, like Earl Jones, want our bank account details.

“No matter what our culture, we all have the same inclination to trust members of our tribe, and the same feelings of indignation and shame when that trust has been betrayed.”

These comments resonated for me after I received a complaint from a Chinese-speaking consumer, who was persuaded to borrow money to invest – despite having a low income and almost no investing experience.

Related: Warning signs of investment fraud

The woman, then 56, earned $40,000 a year in a contract job at a university. She had just bought a house with a 40-year mortgage, while supporting her daughter and her elderly mother in China. Her husband was unemployed.

Despite her tenuous financial status, she said yes when approached by a Chinese-speaking financial adviser with a string of initials after her name and what sounded like a guaranteed strategy.

“She strongly prompted and encouraged me to borrow $100,000 from the National Bank to invest,” the woman says about her adviser.

“She told me this is the best way to gain money using others’ money to improve our difficult life. She promised that in case my money amount dropped after four years, she would pay all interest I paid for this plan.

“She emphasized that I would only profit. No loss in this investment.”

There was some truth in her adviser’s claim. The investment in question consisted of segregated funds from a life insurance company, which offered to give back part of all of the investor’s capital at death or maturity.

However, the investor did not have a written guarantee to cover the interest if the investment lost money after a four-year period.

“I have to pay $466.65 of interest each month since March 2011,” she said. “My health, both physical and mental, has been subjected to a great deal of damage. I suffer from insomnia, palpitation and extreme stress.”

The investor went to the life insurance company and didn’t get anywhere. She also went to the Financial Services Commission of Ontario, which dismissed her complaint.

The matter is now with a lawyer, Ryan McConaghy, who shared her statement of claim and the adviser’s and insurer’s statements of defense.

There were several warning signs, which others approached by an adviser in their social network should heed.

Insufficient information. The investor wanted time to review the materials at home, but was pressured to sign the loan application right away. Didn’t she trust a top adviser at a major insurance company?

Forms done by adviser. The investor had to sign a checklist on borrowing to invest. Later, she learned the adviser had filled out and signed the form without her knowledge.

Falsified financial status. The insurance company was told the investor had excellent investment knowledge, high risk tolerance, an objective of growth, $48,000 in income and $490,000 in net worth (actually $81,000). The loan term was shown as five years, not four.

Vulnerable to market declines. By June 2013, after a market setback, the investor owed $35,000 more than the value of her portfolio. Meanwhile, she had paid $15,000 in interest on the loan.

The adviser said it was the investor’s idea to get into the stock market and buy segregated funds. She had signed the checklist after doing a review with the adviser and had expressed a desire for an aggressive investing profile.

“The plaintiff in her pleading grossly exaggerated her lack of sophistication and abilities, solely in an improper effort to generate sympathy from the honourable court,” the adviser said.

The life insurance company said its working relationship with the adviser was that of an independent contractor. It said the plaintiff was well educated, holding a Ph.D., and married to a man who had owned a small business.

The woman’s losses were a result of her own negligence, the insurer said. She had used a market timing strategy with funds supposed to be held as long-term investments. She had failed to read the documents presented to her. She had failed to take timely action when her investments dropped.

I spoke to the woman and asked her why she had agreed to a strategy of borrowing to invest in the stock market, given her shaky finances. She said she had trusted the adviser’s expertise and promises to repay interest.

The lawsuit, yet to be argued in court, shows that rookie investors can succumb to unrealistic pitches by someone in their affinity group.

The moral: Never let up your guard. Keep your wits about you and your skepticism on high alert.