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?

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