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Speaking of apples and oranges, another favorite trick of those trying to “prove” that active management works is to compare the returns of a portfolio of small cap stocks or value stocks to an index composed of large or growth stocks. Unsophisticated investors might not be able to see through these techniques since they have never heard of an index beyond the Dow Jones or S&P 500. Or maybe they point to somebody like Warren Buffett, who has an exceptional, multi-decade record of beating the market, and say, “See! Warren Buffett beat the market, so it can’t be that hard.” It’s a big step from saying Buffett beat the market to your brother-in-law trained in insurance sales being able to do it. Statistically, sheer random chance should have produced a lot more “Warren Buffetts” than currently exist.
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ACEP Now: Vol 43 – No 02 – February 2024Others warn that index funds have become so popular that they are certain to cause an apocalyptic market meltdown. Indeed, something between 15 percent and 40 percent of the money invested in the stock market is invested via index funds (both traditional mutual funds and exchange traded funds or ETFs). In 2022, for the first time ever, there was more money invested in index mutual funds than actively managed mutual funds. It seems that most retail investors and their advisors may be getting the message. However, some people worry, or at least have a vested interest in getting retail investors to worry, that all that money being blindly invested in index funds will somehow result in some sort of deflating market bubble or other cataclysm. The market is perfectly capable of pricing its securities even with almost all of its money invested passively. Only a tiny fraction of the daily trading on the market is done by the “buy and hold” index funds who buy blindly anyway. The rest of it is done by active managers and traders trying to eke out a bit of extra return. That is plenty of analysis and competitive pricing to ensure markets remain efficient enough that investing passively is still the right move. Those who try to convince you otherwise usually have a serious conflict of interest.
Evidence-based investors have no choice but to conclude that, barring possession of a crystal ball, low-cost, broadly diversified, index funds are the best way to invest in stocks. These funds are tax-efficient, avoid style drift, and eliminate manager risk. While they will be just as volatile as the stock market, in the long run they will guarantee you market returns. If you couple market returns with a physician income and a moderate savings rate, you should be able to accomplish all of your reasonable financial goals, and that’s what the one-player game of investing is all about.
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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.”