The Advantages of Owning a Simple Index Fund

Barron's had an article in this week's edition about the mistakes that investors make, that result in falling short of the S&P 500 or even the mutual funds they own.

This is something that has come up before. Human nature is a pretty big enemy where long term success in the stock market is concerned.

The first crucial error cited is not diversifying properly. Quite simply by avoiding big bets and allocating a portion to many asset classes, you won't get taken down by one bad bet, and you give yourself a better chance of having something that is going up.

As you look across the entire market, there are clearly some groups and individual names that are doing just fine. In fact you'd have no idea the market is down almost 12% YTD by looking at them.

I've got a bunch of names that are up or down 3% YTD, which offsets nicely the ones down more than that YTD 12%. I've been writing about this for ages; this is not about good stock picking, it is about good diversification which is a whole lot easier.

The next mistake cited is timing the market. Many people try to do this and get it wrong. I do believe in using the 200 DMA, which is a timing tool, but it has given a few headfakes over the last few years, which is why avoiding big bets is so important. Furthermore I think the 200 DMA, as a measure of how healthy demand is, is a very simple tool, that is not triggered all that often, but it is the type of thing (like other timing methods) that can cause problems if used too aggressively.

As I have mentioned before, if you just buy an index fund, add to it over time. By just holding it (assuming proper adjustments to asset allocation) you will capture the market's long term average (save for the OER). All of the other things we try to do, trades made, studying we do, new ideas we implement, all work against the fact that buying an index fund and just holding it will deliver a very competitive result at the end.

However, that also means enduring every bit of bear market, financial crisis, housing slump, war event that ever comes along. I do believe that active decisions can smooth out the ride against these events (you can look at the last few quarterly recaps to decide for yourself about that) and that is a big part of the content here. But if you are trying to add value in this manner, you should not lose site of what it means to buy an index fund and just hold it.

Comments

[User 18358]

Buy, Hold, and Pray..