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Don’t Invest in Index Funds

We all know that the best way to take advantage of the tendency of the stock market to gain over time is to invest in index funds [3], right? It makes sense: You get a share of everything on the index, so as the index rises over time, you see increases in your own holdings. Plus, investing in index funds reduces the need to do tons of research — no worries about stock picking and seeing your choices fail miserably. Unfortunately, investing in index funds may not be your best option. When you really think about it, index funds might not be the way to go at all.

Your Index Fund Could Have You Buying High

If your index fund is weighted according to market capitalization, it could mean that you are actually buying high, rather than buying low. When a company becomes more expensive, due to P/E ratios, the index fund needs to increase the holdings in that company — and sell off a cheaper company to do so. Plus, many indices take a long time to get rid of companies that are losing value. One example is General Motors. The company had a share price of $93 in 2000, and then declined steadily. The company wasn’t kicked off the Dow Jones Industrial Average until 2009 — when the share price had plummeted and GM was on the verge of bankruptcy.

Your investment in index funds could actually have you buying high and selling low, which, as you know, is a terrible investment strategy.

There’s Still Risk Involved

While index funds pushers love to tout their relative safety, it’s important to realize that there is still risk associated with index funds. This means that you could still lose out. If the stock market crashes just before you need your retirement account [4], stuffed full of index funds, you’re still out of luck. Sure, index funds are likely to be a good bet long term, but a sudden crash just prior to your golden years of retirement will harm you must as much as the next person, and you’ll have to wait for the market to recover before you see some positive movement in your portfolio.

Why Aren’t You Doing Research?

It seems terribly convenient to invest in index funds because you don’t have to do research. However, you should be research most of your investments. Even if you do invest in index funds, you should be researching them. There are different indices, and they have different holdings, as well as different options for your money. You should know what is on any index you invest in.

Plus, once you realize that research can benefit you, it might become more attractive to you to do some research. Finding individual value stocks at bargain prices can be a bonus, and you might discover that you like dividend stocks [5] as well. A little research can go a long way toward helping you build your wealth through investing. Investing in index funds, though, is just an excuse to be lazy when you should be taking an active interest in your investment portfolio.