Weekend Reading – Misunderstanding indexing and its supporters

Weekend Reading – Misunderstanding indexing and its supporters

Hey Readers!

Welcome to a new Weekend Reading post: misunderstanding indexing and its supporters.

I hope you’ve had a great week…

Before sharing some of my favourite finds from the personal finance and investing blogosphere, here are some recent posts:

Are we headed for a historic housing market correction?

If you don’t want to own any individual stocks like I do, I think these are some of the best ETFs to generate retirement income with.

Weekend Reading – Misunderstanding indexing and its supporters

Let’s start with the positive – I’m a fan of indexing.

I have been, for years, and always will be I suspect.

In fact, I own a few indexed ETFs and have done so, also, for years. 

It’s hard not to appreciate why indexing so works well, and wonders, for some investors.

Indexing 101

Indexing, or index investing – is an investment strategy – that essentially mimics the performance of a market index, less some minor fees to create and operate the fund.

It is a very passive (investment) strategy because it does not involve individual security selection nor trading of any kind. The basket or portfolio of securities defined by the index, and the fund that tracks the index, is designed to be held by investors for the most part indefinitely instead of trading in and out of the fund.

Using Exchange Traded Funds (ETFs) in your portfolio are a popular way to index invest.

The simple and pragmatic arguments for indexing are:

• The market is composed of both passive and active investors, on a massive continuum.
• On average, the performance of passively managed portfolios matches the performance of the market.
• On average, the performance of actively managed portfolios, must, therefore, match the performance of the market.
• Any net returns of actively managed portfolios will be lower than the net returns of passively managed portfolios due to the greater transaction costs associated with active management strategies.

There is also little doubt about this: the costs of managing an index fund vs. active money management are often lower for most investors.

Why?

For one, most of your active money management paid to any money manager or advisor, is sucked up in the analysis: what and how many stocks should go where, when. Two, additional costs are incurred when the money manager buys and sells assets – their almost obligatory need to demonstrate value is at the core of any money manager or advisor work.

Otherwise, why use one?

(I don’t!)

Index funds do not have any of this complexity. Especially broad-market ETFs that invest in the U.S. stock market index for the S&P 500 or the total U.S. stock market. Since the composition of those indexes changes rather infrequently nor does the fund that tracks such an index, index funds can be money-management efficient.

However, a good reminder to many investors, including indexers, that even the founder of one of the world’s most popular (and successful) indexing companies around (Vanguard) didn’t always invest in the same products his company was famous for establishing.

Indexing is great but…not all portfolios are created equal!

I never got to meet Jack Bogle, talk to him, ask him about his portfolio; gain any answers about perfect portfolio construction – but I didn’t have to to figure out that:

• No perfect portfolio exists,
• Personal finance is personal,
• Investing in what you know well, what you can stick with, aligned to your tolerance for risk, etc. are good ideas. Even for Jack Bogle.

The founder of Vanguard Group (said Jack Bogle), used to have a rather basic portfolio: 60 percent in a U.S. stock index fund and 40 percent in a U.S. bond index fund. He maintained that allocation for himself for years. In his elder years, he shifted his strategy: more 50/50 stocks and bonds which is rather conservative.

Fun fact: Jack Bogle was also an active investor at times investing in Bogle Jr’s hedge fund!

Hedge funds aside, some interesting observations about this portfolio allocation over the years:

• No mention of international funds, including Canadian assets.
• Little public mention of cash holdings or cash % of his portfolio.
• No bias to dividends or capital gains or either really – just total return – to invest in a manner that holds the collection of U.S. stocks at a very low cost with some U.S. bonds and take such returns accordingly. 

Many indexers revere Jack Bogle, as they should – Bogle helped transform the world of investing for retail investors as we know it. But make no mistake, he was hardly as “diversified” as much as today’s advisors or money managers would likely do with your portfolio.

So, what is my point?

Indexing is great. There are many indexes and many funds including ETFs that match those indexes for every investor alive, but indexing is by no means is the only way to invest. 

Misunderstanding indexing and its supporters:

In the end, how you construct your portfolio and decide to manage it, is up to you. Use one fund, a few funds, or simply no funds at all. 🙂  Doesn’t matter to me. Your mileage may always vary and it probably should. 

On the subject of portfolio management, did you know Bogle never really believed in portfolio re-balancing either!?

Indexing works but it’s just one investment strategy…

Whether you are 60/40 stocks, 100% stocks and cash, or anything else really, I believe the true genius of Bogle’s message, to me at least, is:

keep it simple – so invest in what you know, invest in what you can stick with it over time, and keep saving and investing.

If part of your wealth-building plan includes building and maintaining a growing business, do it.

If your plan calls for a mix of stocks, ETFs, cash and real estate, go for it.

If your plan includes some private equity or some alternative investments, well, fine by me!

As some links above rightly summarized, the magic behind indexing is not about the exact funds you own nor finding the perfect portfolio. The magic behind indexing is helping many investors simplify their needs with investment products to ensure they invest in a way that meets those needs. Run away from any money manager or advisor that says something different. 

Bogle, one of the world’s most successful investors, a true pioneer and advocate of index investing, who revolutionalized the financial industry for millions of retail investors – never fully ate his own cooking.

He did what most of us would do when it comes to investing: he learned enough to determine what was right for him; he defined his needs, and he invested in a way to meet those needs.

You and I should do the same.

More Weekend Reading!

I like healthy debates and so does Cashflows & Portfolios!

On the site this week they looked at Bonds vs. GICs – which is better?

I’m a big fan of many elements in most portfolios – not just certain stocks, not just any dividend stocks, not just any ETFs 🙂  Dale Roberts was over at Financial Independence Hub recently discussing and building the All-Stock Retirement Portfolio. Read on!

On a similar wave, The Dividend Guy offered his thoughts on Beat the TSX (BTSX) stocks. A very good strategy overall but it can have some flaws – listen for those words of caution from Mike!

I have a page covering BTSX here and I’ve invested in many of these stocks for well over a decade in fact.

Nice work and an enjoyable read in the Globe and Mail from Erica Alini, why we should celebrate financial wins like paying off a mortgage (subscribers only). From the article:

“When you’re tackling major long-term goals such as paying down large debts or saving for retirement, I find that marking your progress can help you to remain motivated. I’m not alone in this.”

You’re not for sure Erica. I have this blog partly for the resons to celebrate my successes but also try to ensure I don’t repeat too many failures. I have a few!

From Robb Engen: should I move my investments while they are down?

Nice reminders and advice from a favourite blog: Dividend Growth Investor. Here are some advantages to owning dividend growth stocks vs. just dividend ETFs. These are similar reasons why I unbundled my Canadian ETF for income and growth years ago. 

Have you considered unbundling your Canadian ETF for income?

Striving to make some sense of the markets? MoneySense has you covered!

Dave from Accidental Fire wrote about the smugness of financial independence. 

Have a great, safe weekend!

Mark