Mark Hebner is a true pioneer of evidence-based investing. He's the founder of Index Fund Advisors, one of the first financial advice firms in the world to work with Dimensional Fund Advisors. Based in Irvine, California, the firm has around $3.7 billion of clients' assets under management.Mark recently gave an interview to the excellent podcast, Rational Reminder. In it he talks about how the firm started, why he places so much emphasis on investor education, and why so many people still struggle to understand the logic of indexing. The episode is nearly an hour long and well worth a listen:Rational Reminder Podcast 116
Here are some of the highlights:
How Index Fund Advisors started
“One of my friends was killed in a car wreck. The widow called me and asked if I would help her with her investments because she knew I was a business person.
“That got me digging into the information. I went to the local book store and picked up 20 books or so. And I started ploughing through those. One of the first things that hit me was, gee, why didn't I read about this before?
“The last thing I want to be accused of was taking advantage of a widow. So I told her, you need to read this John Bogle book, and she took it on an airplane.
“She brought it back to me and said, Mark, this is fabulous. You should start a business and I'm going to be your first client.”
The inspiration for Mark's book
“One of the things I just couldn't believe when I finished all this reading is that so many people continue to be active investors.
“Then it just hit me that they're gambling. I searched online for ‘gambling on the stock market’. It took me to the New Jersey Alcoholics Anonymous website where there was a tab for stock market gamblers. And I said, a-ha, I'm going to use that for the structure for a book.
“I wanted to have all that evidence in a step or in a chapter so that if somebody had that particular issue, it would all be there in one place.”
The importance of statistics
“One of the really important conclusions that I've come to after 21 years now of doing this is that if people don't have some understanding of statistics, even a basic understanding, it's going to be really hard for them to be what I'll call a good passive investor or client of a passive adviser.
“My test is, I say, if I flip a coin and get ten heads, what's the probability of tails? That's my first test. If they say 50/50, I know, oh, I've got a chance. But when they say, oh, it's 80% tails now after all those heads, there’s gambler's fallacy there.”
The value of educational video content
“My subtitle on all my investing videos is ‘Replacing speculation with an education’. It's really about getting a good quality education.
“It's one of the reasons I wrote the book, but then I found I couldn't get a lot of people to read the book. So that's why I got together with Robin Powell. And I did the film (). And it turns out that has been pretty successful because a lot more people will sit and watch our film than try to plough through a book.
“But the education I think is the key. They really have to spend some time learning these concepts. And I also tell people, you’ve got to hear it three times, at least. So the first time is when they're a prospect.
“Probably the second time is when they invest and their first market crash comes along, and then I’ve kind of got to start over. And then the third time is when kind of like what we're seeing now, when their portfolio is not outperforming the market as they like to call it.”
Mark’s favourite chart
“Over time, there's different charts I use to teach people about the dangers of stock picking, but my current favourite chart is part of a SPIVA study that looks at persistence of performance by actively managed mutual funds.
“It looks at 938 large-cap managers over just three years. How many of them beat their benchmark? Only 99. So right off the bat, that's horrible odds. But what I really like about this study is they follow that 99 for the next three years and zero continued to outperform.
“So when these professionals who get paid, I don't know, $1 to $5 million to do this when they can't do it, what makes you think you can do this on your own? To me, that's really strong, compelling evidence.”
The folly of market timing
“When I talk about markets, I always like to speak in the past tense. A lot of people say the market's going up or going down. There is no such thing because the future is uncertain. So you can only talk in the past tense.
“Every day, every moment, there’s new information coming along, and sometimes it's good news, sometimes it's bad news. If I've got really bad news, my future returns look really uncertain. If I’ve got really good news, my future returns look really certain.
“The job of a free market is to set prices so investors will be positioned to earn a fair return given the risk they have in their portfolio. So the price is set inversely proportional to the uncertainty of your expected return. And that price is set by ten million buyers and sellers every day around the world.
“So to me, this is the reason not to try to time the market.”
Why most investors need an adviser
“There is a lot to (evidence-based investing) and it’s evolving constantly. The whole profitability factor, for example… How is someone supposed to be able to keep up with that?
“I just had three separate conferences with Dimensional Fund Advisors, working on ways to try to explain the profitability factor to prospects and clients. This stuff is really very complex. To be able to look at this data, to update this data, to even be able to calculate what returns you earned in your do-it-yourself portfolio. Come on, give me a break.
“I haven't seen a client in 21 years who’s brought in a proper performance report on their returns. And I see a lot of DIY investors. But the real issue is we don't have a record of what these people have done. So how can we conclude that they have done a good job?
“You just need someone to represent you in these capital markets, because it is very complex. It is brutal. It is so difficult. You have to have nerves of steel. It's so hard on the mind.
“I don't want to say it's impossible, but it's very difficult for somebody to do that on their own. Advisers have other advisers to talk to. Who are they going to talk to? They're going to go to some discussion board where somebody is talking about their Tesla hit or something or go to Robin Hood. Oh my God, Robin Hood, huh? We're right back to day traders all over again.”