Author Topic: low cost index funds are superior because (Read 10353 times)

lano · « **on:** May 30, 2014, 06:11:39 AM »

1. Markets are efficient. It is not possible to beat index funds with individual stock picks -- all the information is already in the price.

2. Don't know really, but historical evidence shows that it is the cheapest way to get the market return.

3. Don't know really, but everyone else is doing it.

4. Don't know really, but what are the alternatives?

5. Something else.

I am looking for a logical reason(s). Something that makes sense to you. Saying stuff like go read a book is not good. I want to know what ideas you got from reading the "books."

For a lot of people a large or a major portion of their net worth is currently in low cost index funds. There should be a good simple reason for this.

Jags4186 · « **Reply #1 on:** May 30, 2014, 06:35:25 AM »

If you believe that the stock market/US economy will continue grow like it has for the past 100+ years then index funds will be the best way of accessing that growth.

If you look at every company in the country that is publicly traded, some fail, some perform adequately, and some exceed even the wildest expectations. But since we believe the economy will continue to grow that means that the winners will outweigh the losers. You could try to pick a portfolio of 10, 20, 30 stocks and hope that you picked more winners than losers. If you can/do, hats off to you. I don’t believe I can do that.

If I buy EVERYTHING I guaranteed to get every single winner, every single loser, and since I know the winners beat the losers in the long run, I know I’m going to be OK. That’s why I own index funds.

On top of all that, buying 1 or 2 index funds sure has a lot lower transaction fees than buying a crop of individual stocks.

MaxTheTerrible · « **Reply #2 on:** May 30, 2014, 07:44:57 AM »

It is the simplest & one of the cheapest ways to diversify. It is also the easiest way to invest, I.e. no need to keep track of your holdings, annual reports, etc. All that being said, my personal portfolio is split ~50/50 between index funds and individual stocks (possibly to my own detriment)...

soccerluvof4 · « **Reply #3 on:** May 30, 2014, 08:01:59 AM »

Because there low cost ( if your in Vanguard or a comparable) ..........and they cover an entire index. The amount of costs you pay for the same or lesser products adds up to alot of money over the years and the index funds adjust on there own so it just makes sense.

NumberCruncher · « **Reply #4 on:** May 30, 2014, 08:29:33 AM »

Because after fees, fund managers do worse than than indices on average and there is no evidence that those who perform above the indices aren't just lucky (have a hundred monkeys pick stocks for you, and you'd expect a few to do really well - past positive performance of fund managers also hasn't been shown to be a predictor of future success).

hodedofome · « **Reply #5 on:** May 30, 2014, 09:07:59 AM »

Because it's the best way for the average investor to make money in the market.

It sounds like you need some personal conviction however. And you don't want to read books but get info from other people that have read them. The best way to gain that conviction is to do the research yourself and come up with your own conclusions. That will help give you the conviction you need to pick a particular strategy and, more importantly, stick to it.

rmendpara · « **Reply #6 on:** May 30, 2014, 10:03:41 AM »

1. False, markets are not efficient.

The average person cannot outperform a benchmark by picking individual securities. These people are best served by choosing an allocation that is appropriate based on their risk/return goals and time horizon.

The above-average person can identify when things are undervalued (as a group) and spot when the macro trend has it wrong (i.e. people who knew that 08-09 was a good time to slowly buy in).

Geniuses can produce consistent absolute return in their portfolios in all market cycles (e.g. long-short absolute return hedge funds).

Which one are you?

RapmasterD · « **Reply #7 on:** May 30, 2014, 09:13:54 PM »

Because I like John Bogle. He is ga-ROOVY!

Roland of Gilead · « **Reply #8 on:** May 30, 2014, 09:19:57 PM »

1) False. It has to be false. If every single person that picked an individual stock failed to beat the index, then it would be incredibly easy to beat the index by randomly shorting some individual stock.

edit: Take Brk-A for example. I believe it has beaten the index for the past 50 years? Do you need a longer example?

bobmarley9993 · « **Reply #9 on:** May 30, 2014, 09:41:27 PM »

I strong believe that markets are not perfectly efficient but for all intents and purposes they are efficient. Seriously, there are just so many famous investors who "beat" the market over long horizons by only 1-1.5% (buffet is an exception) that on the one hand it seems the market can't be efficient but on the other hand they are not beating by much, they are full-time investors and they are the best. There is a web-site, gurufocus, which lists the records of numerous guru's. You can click around on it and see how they have performed. You will see that most do not significantly out-perform and will often have 5-10 year periods where they under-perform.

So given that experienced investors barely keep up, for an average joe with a job and a life to live I don't think it's realistic at all to try to beat the market, hence index funds.

butchmonkey · « **Reply #10 on:** May 30, 2014, 10:10:17 PM »

It's the fees.

The market is the sum of all of the trades that occur.

For every dollar "won" by one trader, another dollar must be "lost"by the counterparty.

Worse, every time each of the counterparties makes a trade, they both pay transaction costs and lose money to taxes when they take gains.

So to beat The market, the trader must not only beat the market but beat the market plus the total of all of his costs to trade in the market including taxes. This is a very high bar indeed which is why 80% of active traders will lose to their index, and the amount of their winnings will be surpassed by the amount of the losers Losses.

There are undoubtedly investors who beat the market through skill. The problem is you can't identify them prospectively, only retrospectively.

And the odds of you getting lucky and picking the right active manager are stacked against you.

Being an active investor is like buying a lottery ticket. There's a small chance you'll do well but a large chance you'll to poorly.

Being a passive investor is like being the house in the casino. You'll lose to one or two people, but over time the odds are stacked in your favor.

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lano · « **Reply #11 on:** May 31, 2014, 02:34:01 AM »

I didn't mean to ask if any of the five points are true or not. I wrote them down just because those are the points appear on forums and in conversation. If you disagree with any one of them that is fine -- just mention your own reasons for holding index funds.

The main question was just that: I buy/hold low cost index funds because: ...

In general I agree with Jags4186. Except I would phrase it as such: Over time the real inflation adjusted value of all US companies increases. Over time this value will also be matched by the price quoted for the stock of all those companies. Index funds give me an opportunity, for a fee, to own a part of all US companies and participate in this bet.

This should the be logical foundation. The other answers just do not make sense: they seem to tail off into other subjects or they tend to hide behind even more abstract terms.

For instance:

"The average person cannot outperform a benchmark by picking individual securities. These people are best served by choosing an allocation that is appropriate based on their risk/return goals and time horizon."

Why can't a person outperform a benchmark? Any one person who bought only BRK, or only KO, or only WFC their whole life outperformed the market. Why? Because the value of those companies increased more than the average value of all companies.

What is preventing you from owning just one stock? Fear? Lack of understanding? There are a lot of people who own just one personal business -- can't a person similarly own just one personal stock?

What exactly do you mean by risk? What does it have to do with index funds?

"It is the simplest & one of the cheapest ways to diversify. It is also the easiest way to invest, I.e. no need to keep track of your holdings, annual reports, etc. All that being said, my personal portfolio is split ~50/50 between index funds and individual stocks (possibly to my own detriment)..."

Why is diversification good? What if it is bad for you. Does it matter if its cheap or not then? I mean you certainly do not want to overpay for something that is bad for you -- but wouldn't you rather just not "buy" it in the first place.

...

But aren't you hiding behind an abstraction as well: What is the "value" of any one company or the "value of all" companies for that matter.

True, and that leads me to my point.

Given the correct foundation I can at least state a set of ideas that make sense:

1. The approximate value of a company is equal to the present value of all the cashflows that that company will generate in the next five to ten years.

2. For some companies these cashflows can be approximated with a good degree of certainty -- for other companies the approximation of future cashflows cannot be done with certainty.

3. In the past the real (inflation adjusted) average cashflows of all companies has increased. Index funds give you an opportunity to gain along side this future assumed average increase for a fee. There is no need to worry about whether you can or cannot predict the future cashflows of any one company, and there is no need to worry about what that prediction will be.

These ideas give a clear foundation of what is going on when you buy an index fund, or when you try to buy individual stock. There is no need for abstract words like risk, diversification, market, above average, or genius.

Given this set of ideas you can then clearly answer more questions:

1. Is it worth it for me to try to buy individual stocks?

2. Am I certain that I can predict the cashflows of the company I want to buy and own?

3. How do I predict future cashflows of a company?

4. Would I rather spend the time on something else and just get the average return?

warfreak2 · « **Reply #12 on:** May 31, 2014, 04:30:08 AM »

Quote from: butchmonkey on May 30, 2014, 10:10:17 PM

For every dollar "won" by one trader, another dollar must be "lost"by the counterparty.

If this were true then the stock market would be one of the longest-running Ponzi schemes in the history of the world.

But companies distribute their profits to stockholders (not just through dividends, but also stock buybacks, and internal reinvestments which increase future earnings), that is money "won" by one trader and not "lost" by any counterparty; it's not even "lost" by the company itself, as it wasn't really "theirs" to do what they want with - the directors can't just take all the profits home with them, for example. Even if they just stick it under the company's mattress, that increases the assets of the company, and the shareholders still part-own those assets.

bobmarley9993 · « **Reply #13 on:** May 31, 2014, 07:01:47 AM »

Quote

Why can't a person outperform a benchmark? Any one person who bought only BRK, or only KO, or only WFC their whole life outperformed the market. Why? Because the value of those companies increased more than the average value of all companies.

What makes you think that people can out-perform the index? That is the only issue here and it has been very extensively thought out, studied and debated over the years. It is not a new issue. What I have been trying to say is there is not a lot of evidence that you can do it. To then insult us by saying we are hiding behind abstractions is ridiculous. What evidence are you providing other than using forward knowledge to pick out a few winners.

I sometimes wonder if some of the questions posted on this board are really meant to solicit feedback or are just a platform for individuals to post from.

butchmonkey · « **Reply #14 on:** May 31, 2014, 09:22:29 AM »

Quote from: warfreak2 on May 31, 2014, 04:30:08 AM

Quote from: butchmonkey on May 30, 2014, 10:10:17 PM
For every dollar "won" by one trader, another dollar must be "lost"by the counterparty.
If this were true then the stock market would be one of the longest-running Ponzi schemes in the history of the world.

But companies distribute their profits to stockholders (not just through dividends, but also stock buybacks, and internal reinvestments which increase future earnings), that is money "won" by one trader and not "lost" by any counterparty; it's not even "lost" by the company itself, as it wasn't really "theirs" to do what they want with - the directors can't just take all the profits home with them, for example. Even if they just stick it under the company's mattress, that increases the assets of the company, and the shareholders still part-own those assets.

This is a fair criticism, for my statement lacked specificity.

Let me reattempt my statement:

Every dollar won by one trader (relative to the Index) must be lost by another trader (relative to the index.)

Put another way, since an index is the sum of all transactions within a specific market, every dollar of outperformance must be matched by a dollar of underperformance. Most importantly, costs take away from the performance of both the "winners" and "losers".

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matchewed · « **Reply #15 on:** May 31, 2014, 10:01:10 AM »

lano, what exactly are you asking or stating? Or rather what is the point of this thread?

What do you mean by labeling things like risk and diversification as abstractions? If you're asking why do people invest in low cost index funds then you've already received your answers. You may not have liked the answers but waving them away as abstractions rather than listening is doing a disservice to the people who've responded. If you don't understand the concepts fine,

Investing in a single company has risks associated with it. Investing in low cost index funds has risk associated with it. Risks are potential pitfalls, you just decide which risks you're comfortable with having.

Investing in a single company is a less diverse investment strategy than investing in a total market index fund. Much like investing in a S&P 500 index fund is less diverse than investing in a total market fund. Just because you do not see value in diversification does not mean others don't.

Outside of that my own personal reasons for using low cost index funds are because -

Low cost.

I can invest in singular companies (I have in the past and I hold those shares to this day) and get a wide range of returns that I cannot predict. Or I can pick all the US companies and understand and make an assumption that the US will still be the #1 player for many years to come.

This requires less hands on management of my portfolio as I do not need to know how Company X is doing or what their CEO did or said or what their next strategy/purchase is. I'm relying on the healthy assumption that the US/global economic engine is running and will continue to do so. I do not need to look at cashflows today or make guesses about it tomorrow.

Automatic diversification. Don't label it as an abstraction. That just makes it seem like you don't know what diversification is and why people diversify. If it truly is the case that you don't know what it is then you actually may need to dial it back a bit and read a book regardless of what you said in your first post. It's difficult to have a conversation about investing strategies if we're not working with the same understanding of basics. If it's the basics you're questioning feel free to start a thread on those basics.

Mr Mark · « **Reply #16 on:** May 31, 2014, 05:33:55 PM »

Quote from: bobmarley9993 on May 31, 2014, 07:01:47 AM

Quote
Why can't a person outperform a benchmark? Any one person who bought only BRK, or only KO, or only WFC their whole life outperformed the market. Why? Because the value of those companies increased more than the average value of all companies.

What makes you think that people can out-perform the index? That is the only issue here and it has been very extensively thought out, studied and debated over the years. It is not a new issue. What I have been trying to say is there is not a lot of evidence that you can do it. To then insult us by saying we are hiding behind abstractions is ridiculous. What evidence are you providing other than using forward knowledge to pick out a few winners.

I sometimes wonder if some of the questions posted on this board are really meant to solicit feedback or are just a platform for individuals to post from.

Or people arguing bizarre points of investment theory when they are still up to their eyeballs in student debt....

while we may see investor alley as a way to optimise, it does seem people are still looking for the magic way out, the 100x bagger, the way to hope their profligate ways will be saved by some how, someway, finding a loophole that gives them above market returns while experiencing below market volatility and risk.

So the hard path of saving rate and slow steady cumulative compounded returns can be avoided.

butchmonkey · « **Reply #17 on:** May 31, 2014, 09:44:48 PM »

Quote from: Mr Mark on May 31, 2014, 05:33:55 PM

Quote from: bobmarley9993 on May 31, 2014, 07:01:47 AM
Quote
Why can't a person outperform a benchmark? Any one person who bought only BRK, or only KO, or only WFC their whole life outperformed the market. Why? Because the value of those companies increased more than the average value of all companies.

What makes you think that people can out-perform the index? That is the only issue here and it has been very extensively thought out, studied and debated over the years. It is not a new issue. What I have been trying to say is there is not a lot of evidence that you can do it. To then insult us by saying we are hiding behind abstractions is ridiculous. What evidence are you providing other than using forward knowledge to pick out a few winners.

I sometimes wonder if some of the questions posted on this board are really meant to solicit feedback or are just a platform for individuals to post from.

Or people arguing bizarre points of investment theory when they are still up to their eyeballs in student debt....

while we may see investor alley as a way to optimise, it does seem people are still looking for the magic way out, the 100x bagger, the way to hope their profligate ways will be saved by some how, someway, finding a loophole that gives them above market returns while experiencing below market volatility and risk.

So the hard path of saving rate and slow steady cumulative compounded returns can be avoided.

Translation: get offa my lawn you young whippersnapper's. You kids don't understand the value of real work like me!

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davisgang90 · « **Reply #18 on:** June 01, 2014, 06:56:37 AM »

1. Because index funds mean I get to have a life and not worry about my investments. Set and forget.

Roland of Gilead · « **Reply #19 on:** June 01, 2014, 07:39:03 AM »

Quote from: davisgang90 on June 01, 2014, 06:56:37 AM

1. Because index funds mean I get to have a life and not worry about my investments. Set and forget.

Index funds are worry free because? They never have large drops in price?

greaps · « **Reply #20 on:** June 01, 2014, 02:58:47 PM »

1. Diversification. Lets argue how index's don't accomplish this.

kyleaaa · « **Reply #21 on:** June 01, 2014, 03:39:35 PM »

Because the return of index funds tracking a certain market segment must mathematically be above average for all funds in that segment on a dollar weighted basis. It's really just a no-effort way to get above-average returns.

On efficient markets: with efficient markets, you would expect to see plenty of investors who beat the market over long periods of time merely by random chance, so their existence is not evidence that markets are inefficient.

davisgang90 · « **Reply #22 on:** June 01, 2014, 03:52:23 PM »

Quote from: Roland of Gilead on June 01, 2014, 07:39:03 AM

Quote from: davisgang90 on June 01, 2014, 06:56:37 AM
1. Because index funds mean I get to have a life and not worry about my investments. Set and forget.

Index funds are worry free because? They never have large drops in price?

I don't need them for many years, so I don't give a crap about large drops in price. Keep on dollar cost averaging and let the magic of TVM go crazy.

rmendpara · « **Reply #23 on:** June 01, 2014, 06:09:57 PM »

Quote from: lano on May 31, 2014, 02:34:01 AM

Given this set of ideas you can then clearly answer more questions:

1. Is it worth it for me to try to buy individual stocks?

2. Am I certain that I can predict the cashflows of the company I want to buy and own?

3. How do I predict future cashflows of a company?

4. Would I rather spend the time on something else and just get the average return?

1) Probably not, unless you happen to understand some companies very well and would be able to tell that a certain stock was undervalued.

2/3) Why are you trying to predict cash flows? Are you trying to create a stock model? Most people don't use valuation models correctly.

4) Yes, probably. Most investment advice will show that asset allocation is more important than picking stocks. (search "asset allocation vs stock selection" on Google and you'll see plenty of research) Your most important job as an investor is to decide on an allocation for your overall portfolio (bonds, stocks, industries, etc) which is appropriate for you to reach your goals.

lano · « **Reply #24 on:** June 01, 2014, 08:36:29 PM »

Let's say two seasoned house builders or contractors are talking to one other.

Person 1 tells person 2: "Hey dude you don't want to build a house there -- it would be really hard."

In that case there is a very clear non abstract idea of what "hard" means. And if it is not clear, person 2 can ask person one what he or she means. Person 1 can then go over the points: The weather there is bad, its hard to get supplies and labor, the owner doesn't know what he wants, the subcontractors in the area are bad, etc, etc. (I have zero experience in this area so just guessing.)

And then a discussion and debate about these points can take place.

When it comes to investments, and especially in investments in common stocks, the word hard comes up a lot -- however no one ever seems to question what that "hard" means. The discussion never goes beyond that statement. It usually goes something like: Picking individual stocks is hard, and you must be a genius or above average -- you should instead buy an index fund to be diversified, o and also choose your risk/ return whatever and also choose different assets.

I mean -- can anyone here honestly define the terms clearly?

I read the books (a lot if not all -- reread the good ones a lot as well). One of my Majors was finance. So I know what the terms mean or at least what the books say they should mean. I am not trying to play dumb and just be disingenuous and hackle from the crowd.

I really do think though that the discussion about common stock investing is clouded.

Some people in this thread said that they like index funds because they don't have to worry about picking individual companies. Or they are not interested in picking individual companies. They would rather spend the time elsewhere. That is a perfectly fine and valid answer. You don't need to know the details of every single advanced feature of our society to benefit from it.

However, saying that you like index funds versus individual companies because picking stocks is: hard, or you must be diversified, or you must have different asset classes, or you must have your preferred risk / return profile... is wrong if you don't define the terms beyond a superficial level.

It's wrong because, while the terms sound fancy, they are really just hazy abstractions which prevent clear discussion about the interesting details of investment and valuation.

Here are some questions:

What is risk?

Why is diversification good?

TreeTired · « **Reply #25 on:** June 01, 2014, 08:52:27 PM »

low cost index funds are superior because

Superior to what? I could fill in the blanks with several possibilities, but then I would be doing all the work for you, as well as guessing at what you are asking.

In your finance studies did they introduce the concept of the efficient frontier? Diversification will usually let you increase your expected return while keeping risk constant, or reducing risk while keeping your expected return constant. You can do it yourself by purchasing 10 or 20 individual stocks, and for a buy and hold strategy I personally don't have a problem with owning stocks. But it is certainly easier, and initially cheaper to buy an ETF with a very low expense ratio (definitely cheaper to make one trade in an ETF or index fund vs buying 20 stocks even with a discount broker)

bigchrisb · « **Reply #26 on:** June 01, 2014, 09:09:19 PM »

Quote from: lano on May 31, 2014, 02:34:01 AM

1. Is it worth it for me to try to buy individual stocks?

4. Would I rather spend the time on something else and just get the average return?

I've got a foot in both camps (I have some direct shares and some low cost index funds / closed end funds. I generally like the benefits of the index/closed end funds.

However, one plus of the individual holdings that I don't think gets recognized is the benefits for tax planning. With my individual shares, some have outperformed the index, some have under-performed. In aggregate, its been about the same outcome, but with more work. However, with the individual shares, I've been able to sell the losers to crystalise a tax loss, and buy them back in a different holding entity. Same equity exposure, cost of brokerage, but a big tax loss. Over the last 5 years, doing this has added up to about $40k worth of "tax benefit" for me. In after tax terms, its added about 0.5% p.a. to my total after tax return.

I'm still a fan of indexing, but there are some structural benefits to individual stocks.

butchmonkey · « **Reply #27 on:** June 01, 2014, 09:16:14 PM »

Llano,

I'm not touching the risk question because that's well beyond the scope of this particular topic.

What I will say is this. If you have it broadly diversified portfolio. Something like a total market fund with low costs and you compare it to a fund of 15-30 hand selected Stocks with reasonable diversification, then the hand selected portfolio will have a greater probability of above average performance, as well as a greater probability of below average performance.

In statistical parlance the probability curve will have "fat tails."

But to maintain such a portfolio requires much more in the way of transactions (and costs.)

This is because if one stock grows out of proportion to the others and you want to keep your same diversification characteristics, you will have to sell that stock and buy more of the others.

This is in contrast to a capital weighted index were you buy each stock in proportion to its capitalization with the index. That way if company A goes up and company B goes down your portfolio still perfectly represents the market without any transactions at all.

Once these additional costs are taken into account, your chance of underperformance greatly increases, so you're left with the likelihood that you will underperform, with a much greater chance of seriously underperforming (due to the fat tail risk.) It's a suckers bet unless you have uncommon skill, or insider information. I have neither, and I'd wager the same holds true for you.

lano · « **Reply #28 on:** June 01, 2014, 09:30:44 PM »

Quote from: NC_MJ on June 01, 2014, 08:52:27 PM

low cost index funds are superior because

Superior to what? I could fill in the blanks with several possibilities, but then I would be doing all the work for you, as well as guessing at what you are asking.

In your finance studies did they introduce the concept of the efficient frontier? Diversification will usually let you increase your expected return while keeping risk constant, or reducing risk while keeping your expected return constant. You can do it yourself by purchasing 10 or 20 individual stocks, and for a buy and hold strategy I personally don't have a problem with owning stocks. But it is certainly easier, and initially cheaper to buy an ETF with a very low expense ratio (definitely cheaper to make one trade in an ETF or index fund vs buying 20 stocks even with a discount broker)

Can you explain what you mean by risk?

butchmonkey · « **Reply #29 on:** June 01, 2014, 09:44:13 PM »

Quote from: lano on June 01, 2014, 09:30:44 PM

Quote from: NC_MJ on June 01, 2014, 08:52:27 PM
low cost index funds are superior because

Superior to what? I could fill in the blanks with several possibilities, but then I would be doing all the work for you, as well as guessing at what you are asking.

In your finance studies did they introduce the concept of the efficient frontier? Diversification will usually let you increase your expected return while keeping risk constant, or reducing risk while keeping your expected return constant. You can do it yourself by purchasing 10 or 20 individual stocks, and for a buy and hold strategy I personally don't have a problem with owning stocks. But it is certainly easier, and initially cheaper to buy an ETF with a very low expense ratio (definitely cheaper to make one trade in an ETF or index fund vs buying 20 stocks even with a discount broker)

Can you explain what you mean by risk?

The risk described here is the standard deviation (or volatility) of the portfolio.

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matchewed · « **Reply #30 on:** June 02, 2014, 07:23:19 AM »

Quote from: lano on June 01, 2014, 08:36:29 PM

Let's say two seasoned house builders or contractors are talking to one other.

Person 1 tells person 2: "Hey dude you don't want to build a house there -- it would be really hard."

In that case there is a very clear non abstract idea of what "hard" means. And if it is not clear, person 2 can ask person one what he or she means. Person 1 can then go over the points: The weather there is bad, its hard to get supplies and labor, the owner doesn't know what he wants, the subcontractors in the area are bad, etc, etc. (I have zero experience in this area so just guessing.)

And then a discussion and debate about these points can take place.

When it comes to investments, and especially in investments in common stocks, the word hard comes up a lot -- however no one ever seems to question what that "hard" means. The discussion never goes beyond that statement. It usually goes something like: Picking individual stocks is hard, and you must be a genius or above average -- you should instead buy an index fund to be diversified, o and also choose your risk/ return whatever and also choose different assets.

I mean -- can anyone here honestly define the terms clearly?

I read the books (a lot if not all -- reread the good ones a lot as well). One of my Majors was finance. So I know what the terms mean or at least what the books say they should mean. I am not trying to play dumb and just be disingenuous and hackle from the crowd.

I really do think though that the discussion about common stock investing is clouded.

Some people in this thread said that they like index funds because they don't have to worry about picking individual companies. Or they are not interested in picking individual companies. They would rather spend the time elsewhere. That is a perfectly fine and valid answer. You don't need to know the details of every single advanced feature of our society to benefit from it.

However, saying that you like index funds versus individual companies because picking stocks is: hard, or you must be diversified, or you must have different asset classes, or you must have your preferred risk / return profile... is wrong if you don't define the terms beyond a superficial level.

It's wrong because, while the terms sound fancy, they are really just hazy abstractions which prevent clear discussion about the interesting details of investment and valuation.

Here are some questions:

What is risk?

Why is diversification good?

I've already stated risk as any potential pitfall with an investment. It is good to understand your risks regardless of the actual investment. Index funds have risks, individual stocks have risks. When someone says I'd rather invest in X rather than Y they are implicitly stating that they are comfortable with the risks associated with X given the assumption they understand the risks associated with X. Why question that?

Diversification is more of a scale than anything IMO. Like I said in my previous post, investments can be more or less diversified than other options. Diversification may cushion you from some risks associated with your chosen portfolio.

It is only practical to discuss diversification within the context of the investment or options of investments. We can compare diversification between two investment choices but any single investment choice is as diversified as it will get. There will be risks associated with that level of diversification and it will be up to the individual investor to be comfortable with that given the assumption they know about it.

Just asking these concepts within your bubble with nothing to compare it to is meaningless and even putting it in isolation of index funds is a silly discussion because you seem to be asking loaded questions for an as of yet unknown reason. So again... what's the point? I'm still not seeing what you're getting at. What point are you trying to illustrate? Do you think other people who invest in index funds don't understand these concepts? When people are saying they'd rather invest in index funds because they are diversified and accept the risk they are stating that they are comfortable with the level of diversification and comfortable with the risks.

Using your analogy it seems that you are not of the opinion that your fellow forum members are also builders. Basically you've come in here assuming that index fund investors don't know what the they're doing or why, or at least that's what I'm gathering.

I give a shit about my money. I've looked at what an index fund is, understand how it is structured, what companies are in the ones I invest in, I understand the risks, and have chosen funds that meet my Asset Allocation and the level of diversification I'm comfortable with. I've done all this to meet my investment goals, which I will. What else is there to question?

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Author Topic: low cost index funds are superior because (Read 10353 times)