Stocks — Part XVI: Index Funds are really just for lazy people, right?

Ah, no.  Index investing is for people who want the best possible results.

Over the last year or so some of my investing ideas have drawn comment on other blogs and forums.  Lately I’ve noticed that even those folks seeking to compliment me sometimes frame my position on Vanguard and index funds as sound advice only for average people who don’t want to work very hard at investing.  The idea being that with a little more effort in the selection of individual stocks and/or actively managed funds smarter, more diligent folks can do better.

Rubbish!

bruce-lee-flip

I can’t do this. Can you do this?

I can’t pick winning individual stocks and you can’t either. It is vanishingly difficult, expensive and a fool’s errand.  It will erode your returns in such a fashion as to make planning your withdrawal rate a much dicier proposition.

Take a look at this video clip from a few months back and consider Apple, then most valuable company in the world:  http://video.cnbc.com/gallery/?video=3000116834&play=1

These are very smart people being interviewed, with analytical tools us individual investors can only dream about. Apple was trading at 700, clearly on its way to 1000. The interviewer pushes to get even a hint of possible concerns, and good on him for it. But they were absolutely convinced Apple was cheap and a buy at 700. Their reasoning was sound. Yet here it is opening at 442 today. Oops.

Will it go higher from here? Possibly. That’s why people are willing to buy at this level. Will it go lower? Possibly. That’s why an equal number of people are willing to sell at this level. Never lose sight of the fact that anytime you buy or sell a stock, no matter how careful your research and sound your thinking, there is someone on the other side of that trade just as convinced you’re wrong.

As you may know there is a school of thought that suggests that even the super-star investors, think Warren Buffet, are simply lucky.  Even for a hard-core indexer like me, that is tough to wrap my head around.  Yet here’s research that suggests that only the very top-tier of money managers out perform and that when they do it is almost impossible to distinguish skill from luck:   Luck v. Skill in Mutual Fund Performance

Many years ago I had a martial arts instructor who was talking about effective street fighting.  On the subject of high kicks he had this to say:  “Before you decide to use kicking techniques on the street ask yourself this question:  ‘Am I Bruce Lee?’  If the answer is ‘no’ keep your feet on the ground.” Good advice when you’re playing for keeps.

Bruce-Lee

Are you Bruce Lee?

The point is this:  As cool and effective as kicks look in the movies, tournaments and in the dojo, on the street they are very high risk.  Unless you are both very skilled and significantly more skilled than your opponent (something unknowable in street fighting or investing) they are likely to leave you exposed and vulnerable.  Even, and this is critical, if you’ve had success with them before.

So too with investing. Before you start trying to pick individual stocks and/or fund managers ask yourself this simple question:  “Am I Warren Buffett?”  If the answer is “no,” keep your feet firmly on the ground with indexing.  (If the answer is “yes,” it’s nice to have you here, Warren.)

So let me take a moment to be absolutely clear.  I don’t favor indexing just because it is easier, although it is. Or because it is simpler, although it is that too.

I favor it because it is more effective and more powerful in building wealth than the alternatives.

I’d happily put in more effort for more return. More effort for less return? Not so much.

For more:

http://jlcollinsnh.wordpress.com/2012/01/06/index-funds/

http://jlcollinsnh.wordpress.com/2012/01/02/magic-beans/

http://jlcollinsnh.wordpress.com/2011/12/27/dividend-growth-investing/  

Addendum I:

Here’s Jack Bogle on the Market. Bogle is the best thing that ever happened for us small investors. Listen to this five minute interview and take the concepts to heart. On Market Timing: “I’ve been in this business 61 years and I can’t do it. I’ve never met anybody who can do it. I’ve never met anybody who’s met anybody who can do it.”

Addendum II:

In addition to underperforming Index Funds, actively managed funds cost more, and those costs have a very serious and negative impact on your results. My pal Shilpan has a great post on this:  That Mutual Fund is Robbing Your Retirement

Addendum III:

“After reading your series and the Bogle book, I can’t come up with a reason not to pursue a nearly solely index-fund strategy. It is so elegant in its simplicity and it makes intuitive sense to me, and you can outperform nearly everyone else with zero work and nearly zero fees. That’s incredible!” Brad of Richmond Savers

That comment is from an exchange we had on his blog under the post the link will take you to. I can’t say it any more eloquently than that.

Addendum IV:  Warren Buffett’s plan for his widow

 

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