Hello,
the more I learn about investments the more I wonder if I'm suffering some sort of confirmation bias*. Ever since I found out about MMM and index fund investments I read a lot about that topic, however, most books and articles are recommended by people who also think that index investing is the best form of investments. What are your thoughts on this?
One thing I've learned so far is that what everyone seems to be doing might not be the best thing to do since that might lead to a bubble or something like that. And index investing seems to be just that, everyone seems to be recommending it.
So what makes you think that following that strategy will work out in the future? I've tried to put together points that make sense to me and why they might not work so well as well.
1) Investments in companies that make money seems to be a very reasonable approach to make money as well. That’s why stocks will probably a good investment in the future.
- Well, that might be true but it also depends on how much you have to pay for those companies. Otherwise it would be the best way to just buy the company that makes the most money and that doesn’t work out for obvious reasons.
2) Stocks will outperform other asset classes in the long run because they are riskier and thus have an equity premium. It’s the same with small stocks, they are riskier and that is why they outperformed large stocks in the past.
- That kind of makes sense to me, but what if the general public gets the idea that investing in index funds has been a great way to make money in the long run and thus stock prices will be relatively high which will lower the returns? If lot’s of people jump on that „oh, stocks are low, I’ll buy more stocks now“ train stocks will never really get low until some huge bubble bursts. And if everyone buys small cap stocks they might not perform that well either.
3) There will always be people who think that they can outsmart the market (and some can do that for some time).
- Well, I hope so because otherwise index investing doesn’t make much sense since the market will be inefficient. Might it be true that in a very efficient market the best way to make money is index investing but if everyone did index investing only the market would become highly inefficient?
4) In the end it’s important to diversify, so stocks might outperform (and probably will) other asset classes but there is no guarantee to that. So the best way is to create a reasonable mixture of different asset classes and stick to it.
- That will probably be my approach. However, since my stash is not that big yet it doesn’t make sense for me to invest in 7 different asset classes plus subcategories for each of those.
So what do you guys think about that?
*http://youarenotsosmart.com/2010/06/23/confirmation-bias/