Why Index Funds Mean Fewer Headaches and Worries
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“Pick index funds over actively managed funds” have always been the conventional advice. Actively managed mutual funds would often carry higher risks in hopes of higher returns. There is nothing wrong with adding risk to one’s portfolio but most experts continue to support diversification with funds that track certain indexes.
An article on Yahoo Finance titled “5 Reason to Sell a Mutual Fund” advises us on warning signs that an investor should ditch their mutual fund. Upon looking at these five reasons, I realized that I would never have to be on the lookout if my investment portfolio consisted of mostly (if not all) index funds.
Let review how these 5 reasons to sell a mutual fund can be disregarded with index funds:
- “Market underperformance”
With an index fund, it would perform closely with the market. If I am losing money, there is no portfolio manager to blame – I’ll bark at the economy. There is no need to go through the hassle of comparing to benchmarks or similar funds. - “Fee increases”
Every fund will have fees. The more work that is put into managing a mutual fund, the higher the fees will be. Management of index funds requires much less work than actively managed fund. Thus, their fees are low and tend to remain low. - “Manager Changes”
Typically, investors believe in the talent of a portfolio manager. They often trust the stock selection strategy and asset allocation that produces solid returns. In index funds, the investment objective is to follow the simplest of investment strategies – buy the whole index. I believe almost every portfolio manager can complete this task. If a fund company fails to find someone to fulfill this role, then I don’t this company is worthy of any investors. - “Changing Investment Policies”
I picked a fund for a particular fund for a particular reason – their investment objective, which aligns with my investment goals. If a manager decides to deviate from the fund’s objective by investing somewhere else, it is no longer serving my goals. All index funds will always invest in the index – otherwise, it is no longer an index fund. - “Other Radical Changes”
Major changes send out red flags because a perfectly fine mutual fund shouldn’t need any changes. The article says to be cautious if a fund “suddenly changes its name, merges with another mutual fund or if your fund company gets absorbed into a new fund management company”.Index funds use a generic, straightforward name. An index fund that combines with a similar index fund would still maintain its purpose and if combined with a different fund, its investment objectives have changed. Also, an index fund will do its job even under new management unless new management decides to mess with it.
Simplicity is Bliss
When investments become too difficult to understand, it is a telltale sign that you shouldn’t be touching them because you do not know how they work. Why deal with funds that are too complex? They will often encounter more complications down the road.
Index funds are the migraine-free investments for any portfolio and it is always believed that the majority of our investments should consist of index funds. I totally agree. Do you?
(Photo credit: BLW Photography)
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xanatax said:
Thanks! You made a good point, and explained it quite well. Unfortunately, you haven’t provided a single example! You don’t mention which indices you are tracking, how many, (diversity is a good too), or how you manage them. Thought I’d throw that out there…
Like, maybe you invest in Industry (like DJIA), and Technology (like Nasdaq), S&P 500, Russel 2000, or in Foreign Exchanges (FTSE, Bombay, Tokyo), or in Currency Baskets, or Commodity Baskets, a REIT? Diversify between them? That kind of indices?
My perspective is looking at a basic “Market” fund, not Roth IRA, so I’m not sure what your options are, (or rather, not sure what they even look like), but my interest in trading indices has led me to ETFs (& ETNs), particularly because I want to be able to leverage and short. see for example, QLD & QID (x2 on the QQQ fund), and XPP & FXP (x2 on the Xinhua 25).
My intention is semi-active trading on the stock market, so my needs are quite different. What I get out of this deal is the ability to switch sides when the market looks to be doing the same. Or hedge, when the market is uncertain. Particularly, that I get to do this without having to actually work a short position myself. (ie. I can buy an ordinary long position in an ETN that is itself managing the short position). The x2 leverage is a nice bonus too…
Back to the Market Trading, this Roth IRA you are playing with, out of curiosity, are you allowed to put the money into the market and directly control which stock it is invested in? or directly order a broker to invest it in specific funds? I’m quite curious what the regulations will let you do… for your needs it could be quite easy to write a custom fund based on a dozen indices. very nice to have the stop-losses in place too!
January 18th, 2010 at 3:02 am
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