3 Reasons Why I Love Index Funds

We live in a society where we are taught that we should try to be the best. Be #1 in your class, rise through the ranks of your company and be the best that you can be, be the fastest, smartest, or strongest, best best best. While I agree, we should always try to be the best, the point of investing isn’t to get the highest return, what most consider to be the best, but it is instead of get the highest return for what you’re willing to put into the process and what you’re willing to risk.

I used to read news articles, annual reports, and all those financial pieces on various companies, trying to glean bits of information and figuring out if I could get an edge over the market. I had the time to do that because I was in college, but now? Forget it, reading annual reports? Scouring balance sheets and income statements? No thanks.

So, that’s when mutual funds come into play. You have research without all the hard work of research. You also have diversification (hopefully they’re not diversifying in the general population’s understanding of diversification and actually diversifying and taking into account co-variance and blah blah) without the hard work of actually calculating anything out. The only downside of mutual funds is that very few exceed the market and all are more expensive than index funds.

So, that’s when I moved onto index funds and target retirement funds. The problem with index funds is the geographic and equity exposure. If you’re in an S&P 500 Index fund, you’re in all stocks and you’re in all USA. USA is a wonderful country, man I love it here, but our dollar is getting pummeled because of the trade imbalance and the nearly universal hatred of our President (I voted for him twice, thank you very much), and so you don’t want 100% national exposure. So I’m in target retirement fund to get out of all equity and I’m also in some emerging markets to give me some exposure to EAFE (Europe, Australasia, and Far East).

The beauty of the index fund and target retirement funds is that they are cheap, they are easy, and they will give me at least the market average in returns every single time. The expense ratios are generally tiny for index funds and relatively low on the target retirement funds (not so on emerging markets). In terms of easy, they require no work on my part. I can do something else with that time, even if it is lounging around doing absolutely nothing and being worthless. As for the market average returns, well I think the index fund really speaks for itself on that one. So really, it’s three beauties at once and I love it.

 Devil's Advocate 

Don’t Just Buy Index Funds

Devils Advocate Logo
This is a Devil's Advocate post.

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. (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.

You might like it…
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!

Advertising Disclosure: Bargaineering may be compensated in exchange for featured placement of certain sponsored products and services, or your clicking on links posted on this website.
About | Contact Me | Privacy Policy/Your California Privacy Rights | Terms of Use | Press
Copyright © 2016 by All rights reserved.