Over the past few decades our industry has seen an incredible increase in the number of advisors and clients who are using a passive or indexing investment strategy. Amazingly, 40 years ago there was no such thing as passive or index investing, yet today about 22% of all investments are passive; and every day, investors pour another $85 million into passive vehicles.

One of the most notable proponents of the passive story is the index fund giant Vanguard, and I salute them for all they have done and continue to do.  But there are a variety of ways to invest passively — Vanguard’s indexing is not the only option.

I routinely hear advisors speak of the three dreaded types of prospective clients: engineers, teachers and index investors. I’m sure there are plenty of reasons to “fear” these prospects — one reason being that they can smell a salesperson from a mile away! It takes an advisor with a defined process, solid investment belief and strong “people skills” to earn the trust of these clients in particular (although these skills work with all clients).

Recently, I got a phone call from an advisor I highly respect asking for advice on what he should say at a second meeting with a prospect who is leaning towards investing in an index strategy through Vanguard.  Here is the approach I suggested. I hope you may find it helpful if you are ever in a similar situation:

Let me commend you for preferring a passive/index approach. This makes you part of a select, and growing, group of investors who believe that a passive investment strategy may be the best choice for achieving long-term market returns. In fact, more than 20% of all money invested today is in a passive strategy. Like you, these investors have realized that keeping costs low is critical. They understand that trying to outguess the market is hard work, even for most professional money managers. They also recognize that owning thousands of companies reduces their risk and volatility when one company or industry or even country falls on hard times.  

Here at our firm we also follow a passive strategy. After we help our clients identify their life goals, we build a plan together using simulations. Since these are based on historical market returns, it’s only logical to use passive investments since these offer a higher probability of achieving market returns than an active investing strategy. Again, keeping costs low and owning thousands of companies is critical. So, I think we’re in agreement about our overall investment strategy.

I’d like to share with you my perspective from working with hundreds of clients and studying investment options for more than 20 years. I believe there’s actually a better way to invest passively than indexing. It’s called Asset Class investing.

Asset Class Investing takes the basic concepts behind indexing to another level. This is the approach I use with for all my clients’ portfolios, using institutional funds from a money management firm called Dimensional Fund Advisors. The founders of Dimensional, David Booth and Rex Sinquefield, helped pioneer the first S&P 500 index funds in the early 1970s. In the mid-1970s, they sold the trading technology to John Bogle who then started Vanguard for retail investors and what a story that’s been (as you already know). 

But Booth and Sinquefield were determined to address indexing’s unnecessary limitations that hampered performance and increased costs. So with the help of their former professor at the University of Chicago, Eugene Fama Sr., Sinquefield and Booth developed Asset Class Investing.

Trading stocks — especially small cap stocks — can be expensive. Booth and Sinquefeld found that careful trading could result in cost reductions, with savings accruing directly to an investor’s return. Since asset allocation has the greatest impact on investment returns,

Dimensional also carefully controls the investments included in each Asset Class, giving investors truer market returns than an indexing approach. 

This is why our firm uses this Asset Class Investing approach, and we’re getting more pure market representation than we would using indexing.   

Would you like to see more specifics on how this Asset Class Investing strategy could affect your plan?”

I hope the next time you are talking to a passive investor that you have the confidence to acknowledge that they’re on the right path…but that the path continues far beyond indexing.  

Another hurdle that advisors struggle with is having these passive investors accept the advisory fee... but that’s a topic for another article.

Steve Atkinson is EVP and Head of Advisor Relations at Loring Ward, www.loringward.com, a third-party asset management program (TAMP), with over $8.4 billion AUM. His team is dedicated to helping the independent advisors who partner with Loring Ward to grow their businesses through ongoing support and coaching. Practice management resources and tools area available at www.loringward.com/advisors.


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