Herbert Horwich used to be a mutual fund executive and money manager, managing billions of investor dollars in the lightning-paced world of Wall Street.
He now takes a slightly longer view of the markets, and their players, from his seat behind a professor’s desk at De Paul University, where he is an executive-in-residence for the university’s finance department.
With the luxury of that perspective, and with the experience of more than 30 years managing a group of mutual funds, Horwich holds forth on some intriguing and controversial views on personal finance and the mutual fund industry.
Among these, Horwich believes that as the mutual fund industry has boomed in the last few years to $1.5 trillion in size, many money managers have become consumed with marketing. This has led to a proliferation of funds, particularly specialty funds, for which an average investor does not possess the investment wisdom to make savvy investment choices.
Horwich warns that the average investor is apt to be led astray into poor investment choices unless he grounds himself first in some fundamental economic principles. The edited transcript of a recent interview with personal finance writer Marianne Taylor follows:
Q-You obviously see a great need for better investor education. Why?
A-It’s more than a need, it’s a crisis. The middle class in America is on something of a collision course with its standard of living, which is ever rising in cost, and government and corporate plans that will not be enough for these people to maintain these standards.
Q-It seems that people are starting to be aware of that.
A-Oh, they’re aware of it. They feel a gnawing concern. They don’t know what to do about it. That’s the point: There’s no way they’re going to be able to maintain thir standard without supplementing it with their capital. Very few know how to do that. We have a wonderfully educated middle class that is virtually illiterate in how to save and invest and how to bring some order to building capital. I feel this is a crisis.
Q-What is the typical investment education level of a middle-class investor?
A-Maybe an economics class or two, or a finance course or two, but no real concentration in investments. I really believe there is this illiteracy, and it’s complicated by this intimidation factor. People say, “My God, I can’t understand this.”
Q-Why are many investors intimidated?
A-Well, because it’s been taught badly and discussed badly and reported on television. The television complicates this even further. It doesn’t help in education. It obfuscates. It’s emotional. It exaggerates. They beat the recession up and they’re beating up the recovery. In other words, they’re pounding: recession, recession, recession. They give no perspective to this. This was the ninth recession I’ve been through, and television made it seem like the world was coming to an end. That was totally misleading. It frightened everybody. Instead of giving them some understanding that this was some integral part of the workings of the economy. It simply meant we had to be patient. We came out of the 1980s with a great hangover, great excesses, with debt across the board in households, businesses, let alone the government. The whole financial sector was swollen and sick. So it’s a hangover.
Well, people can understand a hangover. Hangovers do end. But a hangover means you don’t go from one wild party to the next. You have to cool your heels for a few minutes before you go on to the next one. That’s what we were doing. The ’80s ended in more of an excess than usual, so the hangover was more difficult than usual. Right now, we’re working our way through, and things begin to appear better. The mood is lifting.
Q-People miss that perspective?
A-Totally. Without perspective, you can’t understand anything. Giving the middle class, the public, some understanding of this is not such an earthshaking, complex job. The whole concept of what makes the economy tick and what its principal characteristics are, and how you have to take those into account in investment strategy. Simple concepts in investment planning, investment alternatives you use, mutual fund programs you use, these are things you can discuss in plain talk.
Q-Let’s focus on the mutual fund industry. How is it doing at educating investors about the range of choices they have and the risks?
A-They’re doing it very badly. First of all, I underline the fact that the mutual fund concept is solid. It is the only way that a person who is working and thinking about work and family has time to do this. It took the ’80s for it to really break through the public consciousness, and it is now the accepted way, and should be.
This great breakthrough in the ’80s came out of marketing skills that were brilliant. Today, the business is run by marketing people.
Q-What does that matter?
A-You now have close to 4,000 mutual funds. What is a marketing person interested in? More products. My wife and I have children who are grown, and the two of us live in an apartment. We must have 10 boxes of cereal. That’s marketing. There are close to 4,000 mutual funds.
In addition, the industry as it has grown so rapidly has become a very rich industry. That always attracts second-rate people, so that you have a much higher percentage of lower-quality people just because it’s so rich.
That (proliferation of funds) plus this deteriorating quality makes it impossible for (an investor) to wade through all those alternatives sensibly, without some advice, without some guidance. Magazines aren’t guidance. It’s hype. It’s destructive to understanding the investment business, which is basically a long-term prospect.
Q-Are you referring to the publication of lists of “10 hot funds” or things like that?
A-Yes, that sort of thing, or “Earn 20 percent tomorrow.” In other words, flashing these come-ons which are not within the human grasp. It’s more than just selecting a fund. What you need is some strategy for how you learn to build your capital: why this particular mix, why this particular strategy. And you must follow them up.
One of the paradoxes that comes out of this is that no-load funds can be more costly to the small investor than low-load funds. No-load funds are “do it yourself.” It is extremely difficult to do it well by yourself unless you have background or experience. If you’re a relatively small investor, you need a qualified broker and pay 3 or 4 percent (in “load” fees). It’s the best money you can spend. Doing it by yourself, you’ll make mistakes and lose money.
Q-How do you know your broker is acting in your best interests and not trying to sell you the latest hot fund, or one that promises him the best fees?
A-How do you pick your doctor, your lawyer, your accountant? You select a broker the same way you select any other adviser. You must do some cross-checking, and talk to people who have used the broker. You have to be very careful not to choose a broker who’s not had experience for say, 8 to 10 years. Because what happens to the young brokers, is that they are pulled so much by sales pressures, you can’t be sure you’re getting the best thinking.
Q-What is your view on sector funds, which invest only in stocks of a certain industry group?
A-A sector fund is a terrible thing for the uninitiated investor because they must make market timing decisions. When are they attracted to a health-care fund? When health care is hot, right at the top. Then it fades. So the investor moves from that sector to the next hot sector. And what happens? They just destroy their money. And the fact that (many mutual fund companies) permit that tells you they are marketing-oriented companies.
Q-You referred earlier to the crisis that many middle-class Americans face in not having enough investment income to carry them through their retirement. Is there a danger in being too conservative in investments?
A-That is a problem for many people in 401(k) plans. They put all their money in conservative insurance contracts and money market funds. That’s because they don’t understand that being so conservative is speculative. Owning only a government Treasury, for instance, that’s a highly speculative policy. Because owning only one bond means that you have no growth potential, no ability to beat inflation or stay with inflation, and you’re betting against everything that seems to be in the nature of the economy.
People say stocks are too risky. They don’t understand that, in a sense, that’s not so, because it’s only stocks in that list of alternatives that can grow. You can’t do it in bonds, you can’t do it in a money market. It doesn’t have to be in stocks alone. It can be stock in your own business; it may be real estate.
Another thing I try to do is give everyone the right expectations, or at least more sensible expectations. Such as long term, what has been the stock market return? Long term, what has been the bond return? How have Standard & Poor’s-type stocks behaved, how have Nasdaq stocks behaved? If you take the last 50 years, the S&P 500 is about 10 percent, compounded. Well, who is interested in 10 percent if in a magazine you are told you’re going to get these enormous returns?
For bonds, the historical return is about 5 to 6 percent. But bonds did beautifully in the ’80s-10 to 12 percent. Based on what I just said, that is an abnormal result. It’s creating expectations that are unrealistic.
Why have bonds been such a terrific investment (recently)? Because in the ’80s, you basically unraveled all the problems in the ’70s. The long-term Treasury was 14 percent, now it’s 7.5 percent. Which is more in line with what should be?
What happens to bonds when interest rates go down? Prices go up, so bonds have been sensational. Would you trust that if you understood that they were sensational only because they were unraveling the trouble of the ’70s that drove interest rates up to unprecedented levels? You can’t just say, “I’m earning 7 percent.” You’ve got to know why. You’ve got to get some perspective on it.
Perspective. That’s my passion.
