Brief Thoughts on Indexing

If you are not willing to spend much time, don’t have much interest in investing or don’t have much capital to invest, I definitely recommend indexing, sticking to Index Funds (Funds that track a Stock Market’s Index, such as Hang Seng Index or S&P 500).

The short answer is because stock equity as an asset class is probably the top 1-2 performing asset classes in the long run (according to Warren Buffett), and that Index Funds usually beat Actively-Managed Funds on the long run (reasons why Index Funds usually beat Actively-Managed Funds). Indexing as a strategy also doesn’t involve lots of capital to execute.

The long answer is best explained in a free 16 page booklet (click here to read it) written by William J. Bernstein, author of “The Four Pillars of Investing: Lessons for Building a Winning Portfolio”. There’s no other material out there I’ve read that so concisely explains why Index Funds are the best choice for those who don’t know what they are doing. It also explains how to use bonds to balance your portfolio, where re-balancing regularly a fixed ratio of stocks and bonds makes you sell bonds to buy stocks in bear market (buy low), and sell stocks to buy bonds during bull market (sell high).

The longest answer is definitely any book written by John C. Bogle, founder of The Vanguard Group, which the pioneer of Index Funds and the world’s largest mutual fund and third largest ETF provider (as of July 2014). The book I read was “Common Sense on Mutual Funds: New Imperatives for the Intelligent Investor”, and it went in extreme technical detail of different perspectives each chapter why Index Funds is such a great proposition for most people.

 

If you are wondering why I still bother to invest in individual securities if Index Funds usually beat Actively-Managed Funds on the long run, the short answer is it’s because according to “Common Sense on Mutual Funds: New Imperatives for the Intelligent Investor”, Actively-Managed Funds in general do beat Index Funds WHEN not taking taxes and costs (eg. brokerage fees) into consideration.

What this implies is that the only sustainable chance of beating Index Funds will have to involve in strategies that defers / eliminates taxes and costs to the minimum. That I can solve by preventing over-trading.

As an individual investor, I also have two advantages over institutional investors, which is my capital structure and patience.

Since I’m managing small sums of money versus institutional investors, I’m able to buy and sell stocks with relatively low trade volumes easily. If managing larger sums of money, it would be extremely difficult to get into or out of positions of a company that has relatively low trade volumes.

I also won’t fire myself for “poor” short term investment results, thus allowing me to take a longer term approach to investing by holding stocks until they reach or exceed intrinsic value or be content with staying idle with accumulating cash when no good investment opportunities arrive.

This however requires lots of time and interest, which leads to my recommendation at the beginning of the article, “If you are not willing to spend much time, don’t have much interest in investing or don’t have much capital to invest, I definitely recommend indexing”.

 

*Disclosure* I’m not affiliated in any way with any of the authors or websites mentioned in this page. I just think they provide excellent sources of information for those willing to learn.

Advertisements

8 comments

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s