The examples on the previous page show that there is every reason not to attempt to beat the market and, instead, just buy an index fund, or an exchange traded fund (etf) that tracks the market. Vanguard, a pioneer in passive investing, has a number of index funds and etfs with very small fees that will serve the purpose, as will similar funds from other companies. Not only will you outperform most active professional investment managers over the long-term, but you will also save yourself a huge amount of time and stress required in trying to pick market beating investments. Plus, your taxes will be simpler; when I was an active trader my accountant was pulling his hair out – and charging me by the hour – when I filed my taxes every year, trying to reconcile my many trading positions.
Passive Investing – But Which Index?
But even passive investing is not such a simple matter; which index do you want to follow? The S&P is the index that most sophisticated investors use to benchmark their performance, but it does not follow the entire market, only 500 of the largest US companies. You can also buy index funds that follow the broader market, including much smaller companies, as well as those that follow the international market, such as Vanguard’s Total World Stock Index (VTWSX). You can also buy index funds that attempt to track the performance of just about any other asset category; real estate, emerging markets, high dividend paying companies, etc. But the more specialized indexes defeat the purpose of passive investing. If you’re investing in very narrow, specialized index funds or etfs, you might just as well be picking individual stocks.
Index Funds vs. Valuism
If you’ve read this far, you will have found a contradiction in our advice. On the one hand, we say we’re value investors, looking to go in the opposite direction of the crowd. But then we say that most investors are better off buying an index fund, and not trying to beat the market! To compound the problem, with about one third of the market now being index oriented investments, to some degree passive investing is the market!
Value funds have a long term record of beating the market. But most people are not, by nature, value investors. They may like the idea of going against the crowd, but when their investments are doing much worse than the overall market they tend to get very uncomfortable, and then bail out, usually at just the wrong time. Also, value investing requires a bit more work and is not as simple as index investing. So, if you:
- • Really have the emotional discipline to stick with your investments even over periods of 2-3 years when they underperform the market;
- • Can invest the time and energy to carefully select value investments, and have the talents and knowledge base to do this sort of thing;
- • Have a long term investment horizon; and
- • Are a naturally contrarian person comfortable with sailing against the wind,
then you should consider value investing.
Everyone else should stick to index investing. Of course, index funds are still subject to the vagaries of the market. If the broad market falls sharply, so will your index fund or etf; the S&P 500 fell 56.8% from its peak on October 9, 2007, to that cycle’s low point on March 9, 2009. Index funds followed suit. So you need to believe that, in the long run, the market will rise enough to justify the volatility you suffer through. This requires discipline; a common Attitude Media theme. It requires a lot of discipline to follow our advice regarding fitness or nutrition; the same is true in investing. With fitness, it’s the discipline to do something you don’t always feel like doing – exercise. With nutrition it’s the discipline to eat less of what you may like, and more of what is good for you. With investing it’s the discipline to just stay the course with your investment plan and often do nothing – resisting the powerful urge to follow the crowd. It’s ironic that Attitude Media is all about Taking Action; it’s the very foundation of our philosophy. But action is not always correlated with creating value, and in the case of investing the most important thing is often to resist the urge to action in order to follow a long term investment strategy.