Volatility was up in 2011, and brought out all of the “forecasters” in droves predicting which way the markets will blow.  Most have been wrong.  Bill Gross, who runs the largest bond fund in the world bet against US Treasuries, which was the top performer in 2011.  Famed investor Meredith Whitney predicted the demise of municipal bonds.  Following her advice would have been devastating as munis rallied after her “insights.”  Hedge funds that focused on picking stocks were down 7% in 2011 with a Dow up 5%.

One of our members asked, why we recommended Vanguard’s Exchange Traded Fund  VGK an index made up of the largest 482 stocks in 16 European countries when “everyone knows” that Europe is in trouble. VGK was down nearly 18% last year, while the S&P was flat.

First, think of the thousands of investors all around the world, who deeply understand the economic circumstances of every country in Europe, focused every second on figuring out what every one of those 482 companies are worth.  Is your opinion on VGK’s price better than theirs?  Second, VGK belongs in a globally diversified portfolio, because we care about the long term.  Europe will recover.  In 10 years, VGK’s price today will likely look cheap because those 482 companies will be more valuable.  When CNBC says “Europe” remember these are real global businesses making money, employing millions of workers.

A year ago, when TIPS were selling at a high price, one of our members declined to include it in his recommended portfolio because in his opinion “it was over valued.” TIPs were up over 12% last year.

Trying to time and guess the market’s direction is futile for most mortals and investment professionals.  It’s during times like these, that you can really appreciate the calming logic of a simple and disciplined asset allocation investment methodology.  Since we never know how one particular asset class will perform –own them all at a very low cost, in proportion to our risk tolerance.  Then rebalance them as the markets shift.

Sounds easy to “buy low and sell high” doesn’t it?  Would you buy more Europe now if you were under-allocated?  We certainly hope so.  Is your asset allocation right?  This market provides you with a litmus test.  If you have been feeling panic lately, then perhaps your stomach lining isn’t strong enough for amount of equities in your portfolio.  It may be time to consider whether you should increase your exposure to bonds and TIPs.

Markets like these test you.  Stay the course and take a gut check.  Keep rebalancing and make the market’s volatility your friend. If your allocation is right, you’ll be able to keep your mind off the stock market, keep CNBC off and focus on the rest of your life.

Camped out in lower Manhattan for over a month, the protestors have spawned copycat events across the nation and abroad. While some identify with the frustration of youth trying to break into a job market that supplies a meager one job for every five seekers and a youth unemployment rate of 18 percent, others take issue with the movement’s anti-capitalist hysteria that seeks to penalize hard-working and productive Americans.

So what’s the fuss?

Behind all the brouhaha, however, there are some very real frustrations that all Americans, left and right, can identify with. How is it that politicians and bankers were in cahoots creating loose-money legislation and convoluted debt-backed securities that in turn were sold to the unsuspecting? How is it that trillions of dollars of government debt in the form of TARP, QE1, QE2, and beyond have been placed upon the shoulders of future generations to somehow resolve? How is it that some of the very bankers who were complicit in this disaster that destroyed the financial lives of millions of hard working citizens in turn made off like bandits? How is it that the Feds have embraced an inflationary exit strategy that threatens every hard-earned dollar you have saved and invested?

While protestors and non-protestors alike seek to place the blame for this travesty at the right doorsteps, these protests expose some deep assumptions about what is owed to us as citizens. These assumptions, once exposed, reveal some important lessons on investing as well.

Many of the protestors believe that they have a right to a well-paying job. And why should they not expect this basic opportunity? It has been the inalienable right of every American generation to date, spare the Great Depression, and therefore is deeply embedded in the warp and woof of the American mind. This assumption, however, is proving to be ill founded. While much of the third world can only dream of the minimum wage opportunities America affords, we have come to expect a middle-class life as a fait accompli for most, or at least the college educated.

The new reality is that the middle class is shrinking before our eyes as jobs flee to other nations whose middle classes are emerging. And gone the way of the shrinking middle class is the shrinking American Dream. Once assumed to be on tap for all hard-working citizens, this fount of prosperity and success seems to be running dry for many.

Who’s occupying your portfolio?

The new realities are just now beginning to sink in for many investors. You deserve nothing. Times have changed. You can’t just waltz your way into the American middle class anymore. You can’t rely on being a benefactor of past generations. The middle class is shrinking, and many who fail to work harder and invest smarter will be moved out while others in the world economy are invited in.

Additionally, you cannot look to Wall Street or the U.S. government to look after your retirement. It appears that Social Security will eventually fail. When it comes to The Street, we now know that many money managers will work to their own benefit, and if you happen to benefit along the way, you lucked out. If not, it’s your tough luck.

The critical question for today’s investor is, “Who is occupying my portfolio?” Is it an investment advisor? A fund manager? A small selection of equities and thus a small sample of fallible corporate directors and executives? When you look into the virtual room of your own portfolio, do you find yourself both present and vigilant? Sadly, many will find themselves strangely absent. Often it is because they are fearful of getting it wrong. Whether you are a do-it-yourself investor or an investor who delegates his funds to a professional, your presence in knowing what is in your portfolio, both in terms of fees and investment vehicles, and why is critical.

Additionally, at times such as these, the beauty of index investing is revealed. You can remove the advisor risk. You remove the money manager risk. You remove the individual corporate corruption risk.

You enjoy spreading your bets broadly across hundreds if not thousands of companies and are left to focus on what matters most in portfolio management—asset allocation. Now it is up to you to get globally allocated, remain disciplined with rebalancing, and behave like an adult managing something of great importance.

In the end, some may choose to set up camp in a tent, point a finger, and occupy Wall Street. I suggest you occupy your portfolio instead.

In the time travel movie Frequency, this Yahoo stock tip was passed through time to the six-year-old Gordo via a mysterious interplay of a ham radio and the aurora borealis. This small bit of incomprehensible information was not only retained by Gordo, but later, when he grew up and became a stock trader, it resulted in him not only being fat, but quite happy as well.

The power of knowing the future is profound. Just imagine, for a moment, if you were given the privilege of seeing stock market results one year from today. A resourceful individual could easily parlay that knowledge into profound wealth. It is no wonder that economists, stock traders, fund managers, and financial advisers alike are desperately trying to find a way to peak around the corner of time to anticipate what the markets will do.

Forecasting markets is not for the feint of heart. Take, for instance, the recent housing bust and subsequent recession. Top economists and investors alike failed to see it coming. Ben Bernanke, the Federal Reserve chairman, testified at the Financial Crisis Inquiry Commission (FCIC) that, “We knew all those numbers, of course, but a lot of smart people, including people like Paul Volcker and others, . . . got it wrong. It is just another example of how difficult it is to predict.” Furthermore, Alan Greenspan commented, “We all misjudged the risks involved. Everybody missed it—academia, the Federal Reserve, all the regulators.”

It was not only the economists that failed to see the crisis coming, but leading investors as well. Take George Soros as an example. He became one of the world’s richest people by predicting the UK currency collapse and betting accordingly, and yet he took an ill-fated stake in Lehman Brothers just before the bank failed in 2008. Likewise, Warren Buffett, the Oracle of Omaha, lost billions in the downturn and testified before the FCIC that “no one saw the housing bubble.”

But just when you think that such foresight is outside the reach of common man, some prognosticator emerges with a specific contrarian view and then with eerie accuracy hits the nail on the head. It’s as though he found his own flux capacitor-equipped DeLorean and sailed from the future to the present with otherworldly insight.

Take for instance, the small group of esteemed economists and financial managers that called the housing crisis. There is Dean Baker, the co-director of the Center for Economic and Policy Research in Washington, D.C., who in the August 4, 2004 issue of The Nation gave a detailed warning concerning the coming housing crisis in an article called Bush’s House of Cards. His predictions were five years early and largely ignored. Then there is Med Jones, the president of the International Institute of Management (IIM), a U.S.-based research and education organization. Although Jones is less known, he turned out to be the most accurate in predicting many of the downturn’s details.

Nouriel Roubini, an NYU economics professor known as Dr. Doom for his wild and dire predictions, became a media darling because of his accurate foretelling of the crisis. More bearish still is Peter Schiff, who now famously predicted the housing collapse in nationally televised debates. Although ridiculed by experts, he showed great courage, and his detailed analysis proved right in the end.

It is these types of expert forecasts that make investors seek the next accurate prediction. Think of how you might have managed your portfolio differently if you had only listened to these warnings before the housing crash. Furthermore, today, there are forecasters out there who are nailing their predictions right before our eyes. A year from now, many will lament the fact that their laser-sharp predictions were carelessly ignored.

So how does an investor know which forecasts to follow and which to ignore? The first thought that comes to mind is to follow the predictions of those that have gotten it right in the past. This method, however, proves to be ill fated. Take, for instance, the four gurus that called the housing crisis. Since that time, each of these prognosticators has supplied a long list of additional predictions. Sadly, the overwhelming majority of them have been tragically afield. In a famous prediction from 2002, Peter Schiff asserted that the Nasdaq would hit 500 and that the Dow would crash to 4,000. If you had followed his advice, you would have lost your shirt.

Nouriel Roubini has made over 30 economic predictions since 2006, with 22 coming up wrong and seven still awaiting fulfillment. Well, at least he got one right—the housing crisis. Whereas Med Jones seems to have a better batting average, Dean Baker’s predictions are about 50/50.

In the end, stock forecasting seems to be a bit more Abracadabra than most investors would prefer. As much as we would like the aurora borealis or at least something or someone to whisper an accurate stock tip that would leave us fat and happy, we are left with the harsh reality that forecasters often flop.

With no real way of seeing around the corner of time, smart investors are left with the proven methods of global asset allocation, low-cost indexing, and disciplined rebalancing. This proven approach may not provide the wonders of time travel, but it does provide a nice bounty to the principled and disciplined—over the long haul.

In the last 80 years, stocks have returned about 10 percent, while bonds have returned about 5 percent. An average balanced portfolio should therefore return around 7.5 percent over a long time period. If you grow your money at 7.5 percent each year, you’ll double your money every 9 to 10 years. Let us call these “returns before advice and taxes.” This is the baseline.

Paying for investment help can be very expensive. If you pay mutual fund and advisory fees of 2.5 percent, you have a silent “business partner” who is taking a third of your 7.5 percent investment profits for advice. Over a 20-year period, unless these advisers are making up the difference, which is statistically close to impossible, you lose big money—slowly, quietly, and imperceptibly. Your account will grow in good years, but it won’t grow enough. Over time, you’ll notice that everything is becoming more expensive and your portfolio is “small” when years ago it seemed much larger.

If investment advice doesn’t do you in, taxes will. Mutual funds and advisers never report investment returns “after tax” because this would dramatically reduce returns. Most mutual funds are trading machines, generating huge amounts of short-term capital gains. But taxes are never factored into the advertising. Let’s say that federal and state taxes are 40 percent on short-term gains and 20 percent on long-term gains. You invest in two funds. Let’s call them the “Furious Trading Fund” and the “Buy and Forget Fund.” If Furious is up 15 percent, you’ll net 10 percent after tax. But Buy and Forget only needs to be up 12.5 percent, to net you same 10 percent after tax. Furious has to do 20 percent better than Buy and Forget just to get you to the same place!

Smart investors don’t pay much in taxes on their investments because they don’t trade in and out their positions. They spread their money around the world in different types of stocks and bonds in percentages based upon their objectives (called “asset allocation”) using exchange-traded funds (ETFs). They own a core portfolio with most of their net worth consisting of 10 to 15 ETFs to get nearly complete diversity in stocks, real estate, commodities, and bonds. Each ETF represents an entire stock or bond market that is an essential ingredient to a portfolio. They hold these same ETFs forever.

But this is far from “buy and hold.” Over time, the relative proportions of each ETF within the portfolio will need to change. If bonds are up this year and stocks are down, it is critical to trim bond ETFs and add to stock ETFs. People age and should start shifting more of the portfolio into bonds: same ETFs, different weightings.

Here’s where taxes are minimized. After owning a passively managed ETF portfolio for one year, all gains that come from selling the ETFs are taxed at long-term rates. And ETFs have a special tax structure that rarely generates taxable income except for dividends. By trimming and adding, you only incur a small amount of long-term tax, but the gains continue accruing tax-free. The smart investor tinkers around a few times a year, but never “gets in and gets out.”

If you keep Uncle Sam and Wall Street at bay, you can keep most of your returns. If you let them into your portfolio, you may well find yourself half as rich as you could have been.

There is one conspiracy however, worthy of your attention: Those on Wall Street don’t want you to know that their industry is a sham. For Wall Street, the hypnotic malaise they cast over the unknowing investor is nothing less than an $11 trillion dollar shell game. Their gambit makes the baccarat table at the Bellagio look like the neighborhood lemonade stand.

And like any good shell game, they keep the pea moving so you never really understand what just happened. Hideous mutual funds vanish into thin air leaving only winners so that fund companies can claim their funds are leaping tall indexes in a single bound. High fees slip out the back-end of your account while you lie in bed asleep at night, thinking they got your back. And how about that reporting? It’s so convoluted you would have to be a Nobel Laureate in economics to even know what you made—or lost—after fees and taxes in any given year. Did you know that it practically took an act of Congress to force 401(k) providers to tell employees in plain language how much they are paying in fees?

Speaking of Nobel Laureates, fortunately there are a few that have been paying attention: Harry M. Markowitz, Merton H. Miller, William F. Sharpe, and Nobel candidate Eugene Fama, not to mention other notable luminaries such Princeton professor and author Burton Malkiel, John Bogle the founder of Vanguard, and William Bernstein, the acerbic author and truth teller. If you haven’t yet familiarized yourselves with their findings, the time has come to do so. They’ve blown Wall Street’s cover in reams of research. Never mind that they conclusively demonstrate that low-cost indexing beats active management by a long shot, or that the buy, hold, and rebalance style of investing trumps the vein-popping practices of Jim Cramer and crew.

Worse yet, the good guys’ PR campaign is weak. While they stutter in the corner, Wall Street is rolling out eloquent waves of hypnotic media, which roll over us as in a tsunami of minute-long TV ads, billboard artistry, and heart-grabbing radio spots. Each makes you want to pull out your hanky, pick up the phone, and call your mom to say you love her.

Who cares about facts when Smith Barney speaks? Why not talk to Chuck? He sure seems like a nice guy. His name is Chuck. Have you ever met a mean Chuck? Or what about the TD Ameritrade guy, Sam Waterston. He played stalwart Jack McCoy on the NBC series “Law & Order.” He sure cracked the code there, so he’ll be the guy I can trust for my retirement, right?

Yes, Charles Schwab, TD Ameritrade, and others are excellent brokers. For a fair, low price you can have excellent trade execution and fulfillment, as well as receive tremendous customer service and online reporting. But watch your pocket if you go to these firms for investment advice. Chances are they will roll out the four-color glossy print, full-court press, and slip you right into some mutual funds from their supermarket that drip, drip, drip away your hard earned savings in high fees and underperformance.

Conspiracy theories are for the birds. Ours, however, isn’t one of them.  Facts are for the discerning. When it comes to Wall Street, the facts have been revealed by the best economic minds in the world. Are you listening?

The answer lies in whether your investment focus is based upon predicting or positioning.

It’s a lot more fun to invest based upon predictions. Jim Cramer and pundits interviewed on CNBC are highly entertaining. They tell us with utmost certainty what will happen with a company, a sector, or an economy. And they know how to provoke our fear and greed so we’ll keep watching.

Most everyday investors only know an investment world based on predictions. They’ve heard about the mutual fund manager who finds undervalued companies by predicting cash flows, the Merrill Lynch broker who calls with his analyst’s latest tip, the Motley Fool newsletters, or the UBS economist who predicts a drop in the U.S. dollar.

But most of us are still smarting over our damaged portfolios from the 2008 financial meltdown that the forecasters failed to predict.

Another group of investors—institutional investors such as pensions, endowments, and foundations—believe that predicting the future is at best informed fortune telling. After decades of research and experience, they’ve concluded it’s better to focus on being positioned, instead of attempting to predict what will happen in the world. They know there are risks that can’t be articulated or imagined, let alone predicted. So they endeavor to build portfolios to withstand the unexpected.

Most of these institutional investors have fully recovered from the 2008 meltdown. They didn’t sell stocks in March 2009 in a panic—they bought them. What can we learn from them?

First, these investors face sobering tasks. Pension plans have to send checks to retirees every month. Managers at university endowments have to help pay scholarships and faculty salaries. They want a portfolio with a variety of assets that behaves differently depending upon any scenario. They reason through allocations to U.S. stocks, treasuries, foreign stocks, real estate, or commodities. When the world panics, investors flock to treasuries. When inflation worries are front and center, commodities and real estate benefit at the expense of treasuries.

They debate these issues and end up with a policy that can only be changed by committee. Once they agree on the policy, they look for the best ways to “get exposure” to each type of asset. They focus on fees. They only hire managers if they feel they can get outperformance, otherwise they buy index funds. They don’t care about Netflix or Apple. They care about whether they have the right allocation to U.S. growth stocks. And when the markets have big changes and the actual percentages differ from their recipe, they don’t panic. They don’t change the policy. They rebalance back to the policy. These investors are buying Japanese companies this week, probably because their allocations have changed since the panic there.

There is a quiet but growing revolution going on in American retirement investing. Baby-boomers need to retire and they don’t have enough. They’ve grown weary of expensive predictions. They want to be positioned. Earthquakes, tsunamis, and revolts become stress tests for how well a portfolio is positioned. Was your portfolio well-positioned over the last six weeks? Are you trying to predict what will happen next? Think about positioning, not predicting, and manage your family money like the smart guys.

To draw a parallel, we assembled a few articles that describe how random investment success really is.  For example, if you own actively managed mutual funds, you’ll retire with a lot less money than if you’d just bought, held and rebalanced the boring ETFs others and we recommend.  This is a non-debatable fact that’s been proven over and over again.

But why do so many want to believe something that just isn’t true? Ivy League MBAs who are smart, motivated and work hard must be able to beat a dumb computer managing an ETF or an index, right?  Wrong for two reasons.  First, investment pros charge fees that are an impossible handicap to overcome.  And second, unlike other professions like a surgeon, litigator, race car driver or a pilot where success can be accounted for by how well one manages risk, most professional investors who beat the market one year, are just plain lucky.  They win for short periods of time because of random events, not skill or intelligence. Just luck.  We all became acutely aware of this in 2008 when all the gurus somehow didn’t see it coming.

Consider it likely that the great professional investors may really be no better than the 4 finalists in the 8th round of a 1000 monkey coin-flipping contest.  Yes, there will always be a winner. But why did the winner win?  Did someone know something?

This point is made in an article in The New Yorker:  “Blowing Up” by Malcolm Gladwell author of “The Tipping Point” and “Blink.”  Gladwell interviewed Nassim Taleb, a professional options trader.  Taleb’s book “The Black Swan” describes about how random events in the financial markets are common and unpredictable – essentially dismissing 90% of the value of professional investing.

“Wall Street was dedicated to the principle that skill and insight mattered in investing just as they did in surgery and golf and flying fighter jets….  For Taleb then, the question of why someone was a success in the financial marketplace was vexing.  Taleb could do the arithmetic in his head…”

In another article in Fast Company, called “The Myth of Mutual Funds,”  Chip and Dan Heath the authors of “Made To Stick,” explore why we don’t always want to believe the truth about investing.  “Let’s pull off the Band-Aid quickly. You’ve come to believe that mutual funds are a smart place to put your money. They’re not. That’s the assessment of the smartest minds in finance, supported by a mountain of historical data. So two questions: How can this possibly be true? And why, in gleeful defiance of the data, do more people keep buying mutual funds every year?”

Last, read Moneywatch’s  “Hedge Funds – Case Against, part 2” if you’re considering investing in one. Allan Roth writes some compelling pros and cons for doing so.  He addresses the question:  Are these fund managers lucky or smart?   “If I had a dime for every time I’ve heard that hedge funds provide above market returns with lower risk, I’d be a very rich man. Every time I hear this claim, however, I ask for any evidence that supports it. I have had no takers to date, though maybe this column will change that.  Unless you happen to have a few billion to invest (and give me a ring if you do), I’d steer clear of hedge funds as they provide too much risk with too little return.”

To paraphrase Warren, most investors should “do as I say, not as I do.”  The world’s greatest investor warns us against trying to imitate his stock picking abilities.  His unwavering advice for years has been to buy index funds because:  a) very few people have it in their DNA to be a great investor, and b) those who charge you for their investment expertise can rarely outperform the market due to their onerous fees.

To bring home his advice we’ve pulled together a rare 8 minute Buffett video, evidence a $1 million bet he made, and a fable that he wrote.

A Fable.  Read excerpts from Berkshire Hathaway’s 2005 and 2006 annual reports where Buffett describes what happens to the imaginary Gotrocks family when they begin taking help from Wall Street.

“…imagine for a moment that all American corporations are, and always will be, owned by a single family. We’ll call them the Gotrocks… In the Gotrocks household everyone grows wealthier at the same pace, and all is harmonious.  But let’s now assume that a few fast-talking Helpers approach the family and persuade each of its members to try to outsmart his relatives by buying certain of their holdings and selling them certain others….  The more that family members trade, the smaller their share of the pie and the larger the slice received by the Helpers. This fact is not lost upon these broker-Helpers: Activity is their friend, and in a wide variety of ways, they urge it on.”

The $1m Wager. Buffett bet Protégé partners, a fund of hedge funds, $1,000,000 that over a ten-year period commencing on January 1, 2008, and ending on December 31, 2017, the S & P 500 will outperform a portfolio of funds of hedge funds, when performance is measured on a basis net of fees, costs and expenses.  Buffett’s bet is a bet on high fees.  His view:  regardless of how good the money managers are, the hedge fund fee structure is so high, that it will, over 10 years, wipe away any gains achieved from beating the market.

The Lecture. Warren Buffett spoke to a group of students at the University of Florida and answered questions for ninety minutes about his investment philosophy.   Fast forward to the 1:15 minute mark on this great video where he says:

“If you are not a professional investor, if your goal is not to manage money in such a way that you get a significantly better return than world, then I believe in extreme diversification. I believe that 98 or 99 percent – maybe more than 99 percent – of people who invest should extensively diversify and not trade. That leads them to an index fund with very low costs. All they’re going to do is own a part of America. They’ve made a decision that owning a part of America is worthwhile. I don’t quarrel with that at all – that is the way they should approach it.”

Just because you can pick up a golf club doesn’t mean you should bet all your savings on your getting on the PGA tour.  And just because you (or someone in a suit at an investment management firm) can place a trade at an online broker, doesn’t mean you figure out a better strategy than using index funds in an asset allocation strategy for your retirement investing.

Do as I say, not as I do.  Thank you Warren.

Think of the conversations that occur behind closed doors at the White House, corporate boardrooms or U.S. Central Command. We all understand that there are elements of those conversations that are deemed, for whatever reason, unsuitable for public consumption. They are tucked into the classified file, sworn to secrecy and solemn oaths. But every now and again, some of the untold story leaks out – finds its way to the common person. Sometimes the information is so unbelievable, that it is marginalized as ridiculous. Other times it is corroborated with such credibility that all we are left with slack jaws and nodding heads.

Below are three brief but shocking behind-closed-doors accounts about Wall Street and investing that left me stunned.

CEO of a Top Publically Traded Tech Company: Having participated in the Silicon Valley for years and sat on the board of Baidu, I come into contact with a broad network of technology leaders and professionals. Recently, I became part of a stunning conversation with one of the top executives in The Valley.  This individual, while surprising humble, is also profoundly wealthy. For years he used the “top” wealth managers who have access to elite money managers who in turn “outperform” the market to justify their fees. After years of high cost and poor performance and tens of millions lost, this executive was seriously underwhelmed. He pulled his money out, embraced a simple indexing strategy and global diversifications. It takes him only a few hours a year to manage the money himself. He save hundreds of thousands if annual fees and achieves a much better result. Why don’t we ever see that ad during Wimbledon?

Former Banking Firm Top 500 Producer: Imagine being an investment advisor who has built a dream business – over $1B in assets under management (AUM) and a coveted Chairman’s Club member. Making just over 1% a year on AUM, this wealth manager was grossing over $10MM annually in fees. Unfortunately, he had a huge problem – he still had a conscious. The more he study active money management, the more he learned that it not only failed to add value to his customers, but was in fact deleterious.  When he approached management about this problem and sought an indexing approach, he was run out of town. After a legal battle and negotiations, the firm and the manager struck a settlement. He left his customers in the hands of the banking firm and he had to move on. I guess someone is now making money “the old fashion way – earning it.”

$750 An Hour Tax Attorney to the Uber-Wealthy: I was once invited into a private conversation with the uber-wealthy about tax management. The strategy was architected by top legal minds in the country. Profoundly expensive to set-up and maintain, this apparently legal and sophisticated offshore strategy would result in profound tax reduction. Imagine most of your wealth free to compound without tax consequence. These uber-wealthy could invest in the most sophisticated and elite products. When I asked the attorney what the majority of his clients were investing in, he just snickered. Over 60% of their dollars were dedicated to simple and diversified indexing strategies. There was no Wall Street, no active managers, or Jim Cramers – just hundreds of millions, even billions, going into a simple, proven approach used by those in the know.

I hope you are doing the same.

With rapacious accuracy, Rick rips back the covers on Wall Street to expose the true motives in selling this story. Wealth managers are having an increasingly difficult time selling clients on the value of high priced mutual funds that are less tax friendly and have tragically underperformed low cost ETFs.  In light of the giant swooshing sound of clients bailing out of the mutual fund merry-go-round for better constructed and performing ETFs, wealth manager came up with this core and explore pitch to sell manged products for small cap, foreign and emerging market investments. Unfortunately, Ferri points out that there actually is no such creature as an inefficient equity market. As he states:

“Core and Explore would be fine advice if it worked, but it doesn’t. The theory has several flaws. First, how does your adviser know which market is efficient and with is not, or if any market is efficient? The nation’s top academics cannot even agree. Second, why should your adviser suddenly become more skilled in selecting managers in inefficient markets simply because he or she is no longer selecting active managers in efficient markets? Third, there is no unbiased academic evidence to support the notion that active managers outperform in any market.

Two often presumed inefficient markets are U.S. small-cap stocks and emerging markets stocks. According to Core and Explore theory, these are two markets where active managers should have excelled. That has not happened. Data gathered from the S&P Indices Versus Active Funds (SPIVA) Scorecard for the first half of 2009 shows that over 67% of small-cap core funds under performed the S&P 600 index over the trailing five years and about 90% of actively managed emerging markets funds underperformed the S&P/IFCI Emerging Markets Composite index over the same time.

There are no inefficient asset classes where high cost actively managed funds consistently outperform their appropriate benchmarks. This means Core and Explore is about paying for something you do not need and likely will not benefit from. If your adviser has progressed to the point where he concurs with an all index fund portfolio, then you have a good adviser. If he insists that he can select superior funds on the explore side, then perhaps you should do some exploring on your own–for a new adviser.”

I am a big fan of Mr. Ferri’s and strongly agree with his poignant and entertaining expose. I would suggest an important caveat, however. Core and Explore does work, but only if you define the terms quite differently. I have used Core to reflect those assets which are directed at a long-term, reliable and scientifically sound retirement strategy. This Core portfolio should consist of indexes as recommended within the MarketRiders (www.marketriders.com) software. Explore, on the other hand, are the investments outside of my Core retirement portfolio that I am involved with that have a higher risk/return profile. I personally have ownership in a hydroelectric power  company in Chile, oil and gas in the US, a retail store as well as equity in early stage tech companies – for me all part of my Explore strategy that complements the overwhelming majority of my assets in a Core indexed portfolio with MarketRiders.  Even Ferri himself owns land in Texas and has investments outside his index portfolio. I personally like to direct between 10% to 20% of my investible liquid net worth in Explore style investments and see that percentage decreasing rapidly as I move into my 50s and towards retirement.

So, in conclusion, Core does fit with Explore, but when it comes to publicly traded equities, stay true to employing globally diversifed, low cost and tax efficient ETFs.