S&P 500
I know that everyone loves index funds. They have low fees and allow you to passively invest and get the average return of the market. I cannot argue with that. If you are an investing novice and need exposure to the market, then I agree that you should grab an index fund. If you however have a little investing experience, my opinion is different. I believe that you would be better served by becoming a more active investor. Let me tell you why.
I have been saying that index funds are not going to be great growth investments in the future for some time now. Take a look at the 10 year performance of the S&P 500 index over the past 10 years. The S&P 500 is down nearly 70 points for a total loss of -5.69%. This is even with the market bounce back of the past 2 years. Index investing did not work over the past decade.
While I am not a huge fan on most mutual funds, I can name a good number of mutual funds that actually had a positive performance over the past decade. They aren’t even the hottest funds in industries or niche funds that did well. These are boring solid funds. While the market may have been down over the past decade, the mutual funds that I invested in actually were up. One of the better ones returned 52% over the past 10 years.
The secret is that there is no secret. I keep it simple. I have a balanced fund, growth fund, and a value fund that I absolutely love. All three of them beat the S&P 500 and I did not follow a hot fund manager. The common theme among them is that they all have low fees, great management, and pay solid dividends. The growth has been great.
My Issue With Index Funds
Forget about the double digit growth of the market in previous decades. Every investment adviser I know used to love to trumpet that the average return of the stock market was 10%. This was true historically but this is not going to be the case going forward. The new normal is a low growth economic environment domestically. Most U.S. large caps are not the growth plays that they once were.
The Standard & Poor’s 500-stock index gives the greatest weight to stocks with the largest market caps. This means that stocks with the biggest run-ups have the biggest effect on the index. Therefore most index funds are weighted toward stocks that are more likely to be overvalued. Personally, I would rather own a larger percentage of a quality company whose stock underperformed the previous year than a company whose stock was on fire last year.
I think stock investors can do even better than fund investors. Case in point. It didn’t take a ton of foresight to know that General Electric was a good buy when shares were trading at $10 a share. Did anyone really think that Buffett would invest billions of dollars in a company headed for bankruptcy? How about Cheesecake Factory when it was at $5? Or Chicago Bridge & Iron when it was trading at $19? That stock has been a nice 65% gain for my portfolio over the past year. I will admit Bank of America was a major risk when it was in the single digits.
You don’t have to bat 1.000 to be a great stock investor. All you need to do is pick one outperformer and that will make your whole portfolio look good. My returns were much higher buying General Electric, Bank of America, Wells Fargo, Cheesecake Factory, and Alcoa than they would have been buying any index fund. I didn’t know where the market bottom was but I knew that some stocks were selling way too cheaply.
It’s tougher to find cheap values now but there are some available. I still think that the best investment opportunities are in small caps, REIT’s, and financials. Ask me if I think that a self managed portfolio comprised of just a few small caps and value stocks will outperform the S&P 500 as a whole and I will say yes every time.
Final Thoughts
Index funds are perfect for busy investors that do not have time to manage their portfolios. If you have the time and do a little homework, you can beat the returns of an index fund.
To further illustrate my point, in January I am going to create a portfolio of 5 stocks and judge its performance against the S&P 500 index on a long term basis.
Don’t take my College Investor portfolio stocks!! Ha, you can totally include them if you want!
That’s just what I was thinking. I will just cut and paste your list. LOL. I will try to come up with some original picks.
Looking forward to yours&P 500 challenging portfolio in January. You said it loud and clear, Index funds remain the best investment path for those who do not have the time to research and follow the market.
I don’t believe in paying others to beat the market for you, since by definition this is a difficult task, and the fees, tax considerations on top of the fees, etc… will make it unlikely year after year.
Nonetheless, I do believe that if one does take the time and diligence to do their research, it is possible to find opportunities and to make plays that can do well, and better than the market benchmark, over time. There can be more risk associated with doing so (if you specialize in energy, then you have sector-specific risk there), but if it’s what you love and you take the time to do the research, then why not?
Personally, I don’t have that much time to do the research so I am mainly in indexes, though I am currently holding a natural gas play. My friend BTI is a perfect example of this, though (even though he’d call me an index hugger
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Index hugger…I like that description! That’s unique.
I like this post, and the stand you have taken here.
Personally, I have been an index fund kind of guy:) That said, I remember from one of my MBA finances courses that people can construct a portfolio of diverse, relatively non-correlated stocks with a small total number of stocks. That, by the way, can perform quite well as a small “fund”. As someone who’s stretched for time in different directions, however, I have gone the index fund route.
That said, I’m looking forward to this 5-stock portfolio challenge that you’re setting up, and can appreciate what you’re doing. It would be interesting to read your selection criteria.
Now you have me thinking about doing this…don’t think I will right now, not up front this year, but perhaps down the road. We’ll see.
You can take the challenge too!!
I am glad that someone is voicing this. Index funds are fine for the passive investor, but if you want to take an active stance with your cash, good old fashioned stockpicking can’t be beat.
Stock picking is great if you have the time and competence.
I think index funds are great, but not for buy and hold.
Combine investing in index funds with non-greedy market timing and trend investing and you have a formula that can work well even when you do not have the time or competence for stock picking.
But of course, a genius who can pick the right stocks, will do better than someone who is trend investing the index.
I am a fan of the hybrid approach. A good index fund with some good old fashioned stock picking is a win win.
Every generation learns anew. Good luck! I hope that one of your 5 is the next Apple but for some it will be Enron. If it is Enron just keep telling yourself that retirement is over rated. There are plenty of market beaters in that boat today.
Enron was in the S&P 500 index!
yep…one of 500
I am not anti index. I feel that if you have the time and don’t mind doing a little work that you can beat the results.
I’m sort of in line with the thinking here except that I recommend 80% index 20% take your shot. Still suggest no more than 5% in single name.
My maximum is 20% for even my best ideas.