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understanding index funds
Old 07-23-2010, 10:47 PM   #1
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understanding index funds

i just learned about index funds and i've spent the whole day trying to figure them out. i've read a bunch of articles about how they are superior to mutual funds because mutual funds come with expenses that index funds don't. but i have looked at a bunch of index funds and i am not really wowed by their performance. this is probably because i'm very new at this and i'm looking at things the wrong way which is why i'm hoping you guys can help me understand things.

so i was comparing these two funds. this is a vanguard index fund that seems to do okay (im reading it's row as its yearly return, is this right?)
Vanguard Balanced Index (VBINX) Fund Performance and Returns

and here is a latin american mutual fund
Fidelity Advisor Latin America T (FLTTX) Fund Performance and Returns

now it seems like morningstar shows an index fund comparison along side the mutual fund. but as far as i can tell, the mutual fund really out performs both index funds. from 2003-2008 it had returns at 38+ a year. now, i might be totally reading that wrong and i think i am. but even if comparing if im comparing the two funds incorrectly, doesnt morningstar show with its comparison that the index fund is easily beaten? and i think i have seen a lot of funds on morningstar beating their index fund comparison which confuses me as to how index funds are supposedly better.

im hoping you guys can explain it to me because im new at this and struggling with figuring it out.

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Old 07-23-2010, 11:03 PM   #2
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Hi Anders,

You have to compare apples to apples. FLTTX invests in stocks from developing countries (emerging markets) which is a very aggressive investment. VBINX invests in a mixture of 60% large US stocks and 40% bonds which is considered a moderately conservative investment.

So try to compare FLTTX with VEIEX for example. VEIEX is Vanguard's emerging market index fund. Keep in mind, that even that is not a perfect comparison. FLTTX concentrates on South American emerging markets while VEIEX invests in emerging markets from around the world. But it would be a fairer comparison.

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Old 07-24-2010, 05:49 AM   #3
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First, an index fund is a mutual fund. They are both mutual funds. You really are comparing passively-managed index funds with an actively-managed funds.

Second, as FIREdreamer wrote, you need to compare funds with the same asset class or investments in an apples-to-apples comparison. You would not compare a Porsche Cayenne with a Toyota Corolla, would you? They both have 4 tires and a steering wheel, but wouldn't it be better to compare the Corolla to other subcompact cars and the Cayenne to other sport SUVs?

Here's a link for further reading:
Bogleheads :: View topic - Passive works because active doesn?t
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Old 07-24-2010, 07:42 AM   #4
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Anders2010, welcome and good for you for wanting to understand investing better. Most of us were where you are now and many of us have ended up deciding that the Bogleheads have it about right. I'd suggest that you read a few books listed in this link. Many are available at the library or used from an online source.

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Old 07-24-2010, 10:05 AM   #5
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Hi Anders,

Welcome to the forum. As other have mentioned, not all index funds are the same. Different indexes follow different benchmarks (such as a bond index, a Total US Stock index, US SP 500 index, international stock index).

Years back, before I discovered the concept (beauty) of index investing, I used to do what probably a lot of early investors did. That is, go chasing after hot funds. Ended up I had about 20 mutual funds which was totally overkill, not to mention the paperwork and statements in the mail.

Now primarily, I just invest in three indexes (total US stock, total international stock, total bond market) along with a money market fund.

Some have compared indexing as playing the market by not playing. That is, instead of trying to beat the index, just be happy with the index's performance. Another way to think about it is if you were golfing and you always reached par. Even some pro golfers don't reach par consistently, so being average again and again isn't bad at all, but instead, above most of the field.
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Old 07-24-2010, 10:28 AM   #6
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Anders - welcome to the board.

Those actively managed funds you were looking at that were beating the indexes - what time period were you looking at? The danger of investing in an actively managed fund that has been beating the indexes is that you might be arriving at the party too late. Just because a fund has been over-performing doesn't mean it will continue to do so. Often, once a fund has had a good run and everyone finds out, a lot more money flows into the fund as other investors discover it, and the fund manager then has the problem of what to do with all this extra money. It's not always easy for a manager to invest effectively with a sudden influx of money into his fund.

Another potential disadvantage of actively managed funds is that their performance can depend heavily on the fund manager, meaning you need to keep track of who the managers of your funds are and then figure out your next strategy if a manager leaves one of your funds; the next guy might not do such a great job.

If you enjoy doing all this homework, go for it. I don't, so my money is in index funds.
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Old 07-24-2010, 07:35 PM   #7
Confused about dryer sheets
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thanks for all the help guys, I think I'm starting to get it. index funds are the way to go

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