Index Funds = 33% of Market

[JohnH]

I was pleasantly surprised to read in the linked article that Index Funds comprise about 33% of the total market value. I actually thought there were fewer investors who had discovered the wisdom of low-cost Index investing.

But that makes me appreciate the 67% of those who think they can beat the odds. Some of them will, most of them won't. Given enough time, all of them won't because everything eventually regresses to the mean. Nobody can overcome the inevitability of basic mathematics on the long term. Nevertheless, they keep trading with one another, trying to defy common sense.

But the 67% do perform a valuable function. They keep pricies honest with their guesses, they underwrite the costs of active markets with the excessive trading fees they pay, and they keep producing those averages that insure Index Funds continue to produce their guaranteed results.

This just reinforces for me that whenever clients start asking me for investing advice or to help them select an advisor, I tell them to forget the advisor and just read a few things that Jack Bogle wrote. Then call Vanguard.

http://www.utsandiego.com/news/2014/sep/06/social-security-investment-says-fund-pioneer/?#article-copy

[Golden Rocket]

Good Advice

not wild about the Vanguard operation, but your point is very well made.

The eternal argument made by "managed" funds are that their many years of training and deep analytical methods will result in
more advantageous trades and good returns which will more than pay their fee. After years or observation, I've never seen any
confirmation of this. Last I read, only 20% of funds will beat an index, and beating the index is usually not repeated year-after-year.
And what do you suppose the average AGE of fund managers? I've heard about 28-30 years old, i.e. typically less than 10 years
experience.

[JohnH]

You're right about the 20%. And that would be OK if the 20% who beat the indexes were the same funds & managers year-over-year. In actuality, those who comprise the 20% change from one year to the next, so the number who consistently beat the indexes is far less than 20%. I don't know if someone has ever done this analysis, but my guess is that the true number is less than 5%. If it were greater, they would be all over the financial news. I think the traffic actually runs in the opposite direction for another reason. The really bad performers tend to get shut down. So that also skews the numbers away from the actual miserable performance record. Having said all that, 20% should still make the whole "managed account" crowd blush.

Mind to share what you don't like about Vanguard?
I use them for mutual fund and brokerage services (brokerage is mainly for buying the ETF equivalent of the index funds, not active trading).
I've been well pleased with their services and their online presence, plus the education is priceless.

[buzzardbreath]

Vanguard

John, I don't really harbor ugly feelings about Vanguard as led to believe.

Their brokerage service accounts are set up to buy and sell Vanguard products only, and in spite of
the returns higher than 80% of non-indexed funds, I do find their clinging to index funds as showing
lack of imagination.

[JohnH]

Not being able to buy non-vanguard products may have been the case at some time in the past (I wouldn't know), but I've bought and sold individual stocks through Vanguard's brokerage services. Transactions functioned exactly like my eTrade account, and fees are very reasonable.

I agree about the lack of imagination. A broad index fund is very unimaginative by design. It's hard to be imaginative when you want a rock-solid guarantee that you will exactly match the average (minus a very tiny transaction fee). Not much left the the imagination when you're looking at a 100% probability.

Nevertheless, I appreciate people who like to be imaginative. After all, their occasional gains and inevitable losses are what keep the market honest and provide relevant pricing points for the index funds. They never comprehend they are playing a zero sum game, minus the transaction costs.

[DaveO]

Good discussion. I have a mix of active funds some of which I have had for about 20 years and a handful of individual stocks some of which I have owned longer. In the last few years I have moved more towards the index funds. I make no claim of being a great stock picker but it's more fun than watching the index plow ahead. It's no fun to watch the race if you don't have a horse.

[JohnH]

One issue which I've pondered revolves around whether index funds could ever become so successful that there becomes a possibility that they fail to achieve their purpose. Now THAT is an oxymoron. I'm only thinking in terms of broad index funds such as S&P 500 or total market, not some of the silly stuff that tries to index sectors of the market and peel off a few novices. (These sector funds masquerading as index funds should not be called an "index" fund in the first place, but that's another story for another day). Where is the tipping point at which the index funds begin to drive the prices rather than react to them? I'm not concerned with 33%, or even 50%. But at some point, the wheeler dealers and speculators could get overwhelmed by the index fund trading. Without those people who delude themselves into thinking they are smarter than the market, prices can't be trusted. Their actual real-time gains & losses, minus transaction costs, are what keep individual stock prices honest.

Some very knowledgeable people say the index funds are fine unless the number of speculators drops to 20% - 25%. Others say they would be comfortable with a figure as low as 10% (that's scary). But I'm not sure about that, and I think their percentages are nothing more than wild guesses. Personally, I'd get very uncomfortable if index fund holdings exceeded 50% of total market valuation, and would probably distrust their accuracy completely at 60%. But I suppose there will always be plenty of geniuses out there to replace the current geniuses when (not if), they fail. Hope springs eternal in investing, and somebody always thinks they have it figured out. And if the number should ever approach 50%, I hope Jack Bogle is around to give us some good perspective, just as he has done throughout his brilliant career.

[veritas]

what do you tell

Your client that won't call Vanguard or anyone for that matter?

I just helped two middle aged clients who have no retirement savings start their IRAs. They would most likely do nothing as many like them are want to do.

Honestly the paperwork hardly makes it worth my while. But I believe I have done a good service.

[JohnH]

I give them a copy of John Bogle's "The Dream of the Perfect Plan."
(I always keep a hard copy on hand and a pdf for emailing).
I tell them it's absolutely the best thing ever written about investing,
but won't do them any good if they don't read it - several times if necessary.

I tell them about Vanguard.
I tell them that my wife and I have 90% of our equity allocation in the broadest index fund available.
If they ask again, I ask if they've read & understood the article and I tell them about Vanguard again.

I don't have anything else to say to them - I really don't.
You can lead a horse to water, but...

[ATSMAN]

To add to JohnH's observation:

In John Bogle’s book,The Little Book of Common Sense Investing he states that the average U.S. equity fund compounded at 10 percent from 1980 through 2005, while the Vanguard 500 Index Fund made 12.3 percent. Actively managed funds did worse than average, not better.

To add insult to injury the management fees of actively managed funds are almost twice of the average index fund!

I have been investing in indexed funds since the 90s and never regretted it even in 2008!

Just recently when Dow hit 17K I made a withdrawal to pay for some expenses that were coming due. Buy low sell high!

[JohnH]

Today I ran across another insightful thought regarding actively managed funds vs true index funds. Given the performance of actively managed funds, and the fact that one year's winner is next year's loser, the fact remains that choosing a winner is a shot in the dark with a probability of success of only 20% at most in any given year.

So for all practical purposes, 80% of all actively managed funds could disappear today and the only losers would be the fund managers. That's a powerful argument for the long-term investor to rely upon the absolute safety and security of using a broad-based index fund with low expense ratios.

[ATSMAN]

Last month I reinvested roughly $40,000 from an old bond fund into index mid and small cap fund. Let's see how I fare till the next general elections, now that the market has been positive since election.

[taxxcpa]

Dividend stocks

I invest in dividend-increasing stocks like JOHNSON & jOHNSON, PROCTOR & gAMBLE taken from David Fry's web site which you can download from Seeking Alpha.
I have over 100% profit on some like Raytheon

I have NO ETFs

[Burke]

I make no claim of being a great stock picker, but it's more fun than watching the index plow ahead. It's no fun to watch the race if you don't have a horse.

And therein lies the index fund's advantage in my opinion. It's boring, so it can be generally ignored. No emotional attachment to a favorite stock which you cannot bring yourself to sell, whether it is up or down. (It might go up further! It might come back!) Left alone for years, it generally will appreciate. And when you need the money, you don't have to think about what to sell.

I know of a client who invested $25K in a lucrative bond paying 8.75% and sold it at a 20% profit after a couple of years, because he couldn't stand just watching the dividend come in. He'd rather buy 500 shares of stock under $10 and sell it at $11 in a few weeks/months for a few hundred dollars a crack. These people are gamblers, and its the game they enjoy. And the hot tips. He doesn't always win.

[JohnH]

And therein lies the index fund's advantage in my opinion. It's boring, so it can be generally ignored. No emotional attachment to a favorite stock which you cannot bring yourself to sell, whether it is up or down. (It might go up further! It might come back!) Left alone for years, it generally will appreciate. And when you need the money, you don't have to think about what to sell.

I know of a client who invested $25K in a lucrative bond paying 8.75% and sold it at a 20% profit after a couple of years, because he couldn't stand just watching the dividend come in. He'd rather buy 500 shares of stock under $10 and sell it at $11 in a few weeks/months for a few hundred dollars a crack. These people are gamblers, and its the game they enjoy. And the hot tips. He doesn't always win.

Yep, you nailed it.

Low cost + low turnover + broad diversification = Vanguard Total Stock Market Index Fund.
In my opinion, nothing out there can touch it.

It's pretty boring, but 100% guaranteed to perform as well as the US Stock Market.
I can settle for that type of boredom and get my thrills somewhere other than gambling with my retirement security.

On the other hand, I appreciate the thrill seekers as well. They keep the markets honest by creating volume, seldom realizing that over time the best they will ever do is reversion to the mean, and that only if they are really good at their guesses. Unfortunately, many of them won't even accomplish that, because the cruel mathematics demand that somebody always has to be a big loser in a zero-sum game.