DH's disagreement with index funds- Question

[gettingtoyes]

Hi all,

We are early 30s, currently have about $130k in retirement funds (mixture of traditional IRA, roth, converted old 403b plan to IRA, and 403b plan from current job), all in various stocks, a mixture of large cap, small cap, international, etc. After reading about index funds in JL Collins book and reading about it on various MMM-esque sites, I'd like to convert everything over to index funds or at least do a majority of it. However, DH thinks this is too risky. I asked him to write up a response as to why and I'm putting it out here to see if there's anything else that he/I are not thinking of in deciding to just use index funds. Thanks for any insight...

******
So, index funds. I have concerns about this idea of putting all our money into them.

If somebody is arguing, “I don’t want to invest in index funds because I want to beat the market,” then they’re a fool, and pointing them to index funds is reasonable by comparison. You’re never going to beat the market, so you might as well match the market.

But the reason people argue against index funds isn’t out of a desire to beat the market. It’s actually the opposite: 100% index funds would be too risky a portfolio.

Index funds by definition attempt to match the market. Take the S&P 500. An S&P 500 index fund should by definition focus on the 500 biggest companies in the US.

That cannot ever be a diversified portfolio, because that automatically means giant and large cap companies. Furthermore, since some industries have larger companies than others, such an index fund could never be diversified across different sectors, either.

The goal of our current choices in mutual funds is to have a mixture of small, medium, and large businesses, in a wide variety of sectors. Our portfolio *shouldn’t* follow the market, because the market is more volatile than practically any financial advisor would recommend.

This decision will probably cost us money, but we’re trading yearly return for less volatility and risk.

Now, you could argue that at our age, we could stand to take more risk. After all, it just means we might have to adjust our retirement age by 5 years in either direction. However, many people would argue that our current portfolio is *already* too risky. After all, traditional advisors recommend you include bonds in your portfolio. At our age, and with our risk tolerance they usually say 10-20% bonds. We have 0%. People also say you should have a chunk of your money in international funds. We only have 10%. By all accounts our current portfolio is much riskier than most professionals would advise. So it doesn’t seem like a good decision to put all our money in US-based index funds, increasing our risk levels and volatility even more.

Maybe there’s something I’m misunderstanding, but it seems to me that some people argue for index funds based on reliability. That seems like an invalid argument for the reasons I’ve outlined. The valid argument for index funds might be, “You’re young and flexible, so go for it.” My impression is that isn’t what most pro-index-fund people are saying.

People also argue that index funds have lower fees, but Vanguard funds already have super low fees these days, so I don't believe this is a huge drain in exchange for a bit more stability.

I'm always willing to change my mind in light of new data, so I'd be happy to hear what people have to say. However this is the conclusion that my current level of understanding leads me to.

*******

[msilenus]

Index funds by definition attempt to match the market. Take the S&P 500. An S&P 500 index fund should by definition focus on the 500 biggest companies in the US.

That cannot ever be a diversified portfolio, because that automatically means giant and large cap companies. Furthermore, since some industries have larger companies than others, such an index fund could never be diversified across different sectors, either.

The goal of our current choices in mutual funds is to have a mixture of small, medium, and large businesses, in a wide variety of sectors. Our portfolio *shouldn’t* follow the market, because the market is more volatile than practically any financial advisor would recommend.

This reads like your husband just doesn't know about total stock market (TSM) index funds --like he's trying to approximate one using high-fee funds, without caring if the fees are improving returns.

If you don't think the costs are worth it, just buy VTSMX/VTSAX.  Or VTI if you want an ETF form.  Those answer all the concerns about he's expressing about INX and meet all the criteria he's pointing to in your current portfolio.  Fees will be lower.  Diversification will also be higher.  Pure win.

He's also confused about how you reduce volatility.  Diversification is a start, but you also want a mix of asset classes if that's your goal.  Bonds are the standard ballast for an stocks-based portfolio. 

ETA: Working through the Bogleheads introductory stuff would give him a better sense of what indexers recommend and why:
https://www.bogleheads.org/wiki/Getting_started

[MDM]

+1 to msilenus's comment about the Total Stock Market funds.

Before the two of you debate index vs. active funds, it's probably worthwhile to agree on your desired Asset allocation.

After agreeing on an AA, then discuss the funds you will use.  Might be a more productive discussion path.

[cheapass]

Companies in the SP500 and VTSAX are multinational and do a significant amount of business outside the US. There's your international exposure.

If DH is concerned about not having a sufficient allocation of bonds or international funds, why? They both have shitty average returns compared to equities. Why dilute your portfolio growth capabilities with assets that virtually guarantee subpar returns?

Understood, they offer less volatility but unless you're 5 or less years from retirement, why does volatility matter other than psychologically? A great analogy is a person walking up a flight of stairs (compound growth trend) while playing with a yo-yo (short term volatility). I don't care what the yo-yo is doing, I care how steep the staircase is and how fast that person is walking.

Bottom line - diluting your portfolio with assets that have lower returns means slower growth and more years at work before FI/RE.

Sent from my SCH-I545 using Tapatalk

[GuitarStv]

You don't need to buy 100% index fund equities.  You can mix in a percentage of index fund bonds (or any other type of investment) for greater stability.  By re-balancing your investment back to the asset allocation you're aiming for on a set schedule a couple times a year it forces you to sell high and sell low.

Having a percentage of stuff that's more stable than equities makes it easier for you to ride out a couple bad years (you can just withdraw from the fixed income, rather than lose money by pulling out of the equities).

[cheapass]

You don't need to buy 100% index fund equities.  You can mix in a percentage of index fund bonds (or any other type of investment) for greater stability.  By re-balancing your investment back to the asset allocation you're aiming for on a set schedule a couple times a year it forces you to sell high and sell low.

Having a percentage of stuff that's more stable than equities makes it easier for you to ride out a couple bad years (you can just withdraw from the fixed income, rather than lose money by pulling out of the equities).

Wouldn't that just make a case for switching out equities for bonds immediately before retirement?

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[AdrianC]

People also argue that index funds have lower fees, but Vanguard funds already have super low fees these days, so I don't believe this is a huge drain in exchange for a bit more stability.

You don't say what your mix of funds is, so this is generic. Using Vanguard active funds is probably not going to give more stability (less volatility).

Try it yourself:

https://www.portfoliovisualizer.com/backtest-portfolio#analysisResults

I tried VTSAX (total market index) versus four active funds, 2001-2017:

VWNAX Vanguard Windsor II Fund Admiral Shares 25.00%
VSEQX Vanguard Strategic Equity Fund 25.00%
VUVLX Vanguard U.S. Value Fund 25.00%
VTRIX Vanguard International Value Fund 25.00%

           CAGR     Std.Dev.   Max. Drawdown
VTSAX 7.62% 14.85%     -50.84%

Active 7.77%  15.67%     -54.42%

The active funds did a bit better but had a rougher ride. More risk = possibly more return, definitely more volatility.

[Heckler]

SP500 alone - I fully agree with him.  Too risky to be in 500 large cap US. 


However,
VTI: 3600 US All cap
VXUS: 6100 global all cap

Tempered with a helping of 9000 bonds should do it!

https://personal.vanguard.com/us/funds/snapshot?FundIntExt=INT&FundId=0928

https://personal.vanguard.com/us/funds/snapshot?FundIntExt=INT&FundId=0970

https://personal.vanguard.com/us/funds/snapshot?FundIntExt=INT&FundId=3369

[Hargrove]

As already mentioned, SP500 index funds are not the only index funds.

VTSAX and VT/VTI+VXUS throw out very, very wide nets. Wider nets than any portfolio any individual is likely to make.

But besides, SP500 is not all that risky either. What if a company loses a lot of money? well, that tiny fraction of the portfolio is swapped to the new SP500 company if the previous lost enough to fall off. What if they all lose? Like... all the SP500 companies? Well then we're in a catastrophic recession and you didn't miss some enormous economic gains then, either. SP500 index funds are whatever the big companies are at the time, not a snapshot of one year's SP500 winners.

[Heckler]

Asset allocation and knowing your level of risk is the key to not follow the market, but plan your personal level of volatility.

https://www.bogleheads.org/wiki/Bogleheads®_investing_start-up_kit

[Radagast]

The three biggest benefits of broad market index investing are
-Minimize cost
-Minimize turnover (which is another way to say minimize cost - it's important so might as well say it twice)
-Broadly diversified
-Minimize dumb investor mistakes
If you can do that using a different method then you should be fine. I cannot tell what you are doing.

A few notes:
If you have less risk than the market as meant by lower volatility than the market, then you probably have a more concentrated investment in large "value" companies with lower expected return. If you are concerned about being stuck in just a few large companies then this seems like making the situation worse.

If you have less risk than the market as meant by less money on the 100 or so largest companies, then you probably have more money in small companies which are more volatile than the market but with more expected return. In my opinion this reduces the bigger risks (running out of money, tech sector crash), but magnifies the little ones (when the market goes down it goes down even more).

For either definition, avoiding bonds and minimizing international seems to be the opposite of lower risk. Vanguard and David Swenson have concluded that around 30% international is near the minimal volatility point. Putting 50% of stocks in international might reduce big risks. Having 20% bonds certainly lowers risk. I am not sure that you are actually minimizing risk. Which is fine - if you are adding new money regularly for years to come risk works on your side most of the time. I am skeptical of people who expect US stocks to have higher returns over the next 10-20 years than international stocks, so I'd say increase international to at least 30%.

The S&P500 is selected by committee, and is not strictly the 500 largest companies.

[GuitarStv]

You don't need to buy 100% index fund equities.  You can mix in a percentage of index fund bonds (or any other type of investment) for greater stability.  By re-balancing your investment back to the asset allocation you're aiming for on a set schedule a couple times a year it forces you to sell high and sell low.

Having a percentage of stuff that's more stable than equities makes it easier for you to ride out a couple bad years (you can just withdraw from the fixed income, rather than lose money by pulling out of the equities).

Wouldn't that just make a case for switching out equities for bonds immediately before retirement?

It's commonly recommended that you start moving from 100% equity to a mix of equity and fixed assets several years before retirement.

100% equities means that in a down market you can't re-balance your portfolio and take advantage of the time that everything is on sale.  If you're planning on retiring early, you have some negatives with a pure equity solution . . . several years of down markets just before you retire will impact you very significantly if you're entirely in equity.  If you're planning on retiring early, you have some positives to handle this . . . you're early enough in your career that throwing on a few more years of work should still be doable, and then when your funds finally recover you'll be sitting in an even better spot than you originally were.

Seeing more than half of your wealth disappear in a few months (as happened to people holding just equities in 2008) is a real shock to the system . . . if you're going 100% equities you have to know for certain that you're not going to pull your money out of the market at such a time.  Choosing to go with purely equities or with a mix is a personal risk tolerance question.  Neither way is flat out wrong, so you should pick the one that you're most comfortable with.

[bacchi]

Index funds by definition attempt to match the market. Take the S&P 500. An S&P 500 index fund should by definition focus on the 500 biggest companies in the US.

That cannot ever be a diversified portfolio, because that automatically means giant and large cap companies. Furthermore, since some industries have larger companies than others, such an index fund could never be diversified across different sectors, either.

The goal of our current choices in mutual funds is to have a mixture of small, medium, and large businesses, in a wide variety of sectors.

There are index funds for small and medium businesses, too: VFSVX and VEXMX.

[iris lily]

 Am old and FI, but I tell ya, I would have more money if I had invested in index funds and also less  headaches. My own DH is not on board. As for  the headaches, here is an example: we got a K something form to send in with taxes, these forms came from our brokerage accounts. i asked DH waht the hell that was for and he barely knew.

Screw that. Yet, when we go into see one of the brokers, he and they swap market talk and they chat him up and he chats them up. Honestly, to me it is embarrassng, it always seems like they are stroking each others' cocks.

So, Young OP I say to you: it is too late for me, but run! Run like the wind and NOW toward index funds! Take your own mney and buy them if you cant pull your DH along with you. Save yourself!

[gettingtoyes]

Hello all,

This is the "DH". Thanks for all your comments. There were a couple of little things here and there I might be tempted to argue with, but for the most part this is all very interesting and helpful.

It's primarily a problem of self-taught ignorance in that, while I was aware that there were other index funds (mid-cap etc.), I didn't know about total stock market index funds. My wife made it sound like this was about following the S&P 500 or similar, which clearly is not the idea behind this philosophy.

Radagast's post in particular was interesting to me, because there were a couple of things there that should have occurred to me, but didn't. Definitely some good food for thought.

I'm not entirely sold, but I'm more open to the idea now I understand what it's about. I'll definitely read the linked pages. We may very well end up going the index fund route, but I need to educate myself a little more first.

Thanks again.

[Physicsteacher]

Since it appears you are investing solely in tax advantaged accounts and don't need to worry about tax efficient fund placement, you might look into Vanguard's Lifestrategy funds. It's hard to get much more diversified than a fund that has both total U.S. stock market and a broad international equity index plus both U.S. and international bond funds. You can pick the percentage you want in bonds (in 20 percentage point increments), set it, and forget it for an expense ratio of 0.15% or less.

[Goldielocks]

My DH also does not like index funds.  I have a mix of 5 index funds that I rebalance every 4-6 months.

DH does a ton of research and stock picks.   Sometimes stocks that have a great return, less often, stinkers that lose money.

After 2 years, he now has about 30 stocks, each with under $5k in them...  The problem is that he can find the fabulous deals, (sometimes) and made money on them,and after, each one is not now a "loser" moving forward, just a plodder... so he almost never sells and keeps putting the new money into new funds.   Now he is at a point where it is impossible to do the research on all of these (as he is working full time).  He doesn't sell because of lack of information and bias against reversing an earlier decision.... all of his research is looking for the next win, not trimming the "plodders".

I also noted that if he tended to follow a bit of industry momentum, and is invested in only 3 industries across his choices, as what wins each year tend to group around single industries.

Instead,
The great thing about the index fund strategy, across various sectors, size and type of investment,  is that I am forced (by my plan) to rebalance....  much less research, and just get to it and DO IT.

[PizzaSteve]

A different angle about S&P funds, specifically (say your dilemma,  hypotheticallly, is that your only passive index option in a 401k plan is S&P500)...

The 500 largest US companies may sound concentrated on large cap,  conceptually, however, 500 is actually a hell of a lot of companies.  If you actually print the full list of the 500 and show him, then ask to name a US company he would want to own that isnt on the list, it might be educational.  Then ask, if you dont weight them by value, how would you weight them?  More in smaller firms?  That seems more concentrated and risky, as smaller firms tend to fail more frequently.

Just a thought

[Hotstreak]

After 2 years, he now has about 30 stocks, each with under $5k in them...  The problem is that he can find the fabulous deals, (sometimes) and made money on them,and after, each one is not now a "loser" moving forward, just a plodder... so he almost never sells and keeps putting the new money into new funds.   Now he is at a point where it is impossible to do the research on all of these (as he is working full time).  He doesn't sell because of lack of information and bias against reversing an earlier decision.... all of his research is looking for the next win, not trimming the "plodders".

Reminds me of those "horder" shows.  Imagine how many stocks he will have after 20 years of that!

[Goldielocks]

After 2 years, he now has about 30 stocks, each with under $5k in them...  The problem is that he can find the fabulous deals, (sometimes) and made money on them,and after, each one is not now a "loser" moving forward, just a plodder... so he almost never sells and keeps putting the new money into new funds.   Now he is at a point where it is impossible to do the research on all of these (as he is working full time).  He doesn't sell because of lack of information and bias against reversing an earlier decision.... all of his research is looking for the next win, not trimming the "plodders".

Reminds me of those "horder" shows.  Imagine how many stocks he will have after 20 years of that!

I love this comment.  too true!



Yes.  I told him to keep a maximum of 10 stocks, if he keeps the research up, with minimum $10k in each to make the cost of the trades as a % lower...  and to put the rest in an index... he could even use a sector industry specific index, if he wants.

[Feivel2000]

He is right if the only option would be to invest everything in one local ETF. The biggest German index e. g. only has 30 companies in it and, surprise surprise, is pretty motor company heavy. Very pseudo diversified.

But if you look at an index like the MSCI World, you look at an investment in more than 1500 companies from all over the world.

Try to convince him using the cost angle. You mutual funds probably cost 2-10x the (recurring) costs of a typical ETF.

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[Livewell]

Sometimes it takes a while to appreciate the simplicity of index funds, could it really be that easy?

Good reading material:
http://jlcollinsnh.com/stock-series/
https://financialmentor.com/category/investment-advice/risk-management-plan
https://financialmentor.com/free-articles/investment-advice/alternative-investment-strategy/which-type-of-investor-are-you-take-this-test
Also Bogle interviews, vanguard study and Warren Buffett's bet with hedge funds

[Radagast]

After 2 years, he now has about 30 stocks, each with under $5k in them...  The problem is that he can find the fabulous deals, (sometimes) and made money on them,and after, each one is not now a "loser" moving forward, just a plodder... so he almost never sells and keeps putting the new money into new funds.   Now he is at a point where it is impossible to do the research on all of these (as he is working full time).  He doesn't sell because of lack of information and bias against reversing an earlier decision.... all of his research is looking for the next win, not trimming the "plodders".

Reminds me of those "horder" shows.  Imagine how many stocks he will have after 20 years of that!

I love this comment.  too true!



Yes.  I told him to keep a maximum of 10 stocks, if he keeps the research up, with minimum $10k in each to make the cost of the trades as a % lower...  and to put the rest in an index... he could even use a sector industry specific index, if he wants.

Maybe you should do the opposite. Encourage him to accumulate 500 of these things as fast as possible and never, ever sell. Then he will effectively be a no-cost broad market index fund :-) !

[Guide2003]

While there is a lot of advocating on this site for simple portfolios, there aren't a ton of people saying that having a single index fund is the best decision they made as a mature investor. Typically you'll hear of someone buying into a total market fund before they knew a whole lot about what they were doing, and then it seems like the "lazy portfolio" made up of 3-4 index funds is the best hybrid of maintenance simplicity with long-term returns. OP's spouse is correct that a single, non-comprehensive index would be a bad spot to park all your cash, but 3-4 well chosen funds cover you in the diversification department without over complicating the portfolio. When you have both Nobel prize winners in Economics and Warren Buffet saying that passive index investing is the way to go, its worth digging deeper into the research if you aren't totally on board already.

[Father Dougal]

Hello all,

This is the "DH". Thanks for all your comments. There were a couple of little things here and there I might be tempted to argue with, but for the most part this is all very interesting and helpful.

It seems to me that this issue here is diversification and volatility, right?  So, if I understand this properly, you would like to have a portfolio that is less volatile than the S&P 500, and you would hope to achieve this by investing in small cap and non-US funds in addition to large cap?  I think that's the problem right there.  Small cap stocks tend to be more volatile, because they are by nature riskier than the big lumbering giants (that's why bonds of small companies pay a higher interest coupon).  The risk/return position of small caps is different - you should expect a higher return in the long term as reward for taking more risk, but at the expense of higher volatility.

The way to reduce the volatility of your portfolio is to invest in assets that are not correlated with each other (in addition to diversifying), or are correlated but with a beta below 1  (ie, if the market falls 10%, the asset would be expected to fall less than 10%). Usually this means bonds.  Diversifying into assets which are more volatile and not negatively correlated, in my opinion, will increase volatility.  At the extreme, investing 90% in S&P500 and 10% on red on the roulette wheel will not give you less volatility than the S&P 500.

The more I look at all this stuff, the more I come to believe that Jack Bogle's simple approach is the best!  Focus on costs and let the market make you rich(er).

[Kaspian]

You're seriously overthinking this.  Read a book by Bogle, do what he says, and don't try to outwit.  Incredibly intelligent people have already done all this work for you.

Also, I cannot for the life me understand a claim that the S&P companies don't have sector diversity because they're all large.  That's just not a true statement.  Canada, China, the USA, and Russia are all the same because they're big countries?  A watermelon, an ostrich egg, and a cinder block also lack diversity.

Here's your truth:  DH likes stock picking because he's gambling.  He gets a rush of dopamine when he buys a new one.  That's all there is to it.  This isn't investing.

[RangerOne]

The risk to a degree is exactly the same based on the holdings of your indexes. Please remind your DH that indexes do not mean the S&P 500. There is an index for every type of asset class and with a handful of indexes you can own portions of companies and bond classes covering the entire global market.

The US Total Stock Market index typically track over 2000 companies including the companies typically that make up the S&P 500 and other Large Cap Funds as well as a number of mid-cap and small cap stocks in proportions that represent the balance of the Total US market.

There are indexes like this for international equities as well. Indexes like the MCSI world index and its various forms track a set of companies making up some or all of the international market. Every fund will tell you which index it is modeling and you should read up to understand the coverage that each index or fund is offering you.

To mitigate risk you do the same as any other portfolio. You buy indexes in bonds for the US and possibly international bonds and they make up the portion of your portfolio you want to be less volatile. At your age probably 0-20% depending on how risk adverse you are.

For bonus points there are indexes in REITS and Commodities like oil and gold as well for even further diversification. Though many portfolios only worry about Bonds and Equities.

Today there is no diversified portfolio you couldn't make entirely out of indexes. In some respects it is no different from picking a diversified set of mutual funds or individual stocks and bonds.

What it does first is it saves you time because you can build a completely diversified Bond and Equity portfolio with about 4 index holdings, Total Stock Market US, TSM international, Bond's US, Bonds International. Second it usually saves money because the fees on those funds will all be below 0.5% yearly most usually down below 0.2%. The difference between close to 1% fees and 0.2% is pretty noticeable once you have millions invested or even a few hundred thousand.

[RangerOne]

The goal of our current choices in mutual funds is to have a mixture of small, medium, and large businesses, in a wide variety of sectors. Our portfolio *shouldn’t* follow the market, because the market is more volatile than practically any financial advisor would recommend.

This statement also isn't correct. The "Total Market" is a form of diversification specifically in Equities which are just stocks in companies.

The riskiest thing you can do, as you probably both know, is to buy stock all in one company. Then your fate is tied to the good and bad decisions of one company in one sector. It is also conversely the potential highest reward, you could buy stocks in one company for $1 and its value could become $100 per stock over the course of a few years.

Your DH is entirely right that you want to diversify your stock holdings by buying stocks in numerous companies over a wide range of industries. This also happens to be exactly what a Total Stock Market index does.

If you have on offer an S&P 500 index, this is typically supplemented by 1 or 2 additional indexes mid and small cap. A typical midcap index is the S&P 400 index and a typical small cap index is the Russell 2000 index. Those numbers roughly correspond also to the number of companies they track 500, 400 and 2000. A mix of somewhere around 85% S&P 500, 10% S&P 400, 7% Russell 2000 basically covers the entire US stock market which is as diversified as you can get in US stocks. It covers every single industry from Technology to Financial and it does so in proportions that account for their commensurate size and influence over our economy.

The only way you could make a portfolio as diversified would be to manually go out and pick a similar number of representative companies. Most mutual funds are trying to do the exact same thing, though they cost more in fees and may have a slightly different methodology to determine exact holdings.

My company for instance in its main 401k investment doesn't offer mutual funds or indexes. It has CIT's or collective investment trusts were are basically privately available mutual funds typically setup for large companies to invest 401ks and pensions. Each of our CIT funds is directly modeled after an index like the S&P 500 and it offers similar cost ratios somewhere down in the range of 0.02%.

Any holding in any number of companies is inherently risky in terms of your holdings could be worth 50% less overnight if the market crashes. But in general over the long term it always recovers. The pain comes if you risk money that you needed on a yearly basis and cant afford to lose that much for a few years or more. A $401k isn't typically like this, if you $130k becomes $60k tomorrow it is nothing to worry about, in 3 years is will likely be worth as much or more even if you didn't add a single penny over those 3 years. There is always the chance of a long drawn out recession that last a decade, but if that happens there will be no escaping the pain with any mutual fund or index.

If you look closely at the mutual fund holdings you will may find they are modeling after an index fund or comparing themselves to an equivalent one.

But also honestly if the only equity you ever held was the S&P 500 you would be in pretty good shape diversification wise. It contains mostly large cap but also some mid-cap companies and it covers every business sector and is representative of at least 85% of the corporate growth in the US. The hedge against this risk in a portfolio always comes in the form of Bonds, REITS, Commodities and Cash.

Diversification within Equities alone is just the tool we use to say I don't want my investments to be tied to the fate of one company or one industry. Buying the total stock market is the diversification strategy that wins over the long term the majority of the time, and when it loses it doesn't lose by much. Over a 20 year + stretch we are talking like 4/100 mutual funds may beat an equivalent index by a a few percent and there is no reason to favor one mutual fund over another.

[RangerOne]

Maybe there’s something I’m misunderstanding, but it seems to me that some people argue for index funds based on reliability. That seems like an invalid argument for the reasons I’ve outlined. The valid argument for index funds might be, “You’re young and flexible, so go for it.” My impression is that isn’t what most pro-index-fund people are saying.

*******

The argument for index funds has and always will be COST. You could go out an buy mutual funds that are a perfect match for any index or set of indexes. They are all doing a similar thing.

The equivalent index will take less of your money each year though. The average mutual fund is probably charging you a flat fee, plus another 1% of your total investment each year to keep it in that fund. If you earn 10% in a year on that fund you have to go back and subtract 1% for your fees to see your true earnings. In a million dollar portfolio you are giving up $10,000 a year to have them manage your assets.

A total stock market index from Vanguard VTSAX admiral shares has a cost ratio of 0.05%. So for a million dollars you pay $500, plus maybe a $25 quarterly management fee. You just paid a room full of managers $9,500 for a fund that performs no better than an equivalent cheap index fund.

Indexes are not safer, they are not more stable, that don't make you guarantees. There are bad indexes that are too specific. You can have a poorly diversified index only portfolio. There only advantage is cost and cost is everything when we are talking about compound APY earnings and fees.

Mutual funds charge higher fees on the grounds that they can make you more money than a cheaper fund. But they can't or at least they can't promise you that. And since the dawn of the index all the evidence has pointed to the fact that they are highly unlikely to outperform a Total Stock Index or a "long period".

Always go with the cheapest funds that achieve your diversification goals, buy and hold and try not to pay more the 0.5% for any given fund in the form of expense ratios.

[Txtriathlete]

We are early 30s, currently have about $130k in retirement funds

AWESOME! You are well ahead of peers!

mixture of traditional IRA, roth, converted old 403b plan to IRA, and 403b plan from current job, all in various stocks, a mixture of large cap, small cap, international, etc.

How and why did you acquire these? Was it part of a plan or just a "place and time" decision for each? You will hear reference to having an "Investment Plan" here and elsewhere. This plan guides everything that enters your portfolio (not just stocks and mutual funds BTW) as part of the well thought out and coherent plan. You will also hear about "re-balancing" your portfolio from time to time ( I do mine semi-annually) to bring it back into alignment with your goals. Lots of folks are selling equity assets (stocks and stock funds) right now and buying bonds or real estate or something else - this is due to to the big run up in the stock market throwing their portfolio out of balance - the value of equity exceeds the desired percentage in their plan's asset mix due to the increased value of the equity assets.

I'd like to convert everything over to index funds or at least do a majority of it.

Why? How does it fit with your plan? Ideally you should only buy and sell to keep your portfolio balanced.

DH thinks this is too risky. ...That [Index Funds] cannot ever be a diversified portfolio,...The goal of our current choices in mutual funds is to have a mixture of small, medium, and large businesses, in a wide variety of sectors.

Diversification is not about stocks or equity mutual funds, it is about the entire portfolio. A market index fund is not the entire portfolio, as even a very diversified fund mix, such as the world fund, still leaves you at the mercy of the equities market.

Diversification requires you to branch out beyond just equities - you should consider other asset classes (bonds, real estate, gold, etc.) to offset volatility in equities. These other assets act as a "brake" on your portfolio, nothing rises or falls too rapidly or too extremely. How much of a mix you have depends on your risk profile.

100% index funds would be too risky a portfolio.

For many (most?) people this is a true statement. It depends on your risk profile. Its worth having the conversation (if you haven't) regarding your "stomach" for adversity. My spouse is extremely risk adverse - she's a "money in the mattress" kind of gal. I am about to the other extreme, a bit of a gambler. We compromise by her having low earning but non-volatile savings accounts and a paid off house, while I get a "stock fund" to play with. Everything else is part of the portfolio plan - for us its stock index funds, bond index funds and real estate.

Also, I think most would agree that a portfolio should be more than just equities, therefore having only one equity index fund is an inadequate portfolio mix.

As an aside, there are now "mixed" funds, usually called 2040, or 2060, or some such, that provide a "mix" of different assets (usually only equities and bonds though, some have a REIT) that approximate a balanced portfolio. They usually have a higher fee but they have the advantage of being "fire and forget" in that they automatically re-balance periodically to get you to a (usually) conservative risk profile by maturity.   

Now, you could argue that at our age, we could stand to take more risk. After all, it just means we might have to adjust our retirement age by 5 years in either direction. However, many people would argue that our current portfolio is *already* too risky. After all, traditional advisors recommend you include bonds in your portfolio. At our age, and with our risk tolerance they usually say 10-20% bonds. We have 0%. People also say you should have a chunk of your money in international funds. We only have 10%. By all accounts our current portfolio is much riskier than most professionals would advise. So it doesn’t seem like a good decision to put all our money in US-based index funds, increasing our risk levels and volatility even more.

Risk tolerance (and risk profile) is personal and has nothing to do with age per se. What I think you are getting at is the perception that you could "overcome" bad earnings or negative returns over a long investment time period. While this is generally true for those looking to retire later in life, it really depends on your earning/investment timeline and when you want to retire. Some on here have retired in their 30s.

It seems to me that some people argue for index funds based on reliability. People also argue that index funds have lower fees.

Reliability doesn't seem to be the right word for me. I might choose instead simplicity. Instead of having to choose 50 funds or 2000 individual stocks I can choose 3 or 4 comprehensive funds (each with a different objective) and only worry about balancing these few funds periodically.

Fees are highly vendor dependent. it really pays to shop around, especially when looking at index funds. Most here feel Vanguard has the lowest fees. I have index funds with USAA (retired military), Thrift Savings Fund, and a 401K and they all have different fees but are essentially the same thing - S&P 500 index funds.

It generally holds true though that actively managed funds (funds with a specific "objective" and not following an index) will have higher fees, and will also incur taxes you might not see with an index fund due to higher rates of trading.

You guys are asking the right questions. Congrats on getting this far.

[East River Guide]

there aren't a ton of people saying that having a single index fund is the best decision they made as a mature investor.

I'll say it.  VBIAX is my best decision as a mature investor.

[Hargrove]

VTSAX expense ratio: 0.05%
Commission fees through Vanguard: ZERO PERCENT (read as Liberty Prime from Fallout 3)
Amount your 1% charge financial advisor would have to beat VTSAX (and therefore, the market) as a super investor to make absolutely nothing more: 0.95%

Amount that advisor would have to beat VTSAX to actually make you a noticeable return: ~1.5% and up.

Actual stock market returns after inflation: 7%

In other words, the amount they'd need to beat the market is a hilarious 25% more returns than the market offers with just an index fund. That's probably how much better you would have to be than the market, too, if you're paying commissions to do your trades.

Even just one (of the diversified) single index funds is the best decision mature investors can make. There are thousands of people who lost most of their money for every one single Warren Buffett, who is taking all those other guys' money.

PS - Guide was actually saying this in his post, he was just warning against single, non-broad index funds.

[Woody Viet]

I feel like I can chime in here as someone who thinks similarly to your husband.

I own roughly 160 shares each with a 0.5% initial weight in my portfolio (80% of my capital) diversified across virtually every sector imaginable and around 15 countries. These are direct investments that I do through IB. Why do this? Well it allows me to gain better exposures to factor returns than you can get through indexes and makes me both highly geographically and sectorally diversified.

Those investments are all in companies that are a) small caps b) value stocks c) have high operating profitability (quality stocks) and d) have high payout ratios (a proxy for owner orientated management). Now I could go and buy a couple of smart beta ETFs and get the same result. Now I don't do do that. Why? Well if you go and buy ETFs I would pay expense ratios of around 1-2% of AUM per year, whole doing it on my own I pay around 0.2% of my portfolios assets to cover everything, excluding dividend taxes (but including cap gains)

Essentially, as we say in the UK, I'm being a but of a smart arse. I believe that factors represent a mix of risk premia and irrational biases, and they will out perform the market in the long run. So far I've done very well but whether this continues is anyone's guess.

If I wasn't convinced that this approach works then I would definitely have my money in market index funds. The blunt truth is that equal weightings make very little difference, as do sectoral weights (the USA has roughly 33 industrial groupings - exclude one, say banking, and you'd think it would make a difference. It barely does as there are strongly decreasing returns to scale - we're talking excluding about 10% of the US stock market and you only have a tracking error of a few basis points a year. I got this excellent stat  from Andrew Ang's book Asset Management).

Now I agree with your husband - you want geographic diversification. Having say 50% of your money in US equities seems a little imprudent to someone like me. There are lots of deep risks embedded in a single country (William Bernstein wrote an excellent mini book on this). Go and buy an international ETF, a US ETF, an Emerging Markets ETF. Also diversify across asset classes. Make sure you watch the fees, they'll be the biggest determinant of your returns that are under your control.

To summarize, there's very little difference between market and equal weightings, but do diversify across countries if deep risk troubles you or your husband (it doesn't have to be perfect, say no more than 20% of your money in each country)

[Car Jack]

Buy the entire world.

You can do this with nothing but index funds.  Besides everything in the world, what else is there?  With index funds, you can buy every single stock that your DH has in his active funds plus 100 similar stocks to each stock your husband has.  And you can do this a variety of ways.  You can buy a total world fund.  You can buy individual funds (total US stock, total US bond, total international stock and for 4 fund, total international bond) and cover the world. 

It sounds like DH has a misunderstanding of Index Funds and thinks it means Individual Stocks.  That isn't what it means and the S&P 500 isn't the end all-be all of index funds.  Look at SCHB ETF at Schwab.  It's the Dow Broad Market which is 2500 US stocks.  That's a good start for the equity portion.  You can tailor your portfolio however you want.  I don't like international emerging market so use Vanguard Developed International for my ex US portion.  Still lots of stock positions in a sector that I prefer.

If you wanted to make this an academic exercise, you could figure out what's in DH's portfolio (down to the stock position) and compare it to an index portfolio.  I would bet that a well diversified 3 or 4 fund index portfolio would absolutely OWN the active one.  Why?  Because many active funds cover the same exact stocks.  Having 9 different active funds that have AAPL in them isn't diversification.  It just isn't.

[Woody Viet]

Buy the entire world.

You can do this with nothing but index funds.  Besides everything in the world, what else is there?  With index funds, you can buy every single stock that your DH has in his active funds plus 100 similar stocks to each stock your husband has.  And you can do this a variety of ways.  You can buy a total world fund.  You can buy individual funds (total US stock, total US bond, total international stock and for 4 fund, total international bond) and cover the world. 

It sounds like DH has a misunderstanding of Index Funds and thinks it means Individual Stocks.  That isn't what it means and the S&P 500 isn't the end all-be all of index funds.  Look at SCHB ETF at Schwab.  It's the Dow Broad Market which is 2500 US stocks.  That's a good start for the equity portion.  You can tailor your portfolio however you want.  I don't like international emerging market so use Vanguard Developed International for my ex US portion.  Still lots of stock positions in a sector that I prefer.

If you wanted to make this an academic exercise, you could figure out what's in DH's portfolio (down to the stock position) and compare it to an index portfolio.  I would bet that a well diversified 3 or 4 fund index portfolio would absolutely OWN the active one.  Why?  Because many active funds cover the same exact stocks.  Having 9 different active funds that have AAPL in them isn't diversification.  It just isn't.

Here's a link to the whole world (or at least 99% of it): https://www.msci.com/documents/10199/f7349d88-8c6f-46dc-bf0d-f2e02e1f5be5

[CorpRaider]

Yeah, sounds like he's concerned about the allocation to stocks versus bonds.  You can have an index (meaning attempt to measure/replicate the average experience for the asset class) for treasuries or reits or muni bonds or (pretty much) whatever.  Sounds like he wants a balanced fund(60-40 or 80-20 or something) and is comfortable with like the wellington fund or something similar.  The arguments against the S&P 500, meh, it represents like 80% of the market and would be fine but if he likes VTI better, ok.  AAPL and the megacaps are are still going to dominate.  Sounds like he's a life strategy or balanced fund kind of guy.  Much better to do that than think you are a hero in year 8 of an epic bull market and freak out when you get a 50% draw down.  There is zero doubt that a lot of the "100% VTI, because it is rational and I can handle the volatility" people will freak out and sell stocks in the next bear market.

[RangerOne]

Most diversification strategies I have seen weight their equity holdings to the US at around 2:1 against international. But there is no reason you have to follow this entirely. To some degree this is because the US represents somewhere around 1/3 of all equities in the world. So no matter how you slice it the US should likely make up a large portion of the equities.

I agree you should have your DH look at some index fund which are all world indexes which include emerging markets if broad international diversification is your goal. You can review their holdings and history in detail to see how it matches up against your diversification goals.

I always tend to reference Vanguards target date funds as they always maintain a nice split of international and US bonds and equities with 4 simple indexes. And their international index are all world excluding the US with emerging markets included. So their most basic allocation really is trying to buy and hold the global stock market.

I admit recently that I haven't reviewed why it is still recommended to hold a disproportionate % of US equities and bonds. Traditionally I know part of it is because our behavior is has the greatest overall global economic influence and our markets have historically been the most resilient. But that of course is changing.

[NoStacheOhio]

there aren't a ton of people saying that having a single index fund is the best decision they made as a mature investor.

I'll say it.  VBIAX is my best decision as a mature investor.

Cheater, that's two indexes!