Millionaire Expat. Andrew Hallam
of London, reported a study for The Economist, suggesting that the average actively managed unit trust in Great Britain underperformed the British market index by 2.5 percent each year. Fees contributed to those poor returns.3
You might think that's nothing…a bit like a waiter's tip. But it's more like the tip of an iceberg. Here's an example. A 30‐year‐old investor might have an investment time horizon of 55 years. She would start selling parts of her portfolio once she retires. But she would keep most of the money invested, selling portions of the portfolio each year to cover retirement living costs.
If someone invested £5000 and it averaged 8 percent per year, it would grow to £344,569. But if £5000 averaged 5.5 percent per year, it would grow to just £95,028.
Not all actively managed funds fall behind their benchmark indexes. But most of them do. According to the SPIVA Scorecard, 83.22 percent of US actively managed stock market funds underperformed the broad US stock market index over the 10 years ending December 31, 2020.4
Canadians shouldn't feel smug after seeing these results. Canadians pay the second‐highest investment fees in the world (after the expats who buy offshore pensions). During the 10‐year period ending December 31, 2020, the broad Canadian stock index beat 84.29 percent of actively managed Canadian stock market funds. Canadian mutual fund companies also created funds that focus on US stocks. Over that same time period, 95 percent of Canada's actively managed funds that focus on US stocks underperformed the broad US stock market index.5
Other countries' actively managed funds don't perform any better. Over an investment lifetime, beating a portfolio of index funds with actively managed funds is about as likely as growing a giant third eye.
American Expatriates Run Naked
Unlike most global expats, Americans can't legally shelter their money in a country that doesn't charge capital gains taxes. And actively managed mutual funds attract high levels of tax. There are two forms of American capital gains taxes. One is called short‐term, the other long‐term. Short‐term capital gains are taxed at the investor's ordinary income tax rate. Such taxes are triggered when a profitable investment in a non‐tax‐deferred account is sold within one year.
I can hear what you're thinking: “I don't sell my mutual funds on an annual basis, so I wouldn't incur such costs when my funds make money.” Unfortunately, if you're an American expat invested in actively managed mutual funds, you sell without realizing it. Fund managers do it for you by constantly trading stocks within their respective funds. In a non‐tax‐sheltered account, it's a heavy tax to pay.
Stanford University economists Joel Dickson and John Shoven examined a sample of 62 actively managed mutual funds with long‐term track records. Before taxes, $1,000 invested in those funds between 1962 and 1992 would have grown to $21,890. After capital gains and dividend taxes, however, that same $1,000 would have grown to just $9,870 in a high‐income earner's taxable account.6 American expats, as I'll explain in a later chapter, must invest the majority of their money in taxable accounts. If that sounds depressing, it's good to know that index fund holdings don't get actively traded, so they trigger minimal capital gains taxes until investors are ready to sell. And when such holdings are sold, they're taxed at the far more lenient long‐term capital gains tax rate, as opposed to the higher short‐term capital gains tax rate paid by investors in actively managed funds.
Why Brokers Want to Muzzle Warren Buffett
Most financial advisors wish to muzzle the brightest minds in finance: professors at leading business universities, Nobel Prize laureates in economics, the (rare) advisors with integrity, and billionaire businessmen like Warren Buffett. Brokers make more when experts are mute.
Warren Buffett, chairman of Berkshire Hathaway, is well known as history's greatest investor. And he criticizes the mutual fund industry, suggesting, “The best way to own common stocks is through an index fund.”7
That's why Warren Buffett instructed his estate's trustees to put his heirs' proceeds into index funds when the great man dies.8
Nobel laureate Sharpe explains it's delusional for most people (and most advisors) to anticipate beating market indexes over the long term. In a 2007 interview with Jason Zweig for Money magazine, he stated his view:
| Sharpe: | The only way to be assured of higher expected return is to own the entire market portfolio. You can easily do that through a simple, cheap index mutual fund. |
| Zweig: | Why doesn't everyone invest that way? |
| Sharpe: | Hope springs eternal. We all tend to think either that we're above average or that we can pick other people [to man‐ age our money] who are above average…and those of us who put our money in index funds say, “Thank you very much.”9 |
Daniel Kahneman, another famed Nobel Prize–winning economist, echoed the sentiment during a 2012 interview with the magazine Der Spiegel:
“In the stock market…the predictions of experts are practically worthless. Anyone who wants to invest money is better off choosing index funds, which simply follow a certain stock index without any intervention of gifted stock pickers…we want to invest our money with somebody who appears to understand, even though the statistical evidence is plain that they are very unlikely to do so”.10
Merton Miller, a 1990 Nobel Prize winner in economics, says even professionals managing money for governments or corporations shouldn't delude themselves about beating a portfolio of index funds:
Any pension fund manager who doesn't have the vast majority—and I mean 70 percent or 80 percent of his or her portfolio—in passive investments [index funds] is guilty of malfeasance, nonfeasance, or some other kind of bad feasance! There's just no sense for most of them to have anything but a passive [indexed] investment policy.11
In the documentary program Passive Investing: The Evidence the Fund Management Industry Would Prefer You Not See, many of the world's top economists and financial academics voice the futility of buying actively managed funds. But as the title suggests, it's the program most financial advisors will never want you watching.12
Financial Advisors Touting “The World Is Flat!”
Your financial education is the biggest threat to most globetrotting financial advisors seeking expatriate spoils. Consequently, many are motivated to derail would‐be index investors from gaining financial knowledge.
Self‐Serving Argument Stomped by Evidence
Here is one of the most common arguments you'll hear from desperate advisors hoping to keep their gravy trains running:
Index funds are dangerous