By Patrick Manning, Head of Strategic Investments

Recently my grandson who is 21, and my nephew who is 22, expressed an interest in the stock market. Of course I encouraged both of them to pursue this interest, but suggested they start by doing it in a play money account, rather than actually investing. They are both in college and have very little to invest anyway.

Since I am a believer in Passive Investing, I gave them my spiel about how hard it is to beat the market on a consistent basis, and that when they get real jobs  it is very important to start young and put the core of their portfolio in index funds in their 401 K’s so they can have a comfortable retirement. I knew this advice would most likely fall on deaf ears, as despite the fact that I was in the business for over 30 years, it took me until I was in my fifties to figure this out.

Appealing to their competitive natures and the invincibility of youth I issued them a challenge. Put half of your paper portfolio in whatever stocks you want to pick, and put the other half in the Vanguard Total Stock Market Index ETF (VTI). No matter how many times you trade the stocks you pick, or go in and out of the market, just remain fully invested in the half of your portfolio that is in VTI. Then we can see if you are in the small minority of people that can actually beat the market. They both took the challenge.

Because they were completely unfamiliar with standard approaches to investing like fundamental analysis, technical analysis, P/E ratios, value investing, momentum, top down analysis, industry or sector analysis, etc., etc. they essentially picked stocks of companies that they were familiar with, or read about somewhere on the Internet. In many ways my feeling is this approach is as good as any other since most Wall Street professional money managers that pick stocks and time markets do not outperform the market about 65% of the time.

My nephew who has had his portfolio for about a year is being trounced by the market.  My grandson who has only been at it for a week is losing money on 4 of the 5 stocks he picked, but one of them is a penny stock called Chromodex (CDXC) and it is up about 11.7%. Thanks to that stock he is is slightly ahead of the market. Somehow I think that when his first year is up that won’t be the case. But kudos to my grandson, perhaps he will be the next Warren Buffett or Peter Lynch.

In my continuing quest for knowledge on Passive Investing I look for good books on this topic. One I just finished that I think is worth reading is called ” Index Funds – The 12 Step Recovery Program for Active Investors “. It is written by Mark T Hebner. This the condensed 2011 edition, His first edition was praised by many well known financial industry and academic legends such as Harry Markowitz, John Bogle,Burton Makiel, and Paul Samuelson. It is an easy read and is chock full of common sense supported by academic studies that go back as far as 83 years.

My other favorite books on the case for passive investing include: ” A Random Walk Down Wall Street ” by Burton Makiel, ” Common Sense on Mutual Funds ” by John Bogle, and ” The Power of Passive Investing ” by Richard A. Ferri. If you want to get a little more involved in the math side of asset allocation then read ” The Intelligent Asset Allocator ” by William Bernstein. If you want to keep it simple and read a good starter book on investing get ” The Boglehead’s Guide to Investing ” by Taylor Larimore, Mel Lindauer, and Michael LeBeouf.

However, no many books you read  on this topic, the hard part is selecting the correct asset allocation of index funds that meet your risk tolerance. After doing that then you need the emotional discipline to stick to your plan and periodically rebalance your portfolio  to make sure it continues to reflect your desired risk/reward profile. Also, because the industry continually evolves, there are new index alternatives to choose from. Some are an improvement, and some are nothing more than rip offs that are too risky and too costly.

This is where Alhambra Investment Partners comes into the picture. As a fee based only investment advisory firm we have a fiduciary responsibility to our clients. We earn no fees or commissions on any investment instrument we use to construct your portfolio. So turn off the noise of CNBC and avoid the clutches of Wall Streets army of commission based sales forces and contact Alhambra Investment Partners to see if the strategic approach of using no load very low cost passive index funds to construct a portfolio that reflects your risk/reward profile and meets your desired long term investment goals makes sense to you.