When investing, most people think they can find a genius to navigate the shark-infested waters of the stock market.
Pride
Close your eyes and throw a blanket over the stocks on the New York stock exchange. Pretend that you have bought all of them for your investment account.
Sound reckless? It isn’t.
A selection like this (buying all of the stocks in a market) will beat nearly all of the professionals who are paid very large salaries they don’t deserve, to nimbly buy and sell stocks for mutual funds and hedge funds.
Excessive pride and ignorance leads us to look, mostly in vain, for these crafty captains.
But if we swallow our pride and buy a total stock market index such as Vanguard’s Total World Stock Index Fund or Vanguard’s Total U.S. Stock Market Index , that’s it.
Going with one or the other will give you all the stock market exposure you need.
Forget the dancing mutual fund experts. You’ll pay them hidden fees to do worse—and in some cases, a lot worse than the stellar indexed examples above.
Prejudice
Those in the financial service industry will say, “Wait, buying an index fund is too risky. It’s better to buy great mutual funds, run by brilliant managers who can navigate the market’s waters. “
It makes sense, doesn’t it? But the paradoxical reality suggests otherwise.
Do nothing. Buy everything. Beat the pros with indexes.
But what about a falling market?
Finance professionals will suggest that trained fund managers can protect your money during falling markets: that their pulse on the economy will save you; that they can jump out of stocks in the nick of time; that their research and cat-like reflexes can save your money.
An index fund has all of its money in the market, all the time. So it makes sense that having a fund with a manual transmission (and a wily driver) will beat the car on auto-pilot.
If you were investing in mutual funds in 2001, 2002, 2008/2009, your fund values probably dropped heavily. Let out a big roar now. Come on. Let the laughter erupt from your belly. It’s therapeutic. Mutual fund managers can perform no such magic. When stock markets fall, fund investors get hurt.
Proof adding to proof
Since mid April, 2010, the U.S. total stock market index has fallen 8.85%. An investment of $500,000 in a broad U.S. stock market index would be worth $455,741.74. Bummer.
But if you’re a regular reader of this blog, you’ll note that in mid April of this year, I asked readers to give me the names of the best actively managed funds they knew: funds that could leap tall buildings in a single bound, funds that could make you loads of money over the long term, funds with managers smart enough to dodge Wall Street’s bullets so you can dance off into the sunset of your eventual retirement tax haven (Blue Lagoon style) with bucket loads of cash.
I tracked those funds using the portfolio tracker at www.smartmoney.com
The celebrated funds were as follows:
- American Funds Mut;A
- Amer Cent:Hertge;A
- Dodge & Cox Stock
- FMI:Large Cap
- Fidelity Puritan
- Fidelity Sel Energy
- LM CM Value Trust;A
- American Funds NWld;A
- T Rowe Price Eq Inc
- Sound Shore
So, if you bought all ten of them—if you split your $500,000 evenly between these super funds, and held them during a market decline (such as the 8.85% decline of the market index), how much better off would you be?
Answer:
Investing in the total U.S. stock market index would have been better.
Pardon me?
Investing in the total U.S. stock market index would have been better.
Your $500,000 would be worth $454,695.33 with the super funds. With the blanket over the stock market page strategy (the index fund) you would be more than $1,200 better off. Your $500,000 would be worth $455,741.74. And that difference occurred in just 4 short months.
The crazy reality
Professional fund managers, who tap dance in and out of stocks, and in and out of the markets, aren’t able to save your money during market declines. When markets fall, so do their funds. And as a group, they lose to the market indexes during declines (thanks to fees and dancing) and they fall much further behind the indexes during market rises (because they often try jumping their cash reserves into the market after the market has already surged a great deal). Of course, fees and taxes ensure an even larger disparity between actively managed funds and market indexes.
So what do you do?
Swallow your pride. Ignore the prejudice of those whose livelihoods depend on you not knowing the truth. Buy just two indexes:
1. A total bond market fund roughly equalling your age: if you’re 40 years old, have 30% to 40% in this Vanguard bond index, and if you’re 60 years old, have 50% to 60% of your money in this government bond index with Vanguard.
2. And with the remainder, put your money in a U.S. stock market index,or world stock market index.
Buy these through Vanguard.
Take note of these very specific names and symbols. Ignore Vanguard’s other products. Combinations of their other funds at Vanguard can also be good but the endless list of Vanguard’s indexes can be confusing.
Keep it simple. You’ll probably do a heck of a lot better that way.
Live long and prosper with index funds!
