Ep. 41 | Index vs Factor vs Alpha: What Type of Investor Are You?

Not all investing is created equal. In this episode, Tré Bynoe, CFP, CIM, unpacks the three core investment approaches—indexing, factor investing, and alpha strategies—and how to know which one fits you.

Whether you're DIY or working with an advisor, understanding the difference can mean the difference between steady growth and unnecessary risk.

You’ll learn:

• What an index fund really is
• How factor investing aims for better-than-market returns
• Why most alpha strategies underperform over time
• How to benchmark your portfolio the right way
• Which strategy Tré actually uses and why

🎧 Follow and share the podcast if you learned something.

Website | Youtube | Linkedin

Transcript

0:00

Welcome. Wait, I didn't even, do you wanna do the second next episode?

Sierra 0:03

Okay. What is it?

Tre (2) 0:04

This episode is on. Three different approaches to investing.

Sierra 0:10

Sure.

Tre (2) 0:10

It'll be a little bit lighter than the last one.

Sierra 0:12

Yeah. Let's try to keep it quiet. Okay. We'll just talk a

Tre (2) 0:14

little bit about alpha and beta. And

Sierra 0:17

I know all about Alpha. I am the Alpha.

Tre (2) 0:20

Okay. Welcome to the Plain English Finance Podcast, the podcast dedicated to helping you make smart financial decisions. I'm your host, Tre Bynoe, Certified Financial Planner and Chartered Investment Manager. I'm a financial planner with TCU Wealth Management and Aviso Wealth. Start with episodes one or two if you wanna learn more about me. Okay. This episode is on investing, so oftentimes I get a lot of people come to me where, or just in general conversation, where they don't understand. They think of it as my portfolio is going up Good. My portfolio is going down bad.

Sierra 1:01

Yeah, that makes total sense to me. Sorry, we're kind of in a, a goofy, well, I'm in a goofy mood right now, obviously, so

Tre (2) 1:11

That's fair. That's fair. Okay. So benchmarking a portfolio is how we determine whether this strategy is working or not. Okay. Do you know what a benchmark is?

Sierra 1:26

Yeah. I don't know how to

tre 1:29

Tell me.

Sierra 1:31

I thought I did. I'm also looking at your sweater that says bench right now. Oh my God.

Tre (2) 1:39

Yeah. Benchmark.

Sierra 1:40

Yeah. I'm actually like losing my mind. I wanted to make a joke, but I couldn't. I wasn't fast.

Tre (2) 1:48

Oh boy. Benchmark, what is it?

Sierra 1:50

A benchmark is

Tre (2) 1:53

Think of your MS tests.

Sierra 1:55

Okay. Yeah. They. It's like the average, I guess. They're like, did you do better or worse than the last time? Did you do better or worse than the last 18 times you've done these PEG tests?

Tre (2) 2:06

Exactly right.

Sierra 2:07

Peg?

Tre (2) 2:08

Yeah.

Sierra 2:09

It's fine motor skills. I don't have any. So

Tre (2) 2:12

You just have motor skills, they've renamed it just for you.

Sierra 2:14

I call them gross motor skills when I'm like dropping stuff.

Tre (2) 2:19

Okay. But yes, that is a benchmark. It's what are you comparing it to? Okay. And that's a really, really important question when it comes to determining whether a portfolio has performed well or not, whether the manager has performed well or not. Okay? So I'm gonna quickly go through three different investment strategies that people will use and the pros and the cons of them so that you can put them into. Categories better. Better categories as an individual. Okay. Okay. So there's three types. There's indexing, there's factor, and then there's alpha. Okay? Mm-hmm. What do you think indexing is? Because you've heard me say that term before. I know.

Sierra 3:07

And you know what you have told me about indexing, like so many times, because I remember when I was a teller, I would get these little popups. Saying stuff about index funds. Do you remember that? No.

Tre (2) 3:21

I don't remember you getting popups about it.

Sierra 3:23

It would be like, not, not like, not like a spam popup or anything, but in, I don't know if I'm allowed to say like the name of the whatever innovation. You sometimes a note would come up on people's accounts

Tre (2) 3:36

And it would say about index funds?

Sierra 3:37

Yeah, it would be talking. I can't remember'cause it's been so long. Oh, that's interesting. But it was something about indexing and I'm like. Maybe I should not admit to this. I'm like, what this is all about. Okay. Close it anyways. What are you doing?

Tre (2) 3:53

It's probably the index linked GIC.

Sierra 3:54

Yes. That's what it is. Index linked. Okay.

Tre (2) 3:57

Yes. Yeah, yeah. I'm not talking about that.

Sierra 4:00

Okay. Well, I know if I,

Tre (2) 4:01

if I was a bank, I would try to convince people that that was the best way to invest so I could make a ton of money.

Sierra 4:08

Oh.

Tre (2) 4:09

That's, I'm pretty sure they're the most profitable product. We'll do it. You know what, I'm gonna add that to the list because I've had a few people now that come to me and they've asked me, Hey, my person at RBC or my person at Scotia is telling me that this is a great thing to do. Is it? And that's a, I'm gonna bring that up and into the list anyway. Indexing.

Sierra 4:29

Okay. Sorry. But anyway, that besides the point I remember back then. I'm saying, I just would exit the note, but I asked you specifically what is the index linked note thing that I'm getting popped up and you were like, oh.

Tre (2) 4:46

This whole story about index notes. We're gonna go so off topic.

Sierra 4:50

So anyway, back to the note.

Tre (2) 4:55

Okay.

Sierra 4:55

Back to my super interesting story.

Tre (2) 4:58

We need to skip that story for now, we will come back to, to that during the,

Sierra 5:02

They're dying, waiting to know the end.

Tre (2) 5:03

Well then they can wait for the index link.

Sierra 5:05

I don't even know where the end is. So.

Tre (2) 5:07

I don't know either. Okay. An index is, an index fund is trying to track something, an index, something else that is tracking the overall market. Okay. So the S&P 500

Sierra 5:23

mm-hmm.

Tre (2) 5:23

Is an index.

Sierra 5:25

Why?

Tre (2) 5:26

Because it's, Standard and Pause just said, this is like, they make indexes, they make a, it's meant to be like an approximation of a group, of a part of the market.

Sierra 5:37

Okay. What, sorry, define index again.

Tre (2) 5:40

Okay. Google.

Sierra 5:44

Google can't save you now. I'm just kidding. I need to, I need to hear it in a sentence.

Tre (2) 5:50

Okay. A market index is a curated portfolio of financial assets that represent a specific market, segment, sector or economy.

Sierra 5:59

Is it centered? First of all, I can't read from here, so I don't know what I, I'm like, does that say potato Whatcha reading? Oh, curated portfolio. I said centered potato, a curated portfolio of financial assets. Oh, wow. that did not help. Oh, NASDAQ for tech. Duh I'm joking, I have no idea I don't know. That didn't help. I,

Tre (2) 6:38

it's just a, that didn't help. No, we're screwed then.

Sierra 6:41

I have no idea.

Tre (2) 6:41

It's just a group of stocks.

Sierra 6:44

Okay, so somebody is like, Hey, this index is, so theres people that,

Tre (2) 6:47

there's companies that make indexes. Okay.

Sierra 6:50

So they're just picking a bunch of stocks and saying, this index is, the genre is

Tre (2) 6:56

global. This genre is a banking, global banking. This genre is industrials, global industrials, or US industrials this is Canada. This is and there's certain. Each index has different rules in order to be accepted as part of the index. So the biggest index on the planet by far is the S&P 500.

Sierra 7:20

Yeah. Okay. That actually clarified it. Okay. Yeah.

Tre (2) 7:23

So a lot of people will think, for instance, that the S&P 500 is the biggest 500 companies in the comp in the US it is not. Mm-hmm. It is the biggest 500 companies that meet the requirements. Of being in the S&P 500. Mm. And this was a big deal for Tesla, for instance. Mm-hmm. Like Tesla for a long time did not, they were big, they were big enough to be part of the S&P 500, but they, they didn't meet the other requirements so. They were left outta the s and b for 500. And as you can imagine, Elon Musk had very choice words to say about it. Yeah. For a very long time. But finally they were added the whole big thing. So the index is, an index is just this measurement.

Sierra 8:03

Okay. Okay. Yep.

Tre (2) 8:04

And index fund is trying to match that measurement.

Sierra 8:10

Oh, sorry, you, you had me and then you've lost me again.

Tre (2) 8:16

So for instance. You cannot invest in an index. I cannot say, okay, I wanna put my money directly into the S&P 500. Because it's not a product, it's not a, it's not, it's just a list of names. I could go buy the names on the list, but I can't directly invest in the index. I would use the index fund.

Sierra 8:38

So is the index the like requirements, like a piece of paper that says, here's the requirements and these companies fit these requirements, and you're like, okay, cool. That's the index. Now I wanna purchase it. So I have to either buy every single one of those companies, or they've set something up where, yeah, lots of different

Tre (2) 8:58

companies. Yeah. Well then, so for example, Vanguard, which is a fund company, or iShares, which or BlackRock is a fund company. Yeah. They will go and make. A ETF or a mutual fund or something that imitates the index.

Sierra 9:15

Okay.

Tre (2) 9:15

That they're trying to copy.

Sierra 9:17

So they're like, we went and bought all of these, these

Tre (2) 9:20

500, if it's S&P 500, that these 500 names.

Sierra 9:24

Yeah. And you can

Tre (2) 9:25

now give us your money and it will go into this ETF or whatever that is trying to mimic this index. Okay. Okay. So the way that you would determine the. The performance of that index fund is by comparing it to what

Sierra 9:49

The index?

Tre (2) 9:50

Correct.

Sierra 9:51

Okay. I I thought it's an not a

Tre (2) 9:52

trick question.

Sierra 9:53

Yeah. I was like,

Tre (2) 9:54

no, no, no, no. So that's how you would determine whether that index fund is doing well or not. It's comparing it to the index. If the index is down 50%. The fund is down 48%. The index fund failed. Okay. Okay. Okay. They are very clear. An Index Fund's job is not to make money. An index fund's job is to follow the index as closely as possible.

Sierra 10:29

Okay.

Tre (2) 10:31

Does that make sense?

Sierra 10:32

I think so. I just feel like my mind's just kind of giving me some questions and I'm not sure if I

Tre (2) 10:38

hit me.

Sierra 10:40

So

Tre (2) 10:42

just outta curiosity, like apart from your mind they're giving you questions, who else would be

Sierra 10:47

the other voices? Okay. Um, I. Sorry, I gotta go back to that. Okay, so there's multiple companies that are trying to follow the index. How is that a hard task? I guess

Tre (2) 11:10

it's not, that's why they charge very low cost for it,

Sierra 11:13

because it's like, it, oh, you didn't follow the index. It's like you just have to buy these companies.

Tre (2) 11:20

It, it depends. S&P 500 is a, is a bad example of. A type of index that people would struggle to follow because it consists of very large companies. Mm-hmm. But think of if it's a All world index or some companies are so small that it's difficult to buy a meaningful share of the company, or there could be restrictions, or there's a whole host of reasons that could cause it to. To not keep up with the index. Okay.

Sierra 11:50

Okay. Yep.

Tre (2) 11:51

And I'm gonna throw in a side note here. Side note, alert. I guess I'm gonna use the cog analogy again.

Sierra 11:58

I thought you were gonna say I I'm gonna use that for now. Like side note alert. I was like, that should be, that should be,

Tre (2) 12:03

if it links to a different topic, I'm gonna use it really quickly.

Sierra 12:06

The cog, the

Tre (2) 12:07

cog analogy, the fact that an index fund. Is forced to rebalance during certain periods of time if the index changes is a problem. Okay. If a company is removed from the index, that means that Index fund has to sell that company.

Sierra 12:29

Yeah.

Tre (2) 12:29

Okay. Yeah. That creates a problem when it comes to investing as tax efficiently as possible.

Sierra 12:35

Wouldn't it also. Change like the distribution because, okay. Remember a long time ago we were looking at fund facts.

Tre (2) 12:46

Fund facts.

Sierra 12:46

Fund. Facts. Facts. Anyway and there were percentages of

Tre (2) 12:52

Yeah.

Sierra 12:52

The companies. So if you took one out, wouldn't that change everything as well?

Tre (2) 12:56

Yep. And then that means that they would then have to, and that is another reason why you might have differences in like where the index fund isn't quite the same as the index that it's trying to track. Mm-hmm. Right. Flows in and out of the fund if they have to sell'cause they don't have enough cash and there's a big withdrawal for some reason might impact these types of things. Mm-hmm. Okay.

Sierra 13:18

Okay.

Tre (2) 13:19

So that's just something to keep in mind when it, comes to investing, I wouldn't even say to keep it in mind, it's just a. It's a side note that is a cog that will impact other decisions that you would make. Mm-hmm. Okay. But that's an index fund.

Sierra 13:32

Okay.

Tre (2) 13:33

The like index strategy, I guess. Then there is factor strategies. So a factor is a characteristic of a company that historically has performed in a certain way that means that they can group them. So for example. Value. Okay. Value company means often, means that it's a stable company. Typically lower valuations on like multiples of their, of their earnings. Think of a company like Value Company that you would know. Um, Suncor no? Uh. CN Rail.

Sierra 14:18

Okay. Yeah,

Tre (2) 14:19

I wouldn't quite classify them truly as fully valued, but that's definitely, think of that type of company versus Nvidia, uh, versus Google.

Sierra 14:32

I just don't understand why. So the value,

Tre (2) 14:35

so one of the companies is growing very aggressively, like they spend a lot to grow, and the other type of company tends to be more stable, limited growth opportunities, more established type companies. Okay.

Sierra 14:51

Yep. This is, again, my mind is going to marketing because there's four different quadrants. I can't remember them off the top of my head, but one type is a cash cow and one type is this. So you're either like in the stable or you're growing really fast or you're like going down or your staying. Yeah. Yeah.

Tre (2) 15:11

So similar but there, but basically there is, there's different factors that historically have been a persistent source of. Excess return

Sierra 15:21

mm-hmm.

Tre (2) 15:22

Over indexes typically. Okay. Because if it's, if it hasn't outperformed indexes, why would you, why wouldn't you just hold the index? Yeah. Okay. Yeah. Obviously,

Sierra 15:33

yeah,

Tre (2) 15:34

A combination of these two is how I invest. In fact,

Sierra 15:38

I, I knew it. I was gonna say, I bet

Tre (2) 15:42

for the majority. Okay. Yeah. Alpha seeking strategies. This means, Alpha is returns in excess of the index. So if the index, remember I said you have to, in order to evaluate how well an investment is doing, you have to compare it apples to apples. You can't be comparing two completely different mandates. Right? So if I have a, a US equity strategy. Then I should be comparing my active manager, the person that I'm picking to try to beat the market

Sierra 16:19

mm-hmm. To

Tre (2) 16:20

the market that it's trying to beat.

Sierra 16:22

Right.

Tre (2) 16:22

Okay.

Sierra 16:23

Yeah.

Tre (2) 16:23

Alpha strategies, alpha seeking strategies. Vast, vast majority of them underperform.

Sierra 16:30

I knew I was, again, I was like, I feel like you don't like alpha

Tre (2) 16:34

there. There are some things that they have done much better than others. So something that we have seen them persistently do is help on the downside. So when we, when you look at companies, and that's really where you're gonna get. And hope to get the biggest benefit is them protecting the downside. Because we have seen time and time and time and time and time again that to pick a stock or to pick a handful of stocks that outperforms the overall market is very, very difficult to do. And very difficult to stick with for two major reasons. First off, you have to be willing to stick to that strategy, stick to that thesis. While you are drastically underperforming everybody else. Yeah. Okay. So a lot of people still think of investing as like a January to December 31st type of thing.

Sierra 17:27

Yeah.

Tre (2) 17:28

Because that's just the days on the calendar versus a in much longer timeframe. So to but to stick to an underperforming something that is not even underperforming. They could be performing 5% a year, which isn't bad. But then you compare it to the index, which is up 20%, then suddenly you might want to be, it's looking pretty bad. You're looking pretty bad. Right. So oftentimes we don't have the ability to, to stay in the game for that length of time to really get the benefits of it. Mm-hmm. And then the other thing is cost. Just the, the nature of active management means that there comes a higher cost with it. Mm-hmm. Which means that in order to generate a return in excess of what you would've gotten if you had just. Bought index funds, you have to not only beat the market, you have to beat the market by exponentially more than what you would otherwise had to do. Mm-hmm. So even when it does come down to, or the manager is skilled.

Sierra 18:30

If they're skilled, they're, they're gonna wanna charge more even.

Tre (2) 18:33

Right. And that's where you get, there's plenty of like hedge funds and things like that charge the famous two and twenties, they charge 2% and then 20% of the growth. And it's like, even if they could, guess who's making all the money? They are because like, they're the ones that in order to pay for that skill and all these analysts and all this stuff, you need to pay them. Right. And they don't get, they don't, they're not the, they don't operate on a, on a barista salary, that's for sure. Yeah. So some of the brightest minds in the world go into that section trying to beat the market in certain areas. And again, very few have ever been able to do that consistently over a full market cycle. And you do get the outliers. Warren Buffet is a prime example of that. Warren Buffett has also had significant periods of time where he has underperforms the market. So it's, again, it's one of those things that it can be done. Is it worth the risk of underperforming, which is the most likely outcome

Sierra 19:40

and the time? Again, I don't

Tre (2) 19:41

believe so.

Sierra 19:42

If you're underperforming, you're missing out on time as well'cause of compounding.

Tre (2) 19:46

Absolutely, and I always say my goal is not to get the best possible return because I don't know exactly what's going to get the best possible return. My goal is to minimize the risk of a bad outcome.

Sierra 20:00

Yeah,

Tre (2) 20:01

and it's like when it comes to certain types of risk, I just think the risk of a bad outcome is too high in order for it to be worth the risk when we can just take a much lower risk of an out bad outcome route and almost. As close to guarantee we get to the end result as possible. Right. I would just, I sleep, and that's why I say like I can invest a hundred percent equity and have an iron stomach is not because I am super human. It's just because the way I invest is very different than what would give me the, yeah, the, the scariness of. You know, if I'm, if I'm investing in a company and I have a million dollars in a company and the company drops 50%, I am scared. I'm terrified. If I'm investing in every company in the world and the market's dropped 50%, I don't care. Like something's clearly happening. If that, whatever that is happening destroys the entire global economy. Having my money in cash ain't gonna help me either. So you've got bigger problems. You've got bigger problems. Yeah. So it's not, it's not as, I don't care as much, but if it was a single, if it was a handful of companies, yeah. I'm worried. Yeah. So just the way of investing is important here. Yeah. So that's the, those are the three main types of investing. Mm-hmm. Again, as I've said, I fit more into for a lot of things, but I do use active strategies sometimes. It oftentimes it comes, it's there to reduce the ups and downs of the portfolio and to allow people to stay invested through the ups and the downs, the good and the bad times. Mm-hmm. That's mainly, that's the only reason I would do it. It it is not optimal. I do not use it thinking that it is going to outperform or anything like that. Yeah. It's purely a, I need to make sure that if we are going to be investing this way that you can handle the ups and the downs, and I'll tell him that this is, it is suboptimal. It's likely not gonna work out. But again, if I am gonna use it, then I'm looking at looking to minimize fees as much as possible, right? Mm-hmm. Like some of my strategies are costing, they cost 50% less or more than the average what you would get from other places. Right? So it's like, cost is such a huge factor when it comes to investing. Mm-hmm. But yeah, they're the, the three different types.

Sierra 22:28

So would you say generally your strategy is factor-index, like a combo and index-factor-alpha. If necessary like adding the alpha in?

Tre (2) 22:45

Yes. Basically. Okay. Yeah. It's not a case like, it's not a case of like, the factors are real. It's a case of whether their company can target them appropriately for enough, for a low enough cost for it to be able to outperform. Like there's enough data. We have the data, we know, for example, that small companies outperform.

Sierra 23:07

We've talked about that. Bigger

Tre (2) 23:08

companies. Yeah. And that's just. If you think about it, you know it's true, right? It's like, yeah, it

Sierra 23:12

makes sense when you, it makes actually think about it. Yeah.

Tre (2) 23:15

It's like, okay. Yeah. Well, doubling a doubling Nvidia is a lot harder from a 5 billion, a 5 trillion, sorry, billion small numbers.$5 trillion valuation is much harder than doubling a company from a million dollars to$2 million. Yeah. Right. Like, I don't care what you say, it's just, it is always going to be easier to do that than the other way.

Sierra 23:37

Yeah.

Tre (2) 23:38

It's just a case of if the company can effectively access those sources of those factors. Those sources of extra, extra return. Mm-hmm. So, hmm. Yeah. And again, alpha, when you look at the numbers, numbers are there, we have them, I think it was like 90, 98% or some crazy high of. Of active mutual funds didn't meet their benchmark out underperformed what their index would've been if they'd just bought the index. That is a losing battle, to say the least. Yeah. And then when you look at, again, there's a big study, you might even do a whole episode on that, but even when you look at ones that do outperform, you have to think to yourself, okay, now I need to determine how to find these managers ahead of time. Which again, when you look into it, there is no consistent way to do that. Yeah. So it comes back to the case of, okay, what is going to be the least risk of a bad outcome? And that's really how, how I make decisions is a case of when you look at it, it's like, okay, what's the cost of me being wrong? Okay. Is it really worth it to take that risk?

Sierra 24:53

It almost feels like the alpha one is a little bit of a gamble.

Tre (2) 24:57

It's a gamble that you expect to lose.

Sierra 25:00

Yikes.

Tre (2) 25:01

Right? Like, I'm gonna look into this. I think you might have better odds in Vegas. Hmm. Like literally a roulette table. Would have better odds than you beating the index. Obviously there's different type of risk. You don't lose your money if you don't beat the index.

Sierra 25:17

Yeah. Or

Tre (2) 25:17

different type of risk, but you're

Sierra 25:18

not saying

Tre (2) 25:19

but when you're looking at like, if you're looking at, I think what's a 48% chance at red or 48% chance at black? That's a better, odds than, than beating the market.

Sierra 25:28

Look it up.

Tre (2) 25:29

I'll have to look it up. Yeah. But yeah. Anyway. Okay. Those are the three types. So when you are, when you're comparing, when you're comparing yourself even to a friend or whatever you're doing, just keep in mind that you should be comparing apples to apples. If they have a hundred percent Canadian portfolio over the last year, and you have a hundred percent US portfolio over the last year, odds are. Canadian portfolio outperformed, right? You can, you can't compare a hundred percent Canadian portfolio to a hundred percent US portfolio and, and have a, a realistic conversation about comparing the two because they're completely different portfolios.

Sierra 26:07

That makes sense.

Tre (2) 26:08

Right? But if one of you has a Canadian active manager and a hundred percent Canadian portfolio and the other person is sitting on a hundred percent Canadian index fund. Now you can have a conversation about out performance or under performance, right? Mm-hmm. Yeah. So just when you're comparing it compare apples to apples. Yeah. Okay. That's everything from the episode. Did you have any final questions or anything?

Sierra 26:32

No, that one was quick and easy.

Tre (2) 26:34

Nice. I'm glad you loved that one.

Sierra 26:39

I felt like the beginning I was like, really? I was about to, I felt like I was gonna have a fit of laughter. Like I was a little worried. I was like, pull it together. Now. I'm just tired. You just find it so enjoyable.

Tre (2) 26:51

Yeah,

Sierra 26:52

I do. Okay. I like the podcast.

Tre (2) 26:55

All right, perfect. The next one actually, I, I'm not, I, okay. I'm gonna stop saying what the next one is and we can just,

Sierra 27:02

because then we can pick what we want because I have a giant

Tre (2) 27:04

list and I feel like depending on how you feel, it's kind of like how we should,

Sierra 27:08

yeah.

Tre (2) 27:09

We should vibe it up,

Sierra 27:10

vibe it up,

Tre (2) 27:11

vibe it up. Okay. Anyway, we'll see you guys in the next one.

Sierra 27:16

Bye

Tre (2) 27:17

Bye.