Individual Investors ... Buy Low Cost Index Funds ... It's the Smart Way

We get lots of advice from time to time the time, with some of it being good and most of it being well intentioned.


That said, much of it isn't so good nor is it so well intentioned either.


Gathering the salient facts and then seeking the counsel of an objective adviser often can help us discover what will work best for us and be in our long term best interests as well.


And so it is with investing for the long haul.


Stock pickers add higher fees and little value tells it like it is, so let's pay close attention:


"A rising tide lifts all boats, or so they say. That's the inherent promise of indexing for retirement.


But an important corollary should be mentioned: A leaky boat sinks in any tide. Investment fund expenses will kill your retirement plan , no matter what kind of market is ahead.


That's the takeaway from the latest study of mutual-fund performance from Morningstar's Russel Kinnel. . . .

Kinnel found in his latest study that, once again, fees strongly signaled outcomes , whether the market was gently rising or in a period of significant transition. The lower the fees, the better the return—bear or bull market, growth market or value market, in his words.                                        

The cheapest funds killed it and the priciest funds lagged behind, as Kinnel found in an earlier study . For domestic stocks, choosing low-cost funds effectively doubled your success rate in 2008. In 2009 and 2010, as markets bottomed and then soared higher, the pattern continued. To quote Kinnel:                                        
 
"Vanguard founder Jack Bogle has pointed out that markets don't have to be efficient for low costs to work. We know that mutual funds as a whole will get roughly the market's return minus fees and trading costs. Those that charge less are naturally more likely to outperform than those with high costs."


Put more bluntly, active management is less than worthless. The idea that you need an “agile” manager when markets are moving is unsupportable. The dividing line between OK returns and great returns is cost, plain and simple, in any market.


So why not buy an index fund and be done with it? Well, some people like the idea of having a financial adviser. They need, perhaps, a guiding hand who will start them off in an age-appropriate, well-designed portfolio and then rebalance it with discipline. They need, maybe, a voice of reason who will keep them from selling it all in a market decline.
                                

What people do not need, and Kinnel's data shows it, is a stock picker, someone who purports to be able to “beat the market” by selecting a small number of securities and then actively trading that portfolio ad nauseam. A balanced portfolio of cheap index funds or index-style ETFs would do better.                                        

First of all, stock pickers can't beat the market consistently enough to matter. Second, if they do beat their benchmark once and again, they don't beat it by enough to justify the fees they charge year in and year out.


Third, and most important, the active manager is very unlikely to provide anything like personal financial advice."


Summing Up


When it comes to individual investing, it's essential to recognize the financial benefits we receive from being associated with an objective value adding personal financial adviser compared to the wasted money we spend with a value destroying 'expert' stock picking active manager, often known as a stock broker.


Because when as individuals we are investing for the long term, we usually don't get what we pay brokerage commissions for --- in fact, we're likely to get dramatically less.


Thus, the best advice is to not pay much for what we don't get and only to pay for what's of real value.


Such a low cost value added approach may be boring, but it works. And that's what counts.


That's my take.


Thanks. Bob.