Question
My financial advisor says he can beat index funds. I also read an article saying that index funds are worse than Marxism. Why should I invest in index funds if they’re ruining the economy and are so easy to beat anyway?
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ACEP Now: Vol 43 – No 02 – February 2024Answer
There are many lies told about index funds, usually by people and companies who profit from pushing investors into alternative methods of investing, such as actively managed mutual funds or whole life insurance. Most of the lies are easily refuted using prominent and publicly available data. Others are nonsensical and silly. In the end, the informed investor generally concludes, with a nod to Winston Churchill, that index funds are the worst way to invest except for all of the other ways.
One of the most prominent lies is that it is easy to beat the market and the index funds that faithfully track its return. The data refuting this lie are extremely robust. Consider the SPIVA Scorecard published twice a year by Standard and Poors. It demonstrates that over a 20-year time period, fewer than one out of 10 actively managed mutual funds beats the market. We’re not just talking about the big U.S. stocks like Exxon and Amazon, either. In every type of publicly traded investment including U.S. stocks, international stocks, small stocks, growth stocks, value stocks, real estate investment trusts, and every type of bond, the low-cost index funds trounce similar actively managed funds. They do so in bull markets and bear markets. In fact, many of the actively managed funds don’t even finish the race. In the most recent scorecard, over the last 20 years, two-thirds of the mutual funds were doing so poorly that they were closed or merged into another fund. This data doesn’t even include the effect of investment-related taxes. Index funds are notoriously tax-efficient and, when investing outside of tax-protected retirement accounts, this provides a further advantage to index funds.
If the full-time, highly educated, Wall Street professionals running actively managed mutual funds can’t beat the index with a dedicated, highly trained team of analysts and the best computers money can buy, what hope do you have? Or your “financial guy” who was selling cars two years ago? I don’t want to say the answer is zero percent, but it certainly rounds there.
The data for hedge funds isn’t much better. Warren Buffett famously bet hedge fund manager Ted Seides that the S&P 500 Index Fund could beat a diversified portfolio of hedge funds over 10 years. Despite the Global Financial Crisis of 2008 occurring at the beginning of the bet, the index fund trounced the hedge funds. Before the bet was even over, Mr. Seides conceded defeat. He was behind a cumulative 85 percent to 22 percent in year nine of the bet. While in some ways it was an apples-to-oranges comparison, it certainly did not demonstrate that hedge funds have better returns than just buying all of the stocks using an index fund.
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One Response to “The Truth About Index Funds”
February 19, 2024
Todd B Taylor, MD, FACEPDr. Dahle
Thanks for confirming what I have been saying for 30 years. There’s a bit more to it, but the premise is sound advice. Investigate fees charged for index funds. Some can range from .25% to as much as 1.5% for the same portfolio. That’s real money. Also beware of scams (individual solicitation). Always purchase via a legitimate broker. Discount (on-line) brokers (such as Schwab) are just as good as any for this type of investing, where you are not seeking advice.
As for “your “financial guy” who was selling cars two years ago?”, that was a bit of a cheap shot & not to be taken seriously. The vast majority of certified financial advisers (like doctors) are competent professionals, doing what they have learned (been told), with the best interests of their clients. Many people find them helpful, especially when it comes to tax savings, retirement planning, etc. Then there is the comfort factor, not dissimilar to the “worried-well” we see as doctors.
But how to you choose a good financial adviser (assuming you desire one)? Ask them to show you their own personal net worth growth graphic (removing the numbers). If it does not show an average of 8-12% increase over 10 years (2X to 3X increase), look elsewhere. If they cannot manage their own finances to that degree, what chance do they have doing so for you? Same can be said of, those giving “free” financial advice. As Shakespeare said in McBeth, “Look into the seeds of time, and say which grain will grow and which will not, (then) speak then to me.”