In my post yesterday I pointed out several things that were wrong in a recent Investopedia article against index investing. While the article doesn’t portray the true risks of index and active funds, it makes several other points about indexes as well that might make them sound bad to an uninformed investor.
One of the later items in the article is about limited strategies. With an index fund you’re forced to follow the whole market instead of choosing a specific investing strategy. In a way this is wrong - an index gives you access to every strategy currently being used (on average)! That being said, this limitation is protection for many investors since the average “strategy” can only hope to match the index if it has no additional fees or taxes.
The mention that you can’t adjust your portfolio if one sector of the market is overvalued or undervalued is true, but most investors are better off not even trying this as it would require a level of research similar to picking individual stocks. With any of these types of strategies there are a few investors who will want to avoid index funds but most people who find the idea appealing wouldn’t be able to keep up with everything they need to know.
The last point about having less satisfaction may also be true – but as Ramit from I Will Teach You To Be Rich says, would you rather be sexy or rich? You could feel more satisfaction from working hard to get a 3% gain trading individual stocks than a passive real return of 6% over 30 years from a simple indexing strategy that you spend less than an hour a month on. I may not get too excited about my investment strategies but that leaves me more time to get excited about what I can do with the profits. It must be hard to feel the ”satisfaction of being successful with your money” when you have to keep up with what’s happening every day.
Although this article repeats many commonly-held beliefs, they are mostly wrong. Index funds have inherent risk like all equity investments, which active management can’t avoid. If you want to lower the volatility you can prevent losses but it will cost you lower returns. Many people don’t want to have too much excitement from managing their money - I have some interest in finance but it’s still just as important to end up with something you can use for other purposes. What do you think; are any of the reasons given for avoiding index funds valid or do they just point towards buying more bonds?
April 28, 2009 at 8:11 pm
Are index funds really so boring?
I bet that there are a lot of people who held index funds in the late 1990s (when stocks were going up by 20 percent per year) who didn’t find index funds one bit boring at the time. And I bet that there are a lot of people who held index funds last year who didn’t find it a boring experience to see their retirement plans imperiled.
I view this “index funds are boring” idea as a marketing gimmick. It’s reverse psychology. We are supposed to think “oh, some think indexing is boring, but I am so smart and virtuous that I am above all that and so I can index.”
There’s nothing wrong with indexing. It is a wonderful option that provides huge diversification at little risk. I just don’t like the marketing attached to indexing. People who buy indexes are not less inclined to Get Rich Quick thinking than those who do not, in my experience. They just want to pursue Get Rich Quick schemes (or not do so) in a different way than those who invest through other vehicles.
Indexing became popular during a time when indexing brought easy money. That doesn’t mean that indexing is bad (I love indexing). But it suggests that people are drawn to indexing for the same reasons that people are drawn to most other investment choices — a combination of healthy and unhealthy motives.
Rob
April 29, 2009 at 1:37 am
It’s true, index funds can give you periods of excitement (if you can fall asleep at night you must be bored I guess). But actively managed funds seem to have a lot more potential for that type of excitement. And if you switch funds every year you can keep up with the latest strategies to keep you awake.
Indexing doesn’t seem to have as long a history as the rise and fall of interest in the stock market in general so it’s hard to tell what the future will bring. Since it was a relatively new concept before that maybe it still has room to grow. In the end if someone really wants to buy into something they don’t understand, whether they can use index funds or they have to pick individual securities won’t make much of a difference.