There’s still this impression in the financial entertainment media that investing in index fund is great for “beginners,” but it’s not something savvy investors do. The reason those articles pop up with such annoying regularity is that trading and investment houses make more money when you trade a lot. That’s also why wispy rumors of gloom so often blow through financial talk shows. It’s all nonsense.
The modern equities market is a marvel of complexity that spans the globe, and yet many approach it as if it were still the relatively simple system we learned about in grade school watching grainy black and white educational films. Big trading houses, hedge fund managers, and investment houses employ the brightest minds in science and technology to analyze, interpret, and anticipate the market with high speed computer systems that manage thousands of trades a second. Any individual investor who thinks they can beat that rigged system reminds me of someone who thinks they could wrestle a bear. Anyone who believes that has never seen a bear in the wild, and doesn’t understand the problem.
Step one in investing is recognizing that you can’t beat the bear in hand-to-hand combat. That realization is marvelously liberating, because it relieves you of the necessity to be the smartest person in the room. When you stop trying to beat the market, it opens the door to investing so that you can at least match the market returns — and you do that with index funds.
Investing on Autopilot
Index funds don’t require a highly paid fund manager, research analysts, or an office staff — just a simple computer algorithm that keeps the fund aligned with the components of the selected index. The lack of management overhead means the investment houses operating the funds can keep management fees at a minimum. Your fortunes rise and fall with the market, and you have history on your side.
courtesy St. Louis Fed.
Worry Less
You can skip the panic if the market crashes; you have the chart on your side. The market crashes, but it comes back up again. Even if the market didn’t come back up, it’s still going to hold some relative value compared to the economy because, when you think about it, an index fund is the economy.
Better Returns
Even funds that do have a highly-paid fund manager and analysts routinely get beat by market index funds. Index fund portfolios outperform managed funds a staggering 82% of the time. The longer investors were in those index funds, the greater the chances of beating the managed funds.
That’s no ding on fund managers, it’s simply a result of our modern global market complexity. There are too many variables, and too much money in the system, to lend itself to any kind of predictability. Even the most sophisticated systems are working on a thin margin, skimming just a few pennies on high speed transactions. All of the programmed trading lends a certain degree of instability to the market, and there’s really no way to predict how that current is going to run.
Flexibility
With the wide array of fund choices available there’s really no reason to put the effort into trying to beat the market, unless you’re doing it for fun. You can have a highly diversified portfolio holding just four fund classes, that might include an S&P 500 index fund, a European stock fund, a small cap fund for growth, and a bond fund as a hedge. On a 10-year investment window, that mix should be good for 7%-10%.
Pulling down 10%, for doing little more than converting oxygen to carbon dioxide, with minimal fees — that sounds like a pretty good deal.