View Full Version : Index Funds. Love 'em? Hate 'em?
Mighty Frugal
5-1-13, 1:11pm
Do you own index funds. I just learned about them in a Frontline episode. After investigating I discovered I do invest in them for part of my RPP (Registered Pension Plan)
I am an investment dolt so please bear with me. This is what I know about index funds. There is also something called EFTs-which I do not know what they are!!
But mutual funds is run by a company and you pay this company (whether you know it or not) to invest in all sorts of things for you
Index funds are sort of like a stock(??) and you buy shares in a bunch of stocks. So not as many hidden fees.
help?!
ApatheticNoMore
5-1-13, 1:54pm
Index funds will generally have lower fees, I'd be happier to pay more fees if it got better results too, but supposedly it seldom does. I've read the arguments for index funds ("A Random Walk Down Wall Street") and somehow became unconvinced. Maybe that's because I'm not sure how to target with index funds. For instance let's say for example you wanted to only hold dividend paying stocks, how would you do that with an index fund? I doubt you could. Though maybe such targeting is all a waste anyway.
At least when I've bought mutual funds for my Roth I've always known the fees, maybe not paid as much attention as I should have to reducing them, but at least known precisely what they were. I think the point of the episode is that 401k fees are not even obvious. So I don't know, I may be changing some of my investments ... because yes I have been horribly disappointed with the performance of the 401k. Honestly if I had a pension, I'm not sure I'd bother to worry too much about any of this, even if I should. Because pensions have assured many sucessful retirements in the past (though some are shaky nowdays too). Those of us with just self-funded retirements though are in pretty deep in uncharted waters and the risks quite high.
Mighty Frugal
5-1-13, 3:28pm
It's not really pension I think about but trying to get more passive income. We have too much in a savings account (I know, not really a problem!!) I am thankful for all I have and above all value my family (and my) health and safety first but I am pretty proud of the money we have managed to save even with zero raises for a while and dh becoming a SAHD last year.
In Canada the CPP (Canada Pension Plan) is guaranteed to be there for at least the next 50-75 years. So no worries I won't get what I put in all these decades and we also have OAP and I have my RPP and my RRSPs
What I would like to do is 'retire' while still relatively young (I'm 47) and just rely on passive income and part time jobs until we are old enough to collect old age pension
But mutual funds is run by a company and you pay this company (whether you know it or not) to invest in all sorts of things for you
The idea behind an index fund is that it mirrors a certain equity index, like the Dow Jones Industrial Average or the Russell 2000 or the Standard & Poor's 500. So a DJIA index fund, for example, would have stocks in it like Boeing, McDonald's, General Electric, and Home Depot (and 26 more; the stocks that compose the Industrial Average), but would not include, say, Lowe's or Starbuck's (because they're listed on the S&P). The idea is that the index already has been created; no one needs to be paid to spend time identifying winning and losing stock for a portfolio; the index creates the portfolio (for better or worse).
A mutual fund that would invest only in McDonald's, Starbuck's, Burger King, Panera Bread, and other quick-service restaurants, would be called a sector fund. They don't always charge less than index funds, so they're not automatically a low-margin choice.
Index funds are sort of like a stock(??) and you buy shares in a bunch of stocks. So not as many hidden fees.
Index funds can be sold as mutual funds or exchange-traded funds (ETFs). ETFs are the ones you can buy and sell like shares of individual stocks.
Oh -- and we have them and love them. They're not all of our holdings. But they're a good chunk of them since we are not interested in being full-time investors.
rodeosweetheart
5-1-13, 4:52pm
"For instance let's say for example you wanted to only hold dividend paying stocks, how would you do that with an index fund? I doubt you could. Though maybe such targeting is all a waste anyway."
Here are three large cap value funds which "focus on dividend paying stocks and have five-start ratings from Morningstar":
RIMHX, HDPEX, and a Vanguard fund, VEIPX, Vanguard Equity INdex.
This was in our local paper this week.
I do have some index funds, and when I do, I tend to get an S& P 500 type fund or a total market index.
Personally, I prefer to hold individual stocks and lately have been buying for dividend purposes.
Mighty Frugal
5-1-13, 5:03pm
thanks for the info. So do most people have index funds in their mutual funds or as 'stocks' (ETF)
We do a mix of roughly 1/3 individual stocks, 1/3 index and 1/3 sector mutual funds & EFT's.
I'll let someone else explain the different types of funds because I'm not well-versed (dh does the research, he enjoys it). My basic understanding is that they are all ways of buying and holding stocks, just different ways of organizing them. You might enjoy checking out the Vanguard website, they have lots of articles and podcasts available: https://investor.vanguard.com/home/?fromPage=portal
As a side note, I used to be really risk adverse and then I found that what I enjoy the most is buying and holding individual stocks. Go figure!
We have our investments in index funds, also. Index funds seem to be the simplest way for us to invest. We have have No ETFs, No Mutual Funds, no individual stocks as they are a more expensive option for us at this time.
As mentioned by previous posters, Vanguard is a good place to start and I believe their index funds are some of the least expensive on the market.
Do I love 'em or hate em? I'll only be able to answer that when it comes time for us to retire and tap those funds.
A few years ago I read a handful of investing books and ended up putting anything to do with equities into index funds. The books pretty convinced me that in the long run index funds would equal or out perform almost all of the top performing funds of the day or year. Probably the classic is The Four Pillars of Investing, though I think it might be a little dated. Also good was A Random Walk Down Wall Street. As you know, there are quite a few flavors of index funds. You can get growth index funds, international, small cap, etc. Not only am I convinced that index funds are the way to go, but I am nearly to the point that one simple total US market type fund is the way to go.
A large portion of my 401K is in index funds. We are fortunate to have a lot of choices in our plan and a few of them are index funds.
... Not only am I convinced that index funds are the way to go, but I am nearly to the point that one simple total US market type fund is the way to go.
ok! What are a couple of those that you are thinking of?
The key difference between index funds and actively-managed mutual funds is that index funds give you a share of the growth of the entire marketplace (that the index tracks), minus a small amount in fees, while actively-managed mutual fund returns are far more variable, centered generally around the return of their benchmark index fund, but minus much larger fees, typically at least double the fees, but sometimes as much as 50 times as much. Combined with the fact that some mutual funds are simply poorly managed, it results in a situation where mutual funds under-perform their benchmark index the vast majority of the time. (I've seen research showing that mutual funds under-perform their benchmark index as much as 84% of the time. Here are some links: LINK (http://www.businessinsider.com/84-mutual-funds-underperform-2012-3) LINK (http://www.forbes.com/sites/rickferri/2012/10/11/indexes-beat-active-funds-again-in-sp-study/) LINK (http://www.ritholtz.com/blog/2013/01/fund-manager-performance-vs-the-sp/))
With a combination of three or four index funds (one for domestic equities, one for domestic bonds, one for international holdings, and maybe one for real estate or commodities or money market), you can essentially own a piece of the entirety of the marketplace. Put them together in the right proportions, and you have a very highly efficient - the most efficient - means of assuring yourself consistently average returns, in a marketplace where the individual investor can never assure themselves better than average returns.
Why would individual investors buy actively-managed mutual funds, then? Lots of individual investors think they are able to do what research shows even most fund managers cannot reliably do, i.e., pick out the minority of actively-managed funds that are going to be the ones that happen do exceed their benchmark index that year. It's a foolish gamble (as the Frontline episode referred to earlier alluded to). The reality is that every angle for picking funds based on information available to the individual investor has been researched, and the research shows that there is no means of picking the funds that will do well in the future with enough reliability to have a result superior to just investing in the benchmark index, instead. Even if it was possible to pick out the funds that will return to the fund returns better than the benchmark index, subtract out the fees the fund charges you and, again, on average, the individual investor is better off investing in the corresponding index fund.
I'm very slowly (to avoid excessive capital gains taxes in a single year) switching our fund investments to index funds, where possible. (Many 401k plans, including mine, don't offer index funds, because their low fees are supported by not paying big kickbacks to plan custodians and sponsors. I've gotten the dreaded blank stare from the CEO of my company when I suggested that more index funds be added to our 401k choices.)
Mighty Frugal
5-2-13, 8:11am
"With a combination of three or four index funds (one for domestic equities, one for domestic bonds, one for international holdings, and maybe one for real estate or commodities or money market)"
Thank you bUU. I am going to call my bank this week and set up a meeting. I want to move away from mutual funds and into Index and hope to keep it under my RRSP umbrella so no taxes paid (until I take it out)
And next year I'll put all my and dh's TFSA (tax free savings account so you never pay capital gains or taxes on interest) in index funds-all these other years we've just put the max in savings accounts!
You still need to be careful with fees. A "financial advisor" put a large sum of my parents money in an S&P 500 index fund. I can't remember the exact details,but in had like a 3.75% up front load with 2% annual expenses. By their very nature,all S&P 500 index funds should perform about the same.So,the same fund purchased at Vanguard would have been much less expensive.When I shared this with my parents they demanded their money back and went with Vangaurd.
My DW's 401k has index funds, but the expenses are nearly as high as the actively managed funds.So we went with the latter.
ok! What are a couple of those that you are thinking of?
The Vanguard Stock Total Market index Fund (VTSAX) and Fidelity Spartan Total Market Index Fund are where my misc. other index funds are gradually being moved into. I think once you start building several flavors of index funds into your portfolio and juggling the proportions of them you are really trying to do a similar job to a fund manager and you are unlikely to beat the overall market. It maintains market diversity, plus it's a very simple approach.
The Vanguard Stock Total Market index Fund (VTSAX) and Fidelity Spartan Total Market Index Fund are where my misc. other index funds are gradually being moved into.To be clear, for the benefit of other folks, those two funds are essentially interchangeable with each other. You don't need both, but rather one or the other, unless you're trying to cover your domestic equities portion of your asset allocation across a number of accounts, where both aren't offered or have punitive fees attached.
I think once you start building several flavors of index funds into your portfolio and juggling the proportions of them you are really trying to do a similar job to a fund managerHow so? I don't think that's true, at least not in general, as you stated it. Developing holdings that include a domestic equities index fund (like the ones mentioned above), a domestic bonds index fund, and an international index fund, is a reflection of standard asset allocation. It's conceptually what fund managers of Target Date or balanced allocation funds do, but not fund managers in general.
Note though that there are advantages of spinning your own Target Date fund. First, generally, it's less costly. Second, you get to determine the allocation: Most Target Date funds aim for specific allocations (33/33/33 for example) that change over time, and may not be ideal for your own needs, and more importantly, may not be the low-cost index funds you're aiming for.
For example, I have some of my retirement savings in American Funds 2025 Target Date Retirement Fund Class A (AADTX). It actually has no index funds in it; it is a fund of actively-managed funds. (Bad.) Vanguard Target Retirement 2025 Fund (VTTVX), by comparison, is a fund that holds three index funds. However, it's currently set for an allocation of 50/30/20. That might be too aggressive for you, and/or you mean feel that it underweights international too much. With your own three fund portfolio, you can get the index funds you are aiming for, strike the perfect balance, and adjust the allocation when you see fit, rather than subjecting yourself to the Target Date fund's manager's determination.
Developing holdings that include a domestic equities index fund (like the ones mentioned above), a domestic bonds index fund, and an international index fund, is a reflection of standard asset allocation.
+1. The beauty of mutual funds is the diversification and the efficiency of allocation. You may not have to choose individual stocks and bonds, but you still need to make sure the mixture of funds reflects one's personal investment goals and risk tolerance. You also make a very good point about manipulating targeted funds. While many people may not have a bunch of low-cost index funds to choose from by that name, playing a little with targeted funds gives you access to a variety of lower-cost mutual funds/index funds.
To be clear, for the benefit of other folks, those two funds are essentially interchangeable with each other. You don't need both, but rather one or the other, unless you're trying to cover your domestic equities portion of your asset allocation across a number of accounts, where both aren't offered or have punitive fees attached.
Indeed, both the Fidelity total market index fund and the Vanguard are nearly identical. After the recent meltdown in the financial markets, my choice is to own both in order to not have all of my eggs in one institution basket. I admit that this is probably over cautious and probably unnecessary, but it is my choice.
How so? I don't think that's true, at least not in general, as you stated it. Developing holdings that include a domestic equities index fund (like the ones mentioned above), a domestic bonds index fund, and an international index fund, is a reflection of standard asset allocation. It's conceptually what fund managers of Target Date or balanced allocation funds do, but not fund managers in general.
Note though that there are advantages of spinning your own Target Date fund. First, generally, it's less costly. Second, you get to determine the allocation: Most Target Date funds aim for specific allocations (33/33/33 for example) that change over time, and may not be ideal for your own needs, and more importantly, may not be the low-cost index funds you're aiming for.
For example, I have some of my retirement savings in American Funds 2025 Target Date Retirement Fund Class A (AADTX). It actually has no index funds in it; it is a fund of actively-managed funds. (Bad.) Vanguard Target Retirement 2025 Fund (VTTVX), by comparison, is a fund that holds three index funds. However, it's currently set for an allocation of 50/30/20. That might be too aggressive for you, and/or you mean feel that it underweights international too much. With your own three fund portfolio, you can get the index funds you are aiming for, strike the perfect balance, and adjust the allocation when you see fit, rather than subjecting yourself to the Target Date fund's manager's determination.
Your plan and explanation makes perfect sense and follows decent traditional thinking. I will explain my approach. First of all, anything I consider fixed income is in a totally different category that includes a variety of index bond funds, CDs, inflation indexed bonds, and money markets. In my opinion, this belongs in a different discussion. I would say that if all of your fixed income is in indexed bond funds you are subject to interest rate risk that could decrease you net asset value.
When it comes to equities, I would suggest, why do you need international? The total US index funds offers good diversity in one of the strongest economies in the world. Anything international offers higher risk and more market fluctuation. When you get into total international funds you are investing in companies residing in places like Greece and Spain. It is enough for me that many US companies are heavily vested in international operations and that is fine for me in terms of global diversification. You could even throw into the mix emerging market index funds which adds even more risk and fluctuation. Risk and return will always be intrinsically related and there may be some years where international returns will be stellar and others, like recently, when it lags.
I might add for what ever it is worth that most traditional mixes of bonds/fixed income to equities are too aggressive for me. I am perfectly happy scoring singles in the fixed income category in favor of big hit and grand slams in equities. I expect given recent equity returns there will be renewed interest in stocks, but I plan to stay my conservative course.
Four Reasons to Invest Internationally (http://www.getrichslowly.org/blog/2012/03/06/four-reasons-to-invest-internationally/)
Four Reasons to Invest Internationally (http://www.getrichslowly.org/blog/2012/03/06/four-reasons-to-invest-internationally/)
I guess we all have to find a spot where we rest comfortably with our investments and that level of risk is different for people. This quote from your list list pretty much says it for me, "If you consider volatility as a good measure of risk, then international stocks are more risky than U.S. stocks. But you also have other risks with non-U.S. equities, such as political risk that comes from investing in countries with unstable governments or less respect for property rights. Also, corporate governance and investment exchanges in many countries are not as developed and regulated as in the U.S., leading to a higher potential for manipulation and fraud."
I know of folks who insist on keeping all their money in insured deposit accounts. Diff'rent strokes!
I know of folks who insist on keeping all their money in insured deposit accounts. Diff'rent strokes!
Yes, pretty much the opposite end of risk. For me the risk of this is not keeping up with inflation and having diminishing purchasing power over time. That doesn't make me sleep easily either. I think there is a happy medium, but it isn't the same for everyone.
"For instance let's say for example you wanted to only hold dividend paying stocks, how would you do that with an index fund? I doubt you could. Though maybe such targeting is all a waste anyway."
..check here for one example.....Vanguard Dividend Growth Fund (VDIGX)
from MightyFrugal... Thank you bUU. I am going to call my bank this week and set up a meeting. I want to move away from mutual funds and into Index and hope to keep it under my RRSP umbrella so no taxes paid (until I take it out)
I would not go to the bank to invest in index funds. But if you decide to do so... be sure to check out the fees charged. If you go through Vanguard or other brokerage firms you can purchase "no Load" or no charge/minimal fee funds.
Would suggest you read some beginning investment guides, such as "The First Book of Investing" by Samuel Case. This book has a great way of making investment materials interesting.
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