Million Dollar Journey made an interesting post last week in which he listed some points that in his opinion, are the disadvantages of indexing. While I made a detailed comment on that post, I couldn’t resist biting the juicy bait dangled in front of me. So, let’s examine his claims closely:
- No downside protection: Investors wanting a smoother ride should allocate a portion of their portfolio to assets that are less volatile than equities such as bonds and cash. There is little evidence that money managers are able to provide downside protection either. Their returns in bear markets is, at best, mixed compared to their benchmarks. Neither are they able to add value through market timing and if anything, the evidence points the other way — mutual funds have low cash levels in bull market peaks and high cash levels in bear market bottoms.
- No control over your holdings: It is true indexing doesn’t allow you to overweight Royal Bank and underweight BMO. But, we all know how well control is working out for mutual fund managers, eh?
- An indexed portfolio will always be average: It depends on what is meant by “average”. John Bogle estimates that the odds of an index fund outperforming any mutual fund is 95% over 20 years. If that’s average, I’ll take it.
- It’s boring: I used to own AIG (NYSE: AIG) (as an aside, luckily, I sold it last year when indexing most of our portfolio) and every year, I try to read the annual reports. It is usually 250 pages long filled with financial arcana — not exactly what most people would consider interesting.
The bottomline for an investor is to earn enough returns to achieve their financial goals — not some arbitrary score of how many indices they beat over their investing career. Jason Zweig recounts an encounter with a group of retirees in Your Money & Your Brain. Mr. Zweig asked the retirees how much returns they earned to retire to Florida and their answer: “Who cares? We earned enough to retire here”. Passive investing gives most people the best odds of doing just that — achieving their financial goals.
