Why not just invest in index funds?

Question

Like the S&P 500, since it goes up and down with the market. Is the strategy of an "index and a few" (few refering to stocks) a good way to invest? How should a moderate-higher risk investor invest? Also, since most mutual funds underperform, why should you invest in some(or not)?

Answer 1

If you invest in an index fund, you'll do better than almost half of the other investors out there. But if you're smart and willing to do a lot of research, you can make double the money of an index fund with less risk. You have to be willing to take the time to learn, and then you have to take the time to research carefully all your stock purchases and sales. Plus, you have be educated about how the economy works, and where it's going now.

Answer 2

Nothing wrong with your idea, you'll do better than most mutual funds.

Don't forget low-cost international index funds like ETINX.

Also, a Real Estate Investment Trust can add diversification.


Once you have enough money, you can add some individual stocks that you have reason to believe will do better than the averages. Then add covered "Call" options from time to time on some of those stocks.

Given enough capital, you can then reduce your market sensitivity by picking some really terrible stocks and shorting them.

Check out this game, which is all about beating the S&P 500:
http://caps.fool.com

Answer 3

Frankly, there isnt really a good reason for most people not to invest primarily in index funds rather than individual stocks or managed mutual funds. There a many reasons index funds are superior. First, fees. A good S&P index fund from someone like Vanguard runs a fraction of a percent in an annual fee. Many are .18% to .45% A managed fund has typically 1.5-2.5 percent annual fees in addition to any sales charges(loads). So, the managed fund right off the bat is 2% return behind. So in order to beat an S&P Index fund in a year that has 11% gain, the managed fund has to get 13% return just to get even. Also, managed funds are typically traded more heavily and have more tax implications.

Is "index and a few" a good strategy? Absolutely. As always, determine your investment goals and create an asset allocation based on your time frame and risk tolerance. Use index funds for the bulk of your portfolio.

Answer 4

Most mutual funds underperform once adjusted for risk.

For someone wanting to invest in investments less risky than the market, then theoretically the best option is to invest in the index and the "risk-free" rate, or t-bills.

If someone picks their own stocks, they should be wary of the correlation of those stocks returns if they are wishing to invest in the long term, for short term punts, this is not as important, as diversification of risk is not a major priority.

For a moderate-higher risk investor, index funds may not be the best choice.

Although investing in index funds are theoretically the best way to go, when you want a riskier portfolio, it may pay to instead shift to mutual funds. The mathematics of the risk adjustment is often done assuming you increase the riskiness of your portfolio by borrowing at the risk free rate, whereas in reality you can not borrow at these types of rates, in addition to having limits on your ability to borrow or "short sell" t-bills to buy more stocks. Depending on how much you can increase your borrowing and at what rate, it maybe wiser to instead invest in a risky mutual fund maybe then be the best option.

The other major reasons to possibly invest in mutual funds:
-Investing in international markets
-Possibly to invest in industries which you believe may do well
-In some countries, some mutual funds may have some tax benefits

Answer 5

Bogle and Graham thought you are on the right track. They, at times, have been quoted as saying that picking individual stocks is about like betting in a casino.

There are people who definitely have simplified their stocks by buying things like DIA (the Dow Jones Industrials ETF) or SPY (the S&P500 ETF) and are essentially done with it. I knew an old lady who did this, before I had heard of them, and she said that everytime they tell what the Dow or S&P did on the evening news, she automatically knew what the value of her stocks was.

The problem is, while each are selected for a likely market appreciation, you buy those going up along with those going down. Sure it averages out, but what about the year Enron and Tyco made their nose dive? Then too, if you knew, for instance, that Apple (or Lockheed, ahem) was going to fly while Countrywide was going to tank, would you still feel comfortable with comparable holdings of each, instead of minimize or dump the dogs and load up on winners? Still, the market can turn on a dime and do some really strange things. I'm still kicking myself for not buying NY about a year and a half ago, but thinking I'll pick some specific winners. Some did, for a while, but lost it all this summer. Naw, you are onto something--if you can stomach the details of the dead weight you also carry.

Answer 6

The reason would be because there are specific categories that you believe will out perform the S&P. Rather than "index and a few", I prefer all mutual funds, selected for opportunities but well-diversified. My most recent moves have been to increase my portions in China and in a fund that specializes in American companies that export (believing that the low dollar will help them). I just don't see why being average is any less risky than diversifying in growth segments.

Answer 7

Cory has it exactly right.

Answer 8

a lot of people do just that.

Answer 9

yes, I'll do that too.