Is an index fund really a pot of gold at the end of the rainbow?
Nothing Tomorrowful said is wrong, but in my perspective the tone of his comment implies that Index Funds, are overly safe. However, I think they are the right choice for virtually any investor. Let me tell you why. There are a number of economists who believe in the Efficient Market Hypothesis. What this means is that the stock market is perfectly efficient and therefore it is only possible to beat it by chance, and beating it long-term is highly unlikely. Most investors believe that the market is not perfectly efficient. Therefore, it seems like you would have a better than 50/50 chance of beating the market. However, there are two main problems to beating the market. First, there are professionals who spend all day, every day, reading and studying, looking for any tiny inefficiencies or arbitrage opportunities, and who pounce on them the second they are available. They act on new information the instant it is announced. So anytime you try and time a stock, or do your own stock picki
I’m a proponent of index fund investing, as I’ve repeated on AskMe many times. But if I could think of one major drawback to that strategy, it is ikkyu2’s point #2 (that an index fund will invest in companies you may consider socially irresponsible). I’d take that concept a bit further and say that passive investing is yet another mechanism that de-democratizes corporate governance. In the case of shareholder votes, shares owned by index funds will mostly likely be voted according by proxy service companies like ISS. Actively managed mutual funds and pension funds also use services like ISS, but at least there’s the possibility for a human to intervene for particularly important votes. I think this is a serious problem for the capital markets, but I don’t think it’s really something that should influence individua
There really is no “catch” … at least, nothing beyond the inherent risks of putting your money in the stock market versus FDIC or Treasury-backed investments. Fund managers will tell you that their managed funds can beat the market. In a limited sense, they are correct: some managed funds do beat the market, and thus market-driven indexes (indices?) like the S&P 500. However, it is extremely difficult — I would say impossible — to know which funds are going to beat the market in a given year. IMO, mutual fund-picking is right up there with stock-picking. In some ways, worse: when you add the ridiculous expenses that managed funds charge you for (generally regardless of the fund’s performance!) they start looking to me like a device for separating fools from their money. If you’re basically a lazy investor (like I am), looking for both the maximum return on your money but also on your time (i.e. you don’t want to spend a lot of time choosing among thousands of managed funds), I don’t
If you do invest in index funds, be sure to pay close attention to the costs of the fund. My personal favorite is Vanguard usually shows up at the top of the list for being a well managed fund family with very low costs. I suggest that you compare them to what ever other funds you are looking at. Remember that costs of a percentage of the total amount invested (not the earnings) so a 0.5% difference in costs could be the difference between a 5% and 5.5% return on your money. One other options if you are going to just buy the shares and let them sit there for years is ETFs, or exchange traded funds. They are about like a mutual fund but you buy and sell the units like stock. This means there is a commission on the purchase and sale but minimal on-going costs. There are also some advantages in terms of timing on your capital gains but that doesn’t matter if the money is in an IRA.
