Author Topic: ERE and Index Funds?  (Read 4906 times)

SethBahookey

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ERE and Index Funds?
« on: March 07, 2014, 08:53:24 AM »
Hey All,

I've been investing in some index funds now for almost a year. I think the idea of these funds are great, but I find it a bit unsettling that you just "set it and forget it". Either way I try not to let those feelings get in the way as I keep pouring a lot of my money into them as that is what every successful investor advocates, don't let emotions get in the way!

Regardless, I've been going around on a lot of forums and still doing some more research into them because I just feel like I need to get a really good grasp on this stuff so I don't somehow end up screwing myself over by just listening to the masses screaming "buy index funds buy index funds!!!"

On Jacobs site with ERE earlyretirementextreme.com - he really bashes index funds quite a bit. Almost for the same reason above that makes it a bit unsettling for me. The whole idea of just passively putting money into something and not really having any control over it.

Look at Jacob's most recent post that is up today. Again, just talking down index funds.

So what do you guys think? Most all these forums advocate index funds except for ERE which is the main forum that got me into this stuff to begin with.


sherr

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Re: ERE and Index Funds?
« Reply #1 on: March 07, 2014, 09:21:53 AM »
But he's not really down in index funds, he's merely saying that the current rate of economic growth is unsustainable and that index funds are not a magic solution to that problem.

His point is that we've grown all we can, and there's going to have to be a flattening out at some point. He may be right or he may not be, new technologies may provide room for growth in areas that previously were completely untouchable.

He only mentions index funds really two times. The first time is implicitly, but I think it's a fair assumption that index funds are what he's talking about:

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The reason for the popularity is that the simplifying assumptions behind the concept are easy to understand, which has made it possible for Nobel Prize winners to write academic papers on the subject; investing requires very little effort; and it has given Wall Street a new product to sell to Main Street. Who me, cynic?

Here I think he really is being overly cynical, which he himself admits as a possibility. Just because something is simple does not mean that it is worse than something more complex. And actually Wall Street hates index funds precisely because they can't make any money at it. The difference between being able to charge 2% / year in fees vs 0.1% / year is enormous. So I see no basis to this objection, merely an overly cynical rant.

Secondly:
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The final edge is that the magic of compound interest is especially magical when it benefits the few in such a way that it transfers wealth from consumers to capitalists. If everybody becomes a capitalist this wouldn’t work. For instance, when demand for bonds increase, the interest rate drops because the price goes up. Thus if everybody bought bonds, the interest rate would drop and returns would be less. Similarly, if everybody bought stocks, the price level would increase and reduce further appreciation potential. Blindly buying index funds only ensures that stocks are mispriced in the aggregate — although their will be internally diversified, diversification does NOT eliminate systemic risk, which is exactly the kind of risk that the index fund investing is currently creating (see here for more).

His point here is that even though index funds may diversified across the stock market that does not protect you from systemic risk; ie what if all stocks are over-valued with respect to bonds / gold / real estate / whatever. That's absolutely true, and that's why it's not wise to have an asset allocation of 100% stocks.

But even so, he's not really down on index funds specifically, he's down on everyone investing only in the stock market. Does he say index funds are a bad investment compared to managed funds? No. Does he propose a better system to use instead of index funds? No.

In summary I'd say he's making two points:
1) He thinks that the current rate of economic growth is unsustainable and that if you're relying solely on things continuing the way they have been for the last 100 years you may be in for a bit of a rough patch.
2) He thinks that index funds are not a magic solution to #1, nor are they a magic replacement for having a reasonable asset allocation.

#1 may or may not be true. #2 definitely is. So by all means keep on reading and learning and exploring, and continue basing your investments on rationality not on emotion and as part of that read up on asset allocations and find one that works for you.
« Last Edit: March 07, 2014, 09:25:00 AM by sherr »

wtjbatman

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Re: ERE and Index Funds?
« Reply #2 on: March 07, 2014, 09:27:03 AM »
Jacob is great at talking about pan-human scenarios that may or may not occur in... well let's just say a very long time frame. Hundreds of years. He talks about the system breaking down if everyone switches from being consumers to capitalists. Do you think the majority of people around you are ready to stop becoming consumers?

Yeah I didn't think so either. The success of index investing may be assumed based partially on past returns, but that doesn't mean it won't be successful in the future either. And if it's only half as successful as it was in the past, then you will adjust your savings/investments/retirement strategy accordingly.

SethBahookey

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Re: ERE and Index Funds?
« Reply #3 on: March 07, 2014, 09:35:50 AM »
Good points! Thanks guys. I wasn't sure which verb to use as I think that the responses I receive from my posts usually focus on the way I assume something aka me saying "bash" than the actual question i.e. "are index funds good?".

So it's not that he "bashes" them, but I do feel like out of all the ER blogs he puts them down more than other, and so do a lot of his followers (just read the forums).

That's why I was second guessing myself.. and at this point I only have 17-18K in investments so I'm not sure how much my AA will matter at this point, and I'm only 27.. I want to go very aggressive in my younger years, and eventually I'll put more towards bonds and that stuff later down the road.

MrCash

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Re: ERE and Index Funds?
« Reply #4 on: March 07, 2014, 11:51:12 AM »
You mention that you're worried about the lack of control with index funds.  Just remember that you do have control over the asset allocation of your portfolio, even if you are using all index funds.  And you will probably want to adjust the asset allocation as your situation changes to ensure that you maintain an appropriate amount of risk.  You also need to keep your portfolio balanced according to your asset allocation.  This may require more work if you are using index ETFs.  So even if you have a very simple index portfolio, it will not be a simple set and forget situation.

MooseOutFront

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Re: ERE and Index Funds?
« Reply #5 on: March 07, 2014, 01:00:49 PM »
I've recently finished Jacob's book and have been exploring the blog a bit.  I also have taken note of his poo-pooing of index funds.  It stands out as particularly contrarian when compared to just about all the investment advice I've ever read.  But, as was mentioned above he's not talking down index funds in an active vs passive type of way.  I just get the impression that he's more into buying individual dividend producing stocks.  That's something I need to look into more, but for now I feel pretty confident about my lack of knowledge about individual companies so I'm OK with taking what the index gives me.  Though I do know to be realistic about my expectations and projections for real returns.

kyleaaa

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Re: ERE and Index Funds?
« Reply #6 on: March 07, 2014, 01:25:22 PM »
I wouldn't consider owning index funds to be giving in to the masses. If anything, index funds are still generally disparaged by the financial establishment.

skyrefuge

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Re: ERE and Index Funds?
« Reply #7 on: March 07, 2014, 01:28:00 PM »
But he's not really down in index funds, he's merely saying that the current rate of economic growth is unsustainable and that index funds are not a magic solution to that problem.

I wholly agree with your interpretation of that particular post, but here is one where he much more explicitly advocates active investing over passive investing (at least if you think you have the skill for it).

I haven't read all that much from Jacob (and have no idea if he still holds similar beliefs now, 5 years after he wrote that entry), but my assumption is that he, as a Really Smart Person, simply finds it very difficult to believe that he can't perform better than most people at stock-picking. After all, he's so much better than everyone at everything else, why wouldn't that also apply to stock-picking? I believe MMM, another Really Smart Person, has also admitted to struggling with such feelings on the active-vs.-passive question. I think he has sort of settled that struggle by investing "actively" in real estate ("something that he knows", which incidentally is one of Jacob's recommendations), and then investing more passively in the part of his portfolio directed towards equities.

That's why I take such value from someone like JLCollins, yet another Really Smart Person, but in this case, a Really Smart Person with experience, who, after some decades of believing that he was smarter than the stock market, finally admitted to himself that the stock market is one place where, for even a Really Smart Person, it is oddly difficult to be smarter than the group.

http://jlcollinsnh.com/2011/06/02/why-i-cant-pick-winning-stocks-and-you-cant-either/

steveo

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Re: ERE and Index Funds?
« Reply #8 on: March 07, 2014, 02:51:59 PM »
I view it this way. Index funds give diversification within the stock market that means that you won't make a single stock mistake that could stuff up your portfolio. You also won't get a massive winner however you will basically end up getting the average with very little work or stress. You are also not getting ripped off. To me it is a pretty impressive way of investing.

To add to that I think that AA is much more important if you want to increase returns or increase stability of returns so focussing on individual stocks is sort of the wrong way to approach it. To me you would be better off if you wanted to be more active to transfer your funds from stocks to commodities to bonds within some form of AA that suits you. So pick the commodity markets when they are going crazy and stocks are getting hammered.

The thing is I'm basically lazy and even though my focus is now paying off my mortgage I am thinking about how to invest my money and it will be predominantly ala Warren Buffet's recent advice - chuck most of it in stock indexes. Maybe if stocks go crazy and commodities are getting hammered I will take some out of stocks and put into commodities however this is far from clear cut. Initially it will probably (assuming stocks aren't way too high) be just dumping money into stock indexes.

« Last Edit: March 07, 2014, 04:25:40 PM by steveo »

bacchi

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Re: ERE and Index Funds?
« Reply #9 on: March 07, 2014, 03:44:03 PM »
I haven't read all that much from Jacob (and have no idea if he still holds similar beliefs now, 5 years after he wrote that entry), but my assumption is that he, as a Really Smart Person, simply finds it very difficult to believe that he can't perform better than most people at stock-picking.

He works as a quant at a hedge fund. I would hazard a guess that he still believes that he can beat the market.

MrCash

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Re: ERE and Index Funds?
« Reply #10 on: March 07, 2014, 03:46:25 PM »
I haven't read all that much from Jacob (and have no idea if he still holds similar beliefs now, 5 years after he wrote that entry), but my assumption is that he, as a Really Smart Person, simply finds it very difficult to believe that he can't perform better than most people at stock-picking.

He works as a quant at a hedge fund. I would hazard a guess that he still believes that he can beat the market.

However, stock-picking is much different than quant trading.

warfreak2

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Re: ERE and Index Funds?
« Reply #11 on: March 07, 2014, 03:49:37 PM »
He may well be able to beat the market if it's his job to. Remember that actively managed funds are worse than index funds mainly because of the management fees, which he won't be paying.
« Last Edit: March 08, 2014, 03:21:50 AM by warfreak2 »

steveo

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Re: ERE and Index Funds?
« Reply #12 on: March 07, 2014, 04:26:39 PM »
He may well be able to beat the market if its his job to.

Maybe but its no sure bet. Is the extra time and effort worth it.

dragoncar

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Re: ERE and Index Funds?
« Reply #13 on: March 07, 2014, 05:17:13 PM »
He may well be able to beat the market if its his job to.

Maybe but its no sure bet. Is the extra time and effort worth it.

It's a lot more fun with OPM too.