Devil's Advocate 

Don’t Just Buy Index Funds

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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.

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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!


What’s $50 Per Month Worth In Long-Term Savings?

One mindset that is crucial to increasing your wealth is to stop thinking linearly and thinking in “compound” terms. Previously, I’ve discussed how it’s easy to believe that saving $50 or $100/month is not much and thus not worth doing. But that is thinking linearly. Let’s look at saving $50/m over 10 years, using a variety of investment vehicles. Fifty dollars becomes a lot more than you’d think. No amount is too small to save, and fifty dollars is a lot easier to save than a hundred, if you’re struggling. Or undisciplined.

Here’s the general plan: stop thinking linearly and save at the highest rates you can find, without paying ridiculous service fees or penalties. Pretty simple plan, right?

Sure, 10 years X 12 months a year X $50 per month is only $6,000. That’s still $6,000 you wouldn’t otherwise have saved but if you leverage your savings by using online savings accounts, money market accounts or funds, CDs, index mutual funds, and maybe later on, stocks or DRiPs (Dividend Reinvestment Plans), you’ll have more than $6,000 saved in the same time period. Or you could eat that $6,000 in extra donuts and coffee every day for the next ten years. You choose.

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Read The Kirk Report

Who is Charles E. Kirk of the Kirk Report? He’s just a regular guy who started his own stock newsletter (MoneyXperts), has a JD and a B.S. in Philosophy, worked as a private investigator for a law firm, and has traded stocks for a living for the last 10 years. What does that mean for you? It means this guy knows how to write about the markets, knows more about the markets than you do, and it’s worth it to you to read his site. While his site is totally free, he has a member’s only site, and it’s the only member’s site I’ve ever joined in my entire life. I gave him $50 of my hard earned money because he puts out solid stuff.

In general, I don’t use his stock picks or his advice, but I find that his news recaps (Kirk At Work posts) where they lists approximately 30 news articles, and a sprinkling of quotes, are invaluable. Everyone can find the articles on CNNMoney and Yahoo! Finance, he only links to good ones, but the ones that are gems are to primo blogs you’ve never heard of, resource websites you’ve never seen before, articles you’re bound to miss on some brokerage website, and more. The best part is that this list is free daily.

On average I’d say he posts four times daily – one pre-market, one post-market, a Kirk At Work, and perhaps a couple other little posts analyzing particular stocks. Just reading the free public information will give you a leg up on most folks.

What’s in the member’s only site? I have to say it’s not as valuable to me, but I expected that. He has his portfolio, updated daily instead of monthly, and has monthly Q&A’s where you ask him or an industry professional. You also get daily private notes on what he’s thinking about particular stocks.

For $50, you get access to the member’s site but I saw it as giving the man compensation for his Kirk At Work reports and his public data. When you think about it, it amounts to like fourteen cents a day and zero cents if you don’t donate anything.

The Kirk Report isn’t giving me anything for this endorsement, I just like his site alot and think you should read it.


Morningstar Investing Classroom

I wish I had learned about these resources years ago because like most folks, I learned how to trade stocks in bits and pieces – never took a course, never really read a soup-to-nuts book, and never talked to an advisor of any kind. It’s amazing Morningstar offers these for free. They bill the Morningstar Investment Classroom the “best place to sharpen your investing skills and pick up new ones. Whether you’re a novice, an experienced investor, or someplace in-between, we can help you…” It’s a collection of 172 courses on stocks, funds, bonds, and portfolio management which each are only supposed to take ten minutes each. After each “course” you take a small quiz and earn points that you can redeem for free merchandise. I decided to give it a whirl.

Each classroom has five levels of courses, 100-level to 500-level, and you’re permitted to jump to any course at anytime, so you won’t need to finish all 100-levels to take a 200-level. That sort of flexibility is nice because novices can start early and the more experienced can jump straight to what they don’t already know. Personally, I decided to take each course in order just so I was sure the foundation they wanted me to learn was established before I tackled harder topics. Well, I skipped straight to the quiz for a few 100-levelers. 🙂

When you take the quizzes, you earn a points for each correct answer and some of the prizes you can earn are a coffee cup (300 pts), “The Five Rules for Successful Stock Investing” and other books (400 pts), Morningstar Premium Membership or a T-Shirt (650 pts), FundInvestor or StockInvestor subscription (800 pts). The prizes are nice because they’re free and you’re also learning some solid information while you’re going along – a win-win situation so to speak. Give it a shot, you can take the courses without registering but you won’t earn points (they have to keep record of it somehow), maybe you’ll even learn something…

Have any of you taken these lessons or know of any of the other free “classroom” type resources out there?


ETFs and Mutual Funds – Empowering Average Joe Trader

Let’s be honest… the average Joe Trade is awful at picking stocks. I am awful at picking stocks (don’t ever listen to my stock suggestions). Everyone I know is awful at picking stocks… but everyone knows what the hot sectors are these days right? During the Internet boom, everyone knew Internet stocks were crazy! Get in on the IPO and get rich! The problem was Joe Trader picked a stock, it tanked, he (or she) was burned, and quit trading all together. Diversification is Joe Trader’s best friend and ETFs/Mutual Funds allow Joe Trader to capitalize on the “hot sector” concept without swinging at the blazing fastball and striking out miserably. ETFs are like fast moving mutual funds because you can trade them throughout the day, whereas with a mutual fund you need to wait until the end of the day. That’s why ETFs are becoming more popular.

Yahoo! Finance has a great section on ETFs (Exchange Traded Funds). Morningstar has a very good ETF section as well. Read them and understand them thoroughly because I’m not going go into them in detail. The main difference is that ETFs have intraday prices and trade like stocks (with commission fees too!) whereas mutual funds are traded using end of the day prices.

Money is rushing into ETFs like crazy, ETF assets grew 47% to $222 billion, according to Morningstar. (Article, requires free registration, use BugMeNot) Why? Because ETFs empower the regular trader and allows them to invest in a “hot sector” with little work involved. Do you believe, like everyone, that Biotech and Energy are hot? Invest in an Energy-ish ETF. Right now they top Morningstar’s lists of great performers.

There are downsides to ETFs, mostly regarding commission fees eating into your return, so do your due diligence. Allow this article to open your mind to the concept of ETFs and what they can do for the average trader. Instead of pumping all your cash into Company X because you believe that sector is hot, you can consider pumping it into an ETF for that sector instead.


Vanguard Target Retirement Funds Explained

There has been some interest in an explanation of how the Vanguard Target Retirement Funds work since I mentioned them in an explanation about Mutual Funds in a past article (read The Beauty of Mutual Funds). In this article, I’ll give you a little explanation of how these funds work and what you might expect from them (past performance is not an indicator of future performance!).

They’re in the asset class titled “Lifecycle” by Vanguard and several other brokerage houses have very similarly structured, lifecycle mutual funds (Fidelity has the Fidelity Freedom Funds if that rings a bell). The concept is as the target date draws closer, the fund will invest in increasingly stable investments that have higher yields. Vanguard recommends the lifecycle funds for those seeking “an all-in-one retirement portfolio that automatically grows more conservative as their expected retirement date nears…”

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The Beauty of Mutual Funds

The two tenets of investing in the stock market are: “Diversification” and “Buy Low, Sell High.” Simple in spirit, difficult in execution. Mutual funds help you with the first rule of “diversification”, but you’re on your own with “buy low, sell high.” You’ve probably heard of mutual funds before and chances you may even own shares in a mutual fund, but do you really understand how they operate? What’s the load on your fund? Who is the investment manager and what is his or her track record?

A mutual fund is technically a company that holds a portfolio of investments; sometimes people refer to the mutual fund as the portfolio itself. The distinction is minor and not terribly important, but for clarity’s sake the fund actually refers to the “company.” A professional investment manager who manages the various securities held by the fund in its portfolio, that’s how a fund brings “automatic” diversification, runs the fund itself. When you invest in a fund, you’re purchasing shares of the company just as you would with the shares of any other public company.

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