Understanding Index Funds with Benji Bailey

This faith and finance podcast is underwritten in part by Praxis Mutual Funds. They are a leading faith-based family of mutual funds helping people integrate their finances with their values since 1994. With Praxis, your investments can make a difference for you and the world around you. Learn more at Praxismutualfunds.com. Did you hear about the guy who owned last year's top performing funds?

Yeah, too bad he bought them this year though. Hi, I'm Rob West. There's a lot of evidence to suggest that buying and holding index funds will pay off in the long run. Benji Bailey joins us today to make the case with some impressive numbers. And then we'll take your calls at 800-525-7000. That's 800-525-7000.

This is faith and finance, biblical wisdom for your financial decisions. Well, our guest today is our friend Benji Bailey. He's vice president of investments and senior fixed income manager at Praxis Mutual Funds and underwriter of this program. Benji, great to have you back.

Rob, it is great to be with you again. You know, last time we actually talked about bonds and this time it's more about index funds. So some people might not think this is the most exciting topic, but I want to assure your listeners they are both very important.

Yes, no doubt they are. And this is an area of investing that has captured the interest of a lot of folks. I'm glad we can shed some light on it. So let's start there.

Why should indexes be important for investors? Let me just step back a little bit. So this past year, my family and I went to Joshua Tree National Park. I mean, gorgeous park, a fun place to visit with family, you know, but there are signs and those signs directed you to the most impressive sites in the park. You know, we took some trails and of course, frequently there are signs on that trail that remind you that you're on the right path. Signs also might inform you of upcoming turns. Now, could I have figured out the way to go without those signs? Maybe. Okay, well, actually, probably maybe not, right? I probably would have got lost. And I may have wandered around for a long time.

And I would have had some very frustrated family members. But so if my goal is to see the sites that are special at the park, then having signs and guideposts is so imperative. Yeah, that's exactly right. Now, how does this, of course, relate to investing?

Right. So investors have goals, you know, whatever they might be, but in indexes, or you could call them benchmarks, if you want, are necessary guideposts to make sure your investments are getting closer to those future goals. So if you have 30 years until retirement, and you wait 25 years and find out I've been going the wrong direction the whole time, not good, right. So publicly available benchmarks like the S&P 500 for large cap stocks, or the Bloomberg ag for bonds. They're great check ins and comparisons to make sure you're generally on that right path.

Yeah, that's helpful. Now, of course, some folks have heard repeatedly that Main Street investors lose value, or perform poorly when actively trading stocks. Is that generally true?

Yeah, actually, that is correct. So if your goal is to retire, then again, guideposts are important, but so is looking at research to really understand what else can help you along that path. So the Journal of Finance published a study and it showed that people that traded individual stocks a lot, underperformed those that didn't trade it a lot. So the six year period, the market was up about 18%. So the least active traders, so people that still did trade some of their own stocks were up 16.4%.

So not too bad, a little bit worse. But the most active traders up 11.4%. So they underperformed by over 6% on average, because they were just trading so often in these individual stocks. And actually, the study was titled trading is hazardous to your wealth. Exactly right. So then what can investors do with this knowledge?

Well, I think there's a few things, right? Certainly find it an experienced and thoughtful advisor that can help you on the right path and keep you away from trying to trade too much. Now, we also think that something that offers more index like returns can be really helpful, you know, bragging to our friends about our winning stocks may be fun, although not very Christ like, but long term index like returns is really the way to a fruitful retirement. Many people have heard of Warren Buffett, he has a great quote, the stock market is designed to transfer money from the active to the patient.

And if you go to the Bible, Proverbs 1311 says wealth gained hastily will dwindle, but whoever gains little by little will increase it. So really, being patient with your investments, spreading out your risks, we think these are great way to do this. And having a portion of your portfolio in index like returns is really important.

Hmm, that's interesting. So can you explain for our listeners the difference between an active mutual fund and a passive mutual fund? Yeah, so active funds, they have managers that buy a generally a smaller set of stocks, and they think those stocks will outperform the market where passive funds generally buy the stocks in an index and just hold them. Now, we think it's beneficial to have a portion of your account and passive funds because according to a study by Morningstar, over the past 15 years, only 9% of active large cap blend funds had higher returns in their passive peer. So 91% of active funds underperform their passive peers.

Interesting. With us today, our good friend Benji Bailey of Praxis Mutual Funds, we're talking indexes, we'll continue that conversation, including can you use indexes and apply your faith values? More with Benji Bailey just around the corner here on faith and finance.

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What are they? How should you think about them the place they should occupy potentially in your portfolio? And can you align your faith values when you use index investments? And let's go there next Benji, you know, some investors are concerned with just buying the index because they want their values reflected in their investments.

Well, that is completely a valid concern, right? So at Praxis, we don't own every stock in that public index, right? So an investor can invest with their values by removing certain companies that produce objectionable content, while still getting returns that are close to the market. Yeah, but that sounds too good to be true.

Well, that's because it is somewhat right. So the more companies and investor screens out of that index, the more volatile their return will be around that index. So if an investor takes one stock out right now, the S&P 500 buys the other 499, it's not going to really affect their returns that much versus the index. Now, if instead they take out half, like you take out 250 stocks out of the index, and you buy the other 250. Then you can imagine that your returns will be much more volatile. Now, I'm not necessarily saying that they're going to be better or worse by taking out some of those stocks that, you know, don't match with your values. I'm just saying the volatility is going to be much higher.

Yeah, but it's exciting to know that that can actually be done. So what does that look like at Praxis Mutual Funds? Yeah, so at the Praxis Mutual Funds, certainly we desire to be good stewards of our clients money. So we need to get returns that are fair and relatively close to the index. Now, God also calls us to be good stewards of what he's entrusted with us.

So we also need to care for and impact people's lives when we can. In our equity mutual funds, we offer optimized equity index funds. So it isn't investing in the entire index or replicating it. We're just doing an optimized equity index fund. So our large cap stocks, they screen out objectionable companies. And then we use a software program along with a portfolio manager oversight to reinvest the remaining portion of that index in a way that gets close to the public return over the intermediate to long term. We recommend some of these things because it takes the emotion out of investing and that can be really beneficial.

You know, we know we only actually have so much willpower. And so if we can pay attention to our guideposts and think about getting somewhere around market returns with a portion of our portfolio, then we're more likely to really stay on that good path. Yeah, that makes sense. Now, of course, investing with a long range vision really means that you don't have to worry about market fluctuations, right?

That's right. And another feeling that we really want to stay away from is our inclination to invest when things are good, and then want to pull back actually and go to safety when things don't look so good. And this is natural, right?

I feel the same way, right? But it's actually the opposite of buying low and selling high. Buying low, of course, is going to mean you're going to buy when it's a little uncomfortable.

And selling high is probably means you're going to sell when everyone else thinks it's great. So I actually looked back at the S&P 500 over the last 97 years, your average return is about 10%. But there were only five, only five annual calendar periods when the return was between eight and 12%. Only five, and only 12 times when it was between in six and 14%.

So kind of above or below by 4%. There were actually 11 times when it was down eight to 12%, and 19 times when it was up 26 to 36%. So people think that the returns around their index mostly kind of bounced around that average, and occasionally it goes wildly up and down one way or the other.

That isn't true at all. It's actually the market is very volatile, and annual returns aren't likely close to that average. So you need something that helps to keep you less concerned about that volatility that you have with the market. And you need an investment strategy that you can set and then monitor infrequently. And so just like that signpost that tells you that you're on the right path, we also think it's really beneficial to utilize broad indexes to compare your investments to and then have a diversified investment portfolio. In fact, going back to the Bible, Proverbs 21 five says, the plans of the diligent lead surely to abundance, but everyone who is hasty comes only to poverty, or Ecclesiastes 11 two, it actually says, invest in seven ventures, yes, in eight, you do not know what disaster may come upon the land. Hmm, yeah, that's helpful.

You know, I want to go back to something you said a moment ago. And that is really the mechanics of how the screening and the values alignment occurs there at Praxis mutual funds. And you mentioned that it's a combination of software and data gathering alongside the portfolio manager oversight to determine what companies are in and what companies are out, whether that's bond investing or equity investments. Will you just explain a bit more for somebody who's new to this, how that actually works? Yeah, so there's a level of the quantitative where we're looking to see how much revenue does a company generate from these objectionable contents, if that revenue is high enough, and it's a pretty stringent screen that we have.

But they barely need to have very much in revenue at all. And some of these objectionable things, alcohol, tobacco, gambling, or abortion, and then we're going to screen those things out, meaning that we're not going to invest in those. But then we're going to then take an optimizer, it's a software program, as I mentioned, and utilize that then to reinvest in companies that can help it to perform as much like the index as possible. So little pieces of those kind of leftover companies put back together, then to perform as much like the index as we can. And there's, again, still going to be volatility because we're screening things out.

But over time, what we've seen is this optimized portfolio performs very close to the index. Now, the screening out is just one piece of the equation. I know one of the things you're most excited about there at Praxis Mutual Funds is the screening in and the impact that you can have. In fact, I know you all publish annually an impact report that's focused on just that. So talk about that side of how you invest.

Yeah, so incredibly true, we have something that we call Impact X, and the X is a multiplier, meaning that you can do multiple different things and have a multiplier effect to this. So screening out is important, right? Taking certain things out of your portfolio is important, investing with your values.

But there's many other things that you can do. Proxy voting is important, making sure that you vote the way that you want to. There's shareholder engagement.

It's actually taking that vote that you have and trying to make a difference with that. And we also do community development investing. And that's taking about 1% of each of the mutual funds that we have, and really investing it in deep impact, almost think microfinance or other things that where people that really have these needs, and we want to put up a small portion, but still an important portion of each of the funds into those things.

So there's there's seven different factors, and I named a few of those. And those are what we call Impact X, again, have that multiplier effect of making a difference with your money, not just screening things out, but let's make a positive impact on the world too. You know, we talk about every day what it looks like to be a wise steward of God's money. And that includes how we handle it includes how we manage it and plan for it includes how we give it. But it should also include how we deploy it through investment capital and how we're aligning that with what really matters most to us as Christ followers.

Well, unfortunately, we're just about out of time today, Benji. But how can folks get more information? And again, you mentioned our website, praxisinvest.com. It's a great place to start. We have lots of information on our four Diversified Equity Funds, and actually also on the Praxis Impact Bond Fund, which we've talked about in the past. By the way, I want to share my favorite book on this deep dive of biblically views on stewardship is Neither Poverty Nor Riches by Craig Blomberg. And of course, Kingdom Advisors is a great source. And Faithfy has lots of great resources too.

I couldn't agree more about Neither Poverty Nor Riches, one of my favorites as well. Benji, thanks for stopping by today, my friend. It's been great to be with you. That's Benjamin Bailey of Praxis Mutual Funds. The website again is praxisinvests.com. All right, your calls are next. The number, 800-525-7000. I'm Rob West, and this is Faith in Finance.

We'll be right back. If you enjoy this radio program, you're going to love all of the many different resources waiting for you at faithfy.com and the Faithfy app. You'll find powerful wisdom, free podcasts, articles, videos, and more from leading voices such as Randy Alcorn, Howard Dayton, Ron Blue, and our own Rob West. Grow in wisdom and knowledge by connecting with a community of thousands of Christians striving to be good and faithful stewards at faithfy.com or by downloading the Faithfy app. If the heavy burden of debt is robbing you of freedom and peace of mind, Christian Credit Counselors can help. We're a nationwide nonprofit credit counseling organization that has helped over 300,000 individuals in the last 27 years get out of credit card debt 80% faster while honoring that debt in full. To learn how Christian Credit Counselors can help you, visit christiancreditcounselors.org. That's christiancreditcounselors.org or call 800-557-1985. Thanks for joining us today on Faith in Finance. Taking your calls and questions today, 800-525-7000. You can call right now. Let's go to Texas. Hi, Paul.

Go right ahead, sir. Yeah, I guess first I'd like a terminology clarification with the word estate. There's been something that's always confusing to me. You know how you go to financial seminars and they say, well, you know, you can have a will or you can have an estate and then for somebody who only has a will when they pass away and you go through probate, then that whole entity is called an estate. They really become like the same animal or are they really two different things? And then I'll get to my question after I clarify that in my mind.

Yeah, it's a good question. And so essentially your estate, when you hear people refer to that in a legal setting, refers to everything you have that you own or have title to. So, you know, it's the interest you have in property, which is, you know, real estate land and anything permanently attached to it, your personal estate, movable property like money and jewelry and furniture. And then, you know, you would hear that referred to as a life estate ownership for someone's lifetime. And then obviously, you know, part of your estate is any other property or assets as well. So it basically has to do with the total property, both real and personal, that's owned by an individual. And it typically is referred to in the context of an inheritance or what somebody owns that would then be available after death. And that's what when you hear this term settling an estate has to do with the transfer of that real and personal property. Does that make sense?

Yes, thank you very much. Now I'll get to my question, which is kind of a really little niche corner. I have a relative at this least. They did not set up a formal estate and I've already gone through probate and I'm the executor and I have the letters testamentary, et cetera, et cetera. So, you know, as part of handling things, I've created an estate bank account and I have the, you know, the number from the IRS.

The question I have is because I also have an LLC, I'm aware of the beneficial ownership information requirement from FinCEN, which is a financial crimes enforcement network department of the U.S. Treasury. I'm just saying those words for the listeners. I'm pretty sure you know what that is. And the question comes down to it pretty much is says, well, you know, if you have a company formed by your Texas or for me, Texas, your secretary of state, then you need to report people who are in control of that. And then like typical government, it says or anything that's kind of like that. So my real question is, in the course of everything you've done, have you come across anybody with an opinion that says if you're the executor of an estate, is that something you should report, like if you were, you know, the power controlling a company? Yeah, it's a good question. And, you know, you would probably want to get a legal opinion on that to be definitive.

Here's what I would say, just kind of generally to this. Generally, you would not need to report your role as an executor to the financial crimes enforcement network unless the estate's financial activities trigger those reporting requirements. So where might that happen? Well, if the estate, to your point, controls or owns a business that's required to file that BOI report, then you may need to update the report if the executor, you, becomes the controlling party. If the business was previously reported under the deceased name, then you might need to update FinCEN with that new responsible party now yourself as executor. The other would be, you know, if you as executor handle cash transactions exceeding $10,000, the bank may report the transaction to FinCEN.

You wouldn't need to file anything yourself. That's just going to happen automatically. And then there's the SAR, the Suspicious Activity Reports. If the estate is involved in suspicious transactions, you know, large wire transfers, things like that, then, you know, the financial institution could file the Suspicious Activity Report.

That would be very unlikely. So it would generally come down to you, once you assume your role as executor, if there's a business that's required to file that BOI report, then you may need to update yourself as the controlling party. I will say that, you know, and I suspect you've heard this, I mean, it's very new, so there's still a lot of guidance that's coming. But I think it was just March the 2nd where the Treasury Department said it will suspend enforcement of the Corporate Transparency Act and therefore the Beneficial Ownership Information Reporting requirement for U.S. citizens and anyone domestic that had to report previously. So that would mean that potentially, according to this guidance, that there's no longer a requirement to file those BOI reports and no penalties or fines if you, you know, are non-compliant.

And so we're going to need to watch this. It hasn't been entirely eliminated. Again, they've just said they're not going to enforce anything. And this is so new, we'll see ultimately where this is headed under the Trump administration.

But this is just one of their efforts to try to curb what they deem as unnecessary regulatory authority that's, you know, getting in the way of business flourishing in the way that, you know, they would like to in this economy. Thank you so much. Okay, you're welcome. We appreciate your call, Paul. Thanks for being with us today. Let's go to Louisiana.

Hi, Lou. Thanks for your patience. Go ahead. Hey, thank you for taking my call.

Yes, sir. I'm confused. I'm 85. I draw Social Security on there. I used to do side jobs, and whenever I'd file my taxes, you know, because of the side jobs. And whenever I quit working completely, my CPA said, well, you don't need to even file taxes because you're on Social Security. Now they're talking about cutting taxes on Social Security, so I'm really confused, Rob.

It's a great question, Lou, and I can certainly understand why you would be. Let me just say right off the top, if Social Security is your only income, it is not taxable, and you do not need to file. That's kind of right off the bat. Now, the reason they're talking about cutting it is it is taxable for some people, but it requires additional income. So for people that have additional income like pensions or rental income or interest or dividends or withdrawals from an IRA or 401K, then part of your Social Security may become taxable, and that's what President Trump is talking about eliminating. So it has to do with something called provisional income, which is the definition of provisional income is 50% of your Social Security plus other income. So you're taxable and tax-exempt interest. And if your provisional income, which again is half your Social Security plus other income, if that is above, as a single person, $25,000, then it's going to start to make your Social Security taxable.

But if all you have is Social Security, there is no tax that will be paid and there is no return that needs to be filed. Thank you. Because my son was really confused, and he said they're taxing this, so you better check. You better check. So I wanted to check and make sure that I was right. I'm glad you did, and you are.

I appreciate your answer. Thank you. Absolutely, sir.

Call anytime. We appreciate you being on the program. Folks, thanks for being along with us today. We'll see you tomorrow. Have a great rest of your day. Bye-bye. Faith and Finance is provided by Faith Buy and listeners like you.