Index Investing Downsides

in Index Fund, Investments, Mutual Funds

Even though I do Index Investing (mostly) I do realize that with all investing plans there are downsides. I read an interesting article in the Kiplinger magazine (by Elizabeth Leary) that talked about the obvious Index Investing downside, you are investing in the Index. In these raucous days of market corrections, this is a concern to Index Investors

The best quote from the article is:

“By definition, index funds guarantee that you will suffer 100% of the next bear market’s decline,” — Jim Stack, president of InvesTech Research.

Given  you are an Index Investor, you already knew that, but for others the subtleties of the statement is lost. When the Indexes are in a Bull Market, you enjoy the low MER and growth, but when the Bear Market comes (and it has?) you will feel the brunt of the market drop. The argument that actively traded funds make are that they can react quicker to market corrections.

Index Investing

Both of those statements are true, but the losses you incur from Actively Traded funds MERs are usually not mentioned (especially during Bull Markets, so you lose some of your profits). Do all actively traded funds manage to stop-loss during market corrections? No (some do), and some might argue they are some of the market forces that cause the market corrections.

The other point folks forget is that the “Yard Stick” that most Index Funds use correct themselves as well. The S&P (and others) regularly update (add and drop) stocks from their Indexes, depending on what the Index is tracking. They don’t typically do this during a market correction, but the “bad apples” do eventually go away.

Ms. Leary points out that if you buy into the argument about Indexes and how active traders can be more nimble, you are assuming that your Mutual Fund manager are smart enough to deal with rapid market changes. This is a very big assumption to make, you must choose the wisely managed Active Trading Mutual Funds or risk being worse off than if you simply use well-defined indexes. The hard part is figuring out which funds are the wisely managed nimble ones.



My Opinion

I will stick with index investing for now. I tried to be an active investor myself and lost enough money to realize that Market Timing is not possible for an individual investor. Are there Actively Traded Mutual Funds that beat the market (i.e. out strip the Indexes)? Yes, however, it is interesting that it is rare to find any that can make that claim over 10 years.

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{ 6 comments }

{ 6 comments… add one }
  • Bernie February 13, 2018, 7:00 PM

    Are you not comparing apples to oranges here? It wouldn’t be appropriate to compare an indexed fund to an actively managed fund unless the holdings were similar. In reality few managed funds resemble index funds. They may hold a portion of the same holdings but never hold all of the same holdings.

    Reply
    • bigcajunman February 13, 2018, 7:56 PM

      Surprisingly many actively managed funds resemble (if not duplicate) Index Funds, but the idea that if you invest in an actively managed fund you are somehow going to be less impacted by market setbacks is unlikely in my opinion and thus the extra fees for them are not justified.

      Reply
      • Bernie February 16, 2018, 12:55 PM

        I would agree with you, in general. But, if you do some research you’ll find there are some actively managed funds that outperform the market the vast majority of the time. Many of the Mawer family of funds come to mind. I feel its wrong to blindly trust low fees will lead to greater returns.

        Reply
        • bigcajunman February 16, 2018, 12:57 PM

          Lower fees may not always be the answer, but the way many actively traded funds portray themselves, they always “outperform the market”, without doing so.

        • Bernie February 24, 2018, 12:39 PM

          I seldom trust the glowing propaganda that fund company PR Departments. write about themselves, index fund companies included. I prefer to look up the hard facts myself before I act. I’ve noticed a lot of pro index authors sell index funds themselves, either directly or indirectly.

        • bigcajunman February 24, 2018, 12:48 PM

          Agreed, I think when money is involved there aren’t many angels involved. I myself don’t have my own Index Funds, or ETFs, but I buy them (i.e. I am a consumer).

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