30 reasons to fall in love with index funds

[Live And Learn]

Reason number 1 to not love index funds: 20-year-old FOREX traders will mock you for being satisfied with mediocrity.

LOL. Then I shall be mocked ! I am 90% index funds and I love the low fees and relatively good built in diversification. It also means I don't have to watch as an individual stock falls from 10x to x and sweat when to make sell decisions. With index funds its all in the rebalancing for me.

 

[NW-Bound]

I went to the Greyhound race once in my life. Made a $10 bet, knowing nothing about dog races. Of course I lost it. Did not see any potential for fun there.

I felt the same way at the casino. If I learned to play poker, I guess I might feel differently. But to sit at a slot machine, well, I think there are computer simulations one can run on a PC, which give just as random results. So, why is that fun?

 

[Live And Learn]

How did you folks convert from Index funds to W&W in your taxable account at retirement ? Wouldn't that have led to large cap gains recognition ?

 

[REWahoo]

How did you folks convert from Index funds to W&W in your taxable account at retirement ?

My conversion was entirely in my 401k/IRA account. I spent most of my taxable savings between retirement and age 59.5.

 

[mathjak107]

while i do like index funds my managed portfolio has done better than the hypothetical etf mix i track for comparison.

but if there is one thing i don't love about indexing it is there is a good chance it will be a means to its own end.

with only 26% of fund investors it hasn't been an issue yet but the more successful it gets the more over valued those issues will be relative to stocks not in the index. eventually value will be anywhere but in the indexes.

one thing i did notice at fidelity the last few years is large cap funds have been greatly beating their index .

some interesting results have already started to take shape at fidelity, i would imagine other fund families are seeing similiar results.

i only follow fidelity funds so i can only talk about their results.


looking at some of the 2013 results.

out of 26 fidelity large cap funds only 6 failed to beat the s&p 500.

mid caps again saw most of fidelity's funds beat the Russell mid cap index.


looking back to 2012 at fidelity we had 27 large cap funds ,21 beat the s&p 500


2011 saw the s&p beat all but 2 of fidelitys large cap funds


2010 saw out of 27 funds, 21 again beat the s&p 500

that is all i have access to in the archives .

so out of the last 4 years you had the index win once and the managed funds win 3x

i guess the last 4 years we can say managed large cap funds at fidelity have beaten indexing 75% of the time but more important the number of funds beating the index has been near land slide except 1 year..


who knows if the tide is turning and things will now be a stock pickers market but it certainly bares watching to see if indexing and valuations are starting to affect the typical results we are used to which is indexing usually wins.

 

[panacea]

I have a mix b/t index and active funds. I mostly like indexing for US large caps and also for some mid caps, whereas I think some discretion in international, and US small caps can be valuable, especially during market downturns.

 

[Gumby]

All I want is money. If it makes me money, I want it. All I love is money.

I hear you. My goal is to have more money at the end of the year than I had at the beginning, and I don't particularly care how I get there. Over the years, I've maintained an ever shifting variety of index funds, actively managed funds, ETFs, MLPs, individual stocks/bonds, foreign currencies, CDs, REITs and other things.

 

[CyberBob]

You don't have any index funds at all? I know you've mentioned the two W's, but is that it?

Apparently, a W fund is kind of like an index fund, since Jack Bogle recently stated:

In Wellington Fund's case, in the last decade 97% of its return has been determined by the return of the index I put together for them in 1978.​

John Bogle: Vanguard Founder Discusses How To Invest - NASDAQ.com

Bob

 

[nash031]

who knows if the tide is turning and things will now be a stock pickers market but it certainly bares watching to see if indexing and valuations are starting to affect the typical results we are used to which is indexing usually wins.

Historically, active management can succeed in beating indexing in bull markets. The problem is that when it underperforms (either in a bear or a stagnant market) it REALLY underperforms, and then you're usually paying 1-2% off the top whether it does well or not.

The key is over the long term (decades), indexing wins 80% or more of the time, even before fees and expenses. One three or four-year bull period is not what most indexers are interested in.

 

[mathjak107]

historically what was, may change as indexing becomes more and more popular which was why I think it may be an end to its own performance.

in fact based on fidelity's recent results maybe it already has started shifting.

time will tell.

 

[jollystomper]

I started my 401K in 1984 with 2 index funds (total stock market and bond) and (as MegaCorp added additional options) shifted to 4 index funds (Large stock, small/midcap, bond, international) by 1994, and have kept it like that. I just decided I'd be better off matching the market for my 401K since it is a long term thing, and I haven't been disappointed.

Perhaps (just a speculation on my part) index funds work bet in conjunction with consistent dollar cost averaging over the long term. The combination has really boosted my 401K over 30 decades, and with the level of my investment risk tolerance I'm happy hitting "singles" instead of trying to swing for the fences.

 

[NW-Bound]

Historically, active management can succeed in beating indexing in bull markets. The problem is that when it underperforms (either in a bear or a stagnant market) it REALLY underperforms, and then you're usually paying 1-2% off the top whether it does well or not.

The key is over the long term (decades), indexing wins 80% or more of the time, even before fees and expenses. One three or four-year bull period is not what most indexers are interested in.

Yes, the problem with managed funds is that when hot sectors turn cold, the door is suddenly too narrow for them to exit all at once.

As an individual stock holder, I like the more visibility I get into the individual sectors of the market. I can see when people bid up hot stocks, and when they either have enough and decide to bail.

It is interesting to watch individual stocls. But I want to stress that it is not that easy to make money of this. Not at all. One may sell out too soon, then does not know what to do with the money. Or plunk money in a sector that is deserted, and sit there for a few years while the market is rising and leaving you behind.

 

[ERD50]

while i do like index funds my managed portfolio has done better than the hypothetical etf mix i track for comparison.

but if there is one thing i don't love about indexing it is there is a good chance it will be a means to its own end.

with only 26% of fund investors it hasn't been an issue yet but the more successful it gets the more over valued those issues will be relative to stocks not in the index. eventually value will be anywhere but in the indexes.

....

who knows if the tide is turning and things will now be a stock pickers market but it certainly bares watching to see if indexing and valuations are starting to affect the typical results we are used to which is indexing usually wins.

Interesting idea, and certainly possible (I guess, but maybe not, due to the size of the market?).

But no doubt we will hear about it if it happens. The bogleheads and other indexers will have plenty of salespeople and 'internet experts' (and maybe a few FOREX traders) loudly pointing out how the indexers are finally wrong, after all these years (we told you!).

If/when that happens, I may be too old to be aware enough to make changes. But maybe the disadvantage would be slight, and not a big deal at that point?

-ERD50

 

[photoguy]

historically what was, may change as indexing becomes more and more popular which was why I think it may be an end to its own performance.

The market is a feedback system, so if pricing ever becomes even slightly out of whack because too much money is in indexes, investors will move to take advantage of the anomaly and quickly eliminate it. Given the lengths traders will go to for the *tiniest* gain (or perceived possible gain), I don't think indexing's dominance will ever end.

in fact based on fidelity's recent results maybe it already has started shifting.

The fidelity results need to be properly normalized against some kind of factor model. Otherwise there's just too much slop in what is a "comparable" fund.

 

[NW-Bound]

I hear you. My goal is to have more money at the end of the year than I had at the beginning, and I don't particularly care how I get there. Over the years, I've maintained an ever shifting variety of index funds, actively managed funds, ETFs, MLPs, individual stocks/bonds, foreign currencies, CDs, REITs and other things.

I do not know what turnover you have, but mine is actually very low. Wellesley looks like a day trader compared to me. I am kicking myself now for bailing out of some sectors too soon earlier this year, and left behind 50-60% gains. I am not as aggressive as I used to be, and that is a good thing, I think.

 

[ERD50]

Historically, active management can succeed in beating indexing in bull markets. ...

'Can', or 'does' (on average)? I don't recall seeing data on this, I'm guessing you'd still need some luck in picking the active funds that will outperform in a bull (before they outperform, not in hindsight).

The problem is that when it underperforms (either in a bear or a stagnant market) it REALLY underperforms,

So in addition, you'd have to predict the bull/bear cycles to avoid wiping out your 'excess' gains! That alone could really help an investor, index or not.

This sounds like a rear-view mirror analysis, not something we can take advantage of going forward?

-ERD50

 

[CaliforniaMan]

Interesting idea, and certainly possible (I guess, but maybe not, due to the size of the market?).

But no doubt we will hear about it if it happens. The bogleheads and other indexers will have plenty of salespeople and 'internet experts' (and maybe a few FOREX traders) loudly pointing out how the indexers are finally wrong, after all these years (we told you!).

If/when that happens, I may be too old to be aware enough to make changes. But maybe the disadvantage would be slight, and not a big deal at that point?

-ERD50

The market is a feedback system, so if pricing ever becomes even slightly out of whack because too much money is in indexes, investors will move to take advantage of the anomaly and quickly eliminate it. Given the lengths traders will go to for the *tiniest* gain (or perceived possible gain), I don't think indexing's dominance will ever end.



The fidelity results need to be properly normalized against some kind of factor model. Otherwise there's just too much slop in what is a "comparable" fund.

Like many others here I have been in index funds a long time, and often wondered 'what if everybody did it'? Let's take it to the extreme. At that point (at the of course theoretical extreme), who would price the stocks? People just buy and hold a piece of everything until they need the cash for expenses and then sell. There is no trading, no way to price equities, and no efficiency. Then what would happen?

Well then someone (assuming not everyone is an automaton) would see that one company is actually worth much more than its market price, and buy that company. Now they could go back on the market and sell the stock again if they want (of course it goes into the index) or just keep pocketing the dividends. I think eventually you get to the point that indexing cannot fail, because you cannot invent a system whereby enough people index to make it fail. You would have to eliminate all logic, greed, and hubris to make that happen.

I do believe that there is enough logic, greed and hubris to keep the market functioning relatively efficiently for a very long time, at least longer than my time frame.

 

[mathjak107]

'Can', or 'does' (on average)? I don't recall seeing data on this, I'm guessing you'd still need some luck in picking the active funds that will outperform in a bull (before they outperform, not in hindsight).


So in addition, you'd have to predict the bull/bear cycles to avoid wiping out your 'excess' gains! That alone could really help an investor, index or not.

This sounds like a rear-view mirror analysis, not something we can take advantage of going forward?

-ERD50

The reverse could be true too.

if enough managed funds are able to find where values lie if indexing becomes overvalued then you would be taking the long shot that indexing wouldn't beat your managed fund statistically.

lets look at last year as an example not that one year means anything.

statistically with 21 out of 26 large cap funds beating the index the odds are pretty good just picking one blindly that you will beat the s&p 500.

that makes indexing odds quite poor at beating those managed funds.

see how it goes both ways?

 

[devans0]

historically what was, may change as indexing becomes more and more popular which was why I think it may be an end to its own performance.

in fact based on fidelity's recent results maybe it already has started shifting.

time will tell.

I don't see how this can happen. Selective pump and dump on a massive scale? By the very act of trading, they adjust the prices and are assimilated into the Borg.

I have consciously set my asset allocations to reflect global market capitalization. To the degree that I succeed, my goal is to average out the highs and lows of various sectors, so that if one index is out of favor, another will pick up the slack. If there are flaws in my strategy, I'd love to hear about them.

 

[nash031]

The market is a feedback system, so if pricing ever becomes even slightly out of whack because too much money is in indexes, investors will move to take advantage of the anomaly and quickly eliminate it. Given the lengths traders will go to for the *tiniest* gain (or perceived possible gain), I don't think indexing's dominance will ever end.


The fidelity results need to be properly normalized against some kind of factor model. Otherwise there's just too much slop in what is a "comparable" fund.

The first paragraph speaks to the paradox of indexing: in order to be really successful, it almost requires that timers and traders continue to time and trade.

The second I agree with, essentially saying that three bull years is too short a period to declare any kind of trend. It's akin to declaring gold the best investment vehicle around just by looking at its performance around three years ago. I'm interested in what I can do to make a good return over 30 years, not 3... and in that regard, I understand the impact of a 1% expense ratio against a 0.1% ER... that is where indexing wins me over. It's like racing a triathlon without having to do the swim leg: a few might catch me, but most will not.

 

[nash031]

that makes indexing odds quite poor at beating those managed funds.

... for that year that's already passed. The point ERD is making, and I agree, is that your chances of guessing which funds may or may not beat the benchmark each year get less and less as you try to do it year after year (or period after period). Last year, you had an 80% chance of picking a large cap managed fund that beat the index, but that percentage changes every year, certainly many years being significantly less.

So first, you have to pick the sector (large cap, small cap, int'l, etc.) that will out perform, THEN you have to pick a fund that will outperform. And then you have to repeat it.

When you start to factor the odds of getting that choice right all or most of the time, coupled with the head start you get due to exceptionally low expenses with indexing, I'll take indexing every time. Recall that part of the benefit of indexing is the "set it and forget it" ability with your portfolio. Certainly if you're desperately seeking index-beating returns, indexing isn't for you, but most indexers are satisfied with above average returns, low expenses, small tax obligations from dividends, and ease of use.

(Note: "average" is not defined by the index, IMO.)

Either way, one should be planning with a number (i.e. 6% pre-inflation return, or 3% real return, etc.) rather than saying "assuming S&P returns" or "assuming 1% over S&P returns." How you get there... well, that's up to the individual!

 

[NW-Bound]

The main reason I do not like index investing is that it keeps pumping money into stocks that have risen, while taking money from stocks that have declined. Yes, stock prices usually rise for good fundamental reasons, but buying indiscriminately often drive them to stratospheric levels, causing greater crashes later on.

Hot MFs that beat indexing usually chase hot stocks and overweigh these sectors compared to the index. On the other hand, conservative MF managers who also do not index look for contrarian plays. These conservative managers will trail the index in bull years, but will not give back all the gains in a crash like hotshot managers do. They are the true tortoise in my view.

 

[easysurfer]

I have both active and indexed.

I also liked both Ginger and Mary Ann.

btw..Surveys say most guys like Mary Ann

 

[Gumby]

I do not know what turnover you have, but mine is actually very low. Wellesley looks like a day trader compared to me. I am kicking myself now for bailing out of some sectors too soon earlier this year, and left behind 50-60% gains. I am not as aggressive as I used to be, and that is a good thing, I think.

I actually have low turnover. It is mostly a question of directing new contributions.

Doing nothing has often proved to be the best course of action for me.

 

[ejman]

I've grown a bit concerned that over the years W&W have grown to be 34% of my total liquid NW so I decided in my last rebalance in 2013 to do so into Vanguard Target Retirement Income which is composed of all index funds but a roughly similar AA to Wellesley instead. Oy vey - I don't know what pixie dust gets bestowed upon W&W but it doesn't extend to the index funds that make up the ending Target Retirement fund.