Indexing

Welcome to my popular Indexing page.

This page is a short primer for all DIY investors to learn about index investing and why we continue to use low-cost indexed funds ourselves in early retirement. 

Read on!

Q&A with Mark: Indexing, what is that?

The premise behind index investing is simple:

1. You can achieve market performance less minuscule money management fees.
2. You can obtain great diversification from companies and countries from around the world.
3. You can largely “set and forget” (to some degree) your entire portfolio.

Indexing or index investing is a passive investing strategy that attempts to generate similar returns as a broad market index.

Investors can use index funds to replicate the performance of a specific index – generally an equity or fixed-income index – by purchasing Exchange Traded Funds (ETFs) that closely match the underlying index.

A quick example:

The S&P/TSX 60 Index is a stock market index of 60 large companies listed on the Toronto Stock Exchange. Launched on December 30, 1998 by the Canadian S&P Index Committee, a unit of S&P Dow Jones Indices, the index has components across nine sectors of the Canadian economy.

You can own all the top-60 stocks in Canada via one simple Exchange Traded Fund: XIU. (This is my favourite low-cost Canadian ETF that invests in Canada.) 

There are numerous advantages of index investing using low-cost ETFs:

1. Empirical research has demonstrated that index investing tends to outperform actively managed funds over time. Why? The fund manager is cherry-picking stocks; index investing is not. By taking a hands off approach to investing that eliminates many of the biases and uncertainties that arise in any stock picking strategy. 
2. Since index investing takes a passive investment approach, index funds including indexed ETFs usually have lower management fees and expense ratios than actively managed funds. The simplicity of tracking the market without a portfolio manager (to cherry-pick stocks) lowers investing fees for you, the DIY investor. Further, broad market index funds also tend to be more tax efficient than active funds because there is less trading and/or chasing performance.
3. Maybe most importantly, index investing is an effective method of diversifying against individual risks. In other words, an index fund can consists of a broad basket of stocks instead of just a few. This serves to minimize unsystematic risk related to a specific company or industry without decreasing expected returns.

Personally, since 2009 on this site, I think index investing inside your tax-deferred (RRSP) and/or tax-free (TFSA) accounts using low-cost, diversified ETFs that track a broad market index can work very well for the majority of investors. 

I/we continue to invest this way for part of the retirement portfolio…

Even the greatest investor of our time believes in indexing…

Even the greatest investor we know says you should index (Warren Buffett).  

Here’s a quote, from page 20 of his annual letter to Berkshire shareholders, dated February 28, 2013.  After all of his Berkshire shares are distributed to charity, take the cash, Buffett says, and just buy index funds:

“My advice to the trustee couldn’t be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard’s.) I believe the trust’s long-term results from this policy will be superior to those attained by most investors — whether pension funds, institutions or individuals — who employ high-fee managers.”

He goes on to say:

“Both individuals and institutions will constantly be urged to be active by those who profit from giving advice or effecting transactions. The resulting frictional costs can be huge and, for investors in aggregate, devoid of benefit. So ignore the chatter, keep your costs minimal, and invest in stocks as you would in a farm.”

So, be boring when it comes to investing. Index investing does that. 

Q&A with Mark: What your your favourite ETFs?

I’ve got an entire page dedicated to low-cost ETFs.

My ETFs

Q&A with Mark: If you suggest indexing for many DIY investors, why do you own any individual stocks at all?

Great question.

My simple answer is and has always been since 2009:

“I feel I get the best of “both worlds” through my hybrid investing approach.”

I can own individual stocks for income.

I can own low-cost, lazy ETFs for growth.

This is my investing approach and your mileage may vary. 

Check out my Archives page for all my past content related to the world of indexed ETFs.

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