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Don’t Just Buy Index Funds

What would you rather do, throw a ball with your kid or pore over balance sheets and income statements? Would you rather listen to a shareholder meeting or go shopping with your friends? How about enjoying a nice night on the town or checking the latest interest rates? Honestly, I’m pretty sure everyone out there would much rather throw a ball, shop, and enjoy a night out over the alternatives in all three cases and that’s what the driving idea behind advice like “just buy an index fund and do something else with your time.” Honestly, it’s really good advice and that’s why I’m tackling it in the latest edition of the Devil’s Advocate [3]. (The Devil’s Advocate series is a series of posts that tries to argue the other side of “conventional wisdom” or common advice)

There are basically two main arguments against just blindly investing through index funds and they are:

  1. Index funds are not without risk.
  2. Even though you may not like it, you really should be spending time on research.

1. Index funds are not without risk.
Oftentimes people believe that by picking an index fund you’re going with a “safe” investment because you’ll get what the market returns, minus fees. You won’t beat it but you won’t lose to it, so it represents really the “best” that you can get with as little risk, and effort, as possible. Now, in the full specrum of investing options, to say that index funds are not risky would be wrong. With an index fund, you’re still talking about investing in stocks, which always comes with risks.

If you choose, say an S&P 500 index fund, you also run into the issue of country-specific risk – the United States. Depending on what you think your asset allocation should be, you should consider an international component because putting everything in the US is just as bad, from an allocation perspective, as putting it all in stocks or bonds or art or real estate. There are also other types of risk to consider, outside of stock market volatility and country-specific risk, and you don’t get protection from those by picking an index fund.

Even though you may not like it, you really should be spending time on research.

The part of the advice pundits give about index funds, where you get to spend no time on your investments and get to spend it on other things, doesn’t sit well with me. Certainly, if you want to spend absolutely zero time on one of the most important decisions in your life, your investments, then an index fund is definitely your best choice. However, should you be spending zero time on that in the first place? Probably not considering how much time you probably spend researching the other less financially important things in your life.

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This reason doesn’t fit with the two main reasons why going with all index funds might be a bad idea but it’s definitely a “soft” reason why you should consider life outside of index funds. Part of the fun of investing is learning about companies, learning about industries, and learning about other countries and cultures. At the end of the day, you might read a lot of news articles or annual reports about Company X and decide that investing in them isn’t right for you right now, but you’ve still learned a tremendous amount about how Company X does business, how that industry does business, and it could pay dividends down the road. Along the way, you’ll also learn a lot about investing in general and it will help make you a more well-rounded person from both a financial and cultural perspective. Certainly, if investing is boring to you and you don’t ever want anything to do with an annual report or a balance sheet then slogging through them isn’t right for you.

What do you think? Are these reasons against index funds legit or was it a bunch of crap? Do you have any on your mind that trump these? Please let me know!