For most people, investing in the whole market (a.k.a. index) is the right thing. Period.
It's not exactly rocket science either: Just buy the broadest index you can cheaply get. The MSCI World is probably a good candidate for that. The whole market is likely to be less volatile over the long run than any given segment.
Sure, if you want to do your research, maybe you'll end up thinking that a certain market segment is more attractive than another. But don't claim that all people must do this.
Having other people manager your finances is problematic, because that other person is not likely to have your best interests in mind, especially not if his income from this comes from kickbacks.
S&P 500 Price has returned -1.5%/annum on price alone since 1999, while S&P 500 dividend return has been 4.9%/annum over the same period.
Longer term, since 1971, S&P 500 Price has returned 6.3%/an, while dividend has returned 5.6%/an.
So, yes, if you are a lucky soul who was 21 years old in 1971, bought the market, and held it to today, you would be slightly better off than you would be with dividend.
But what if you were a 45 year old in 1999 who started their retirement savings and are nearing retirement with over a decade of negative returns?
Time horizon and suitability of your choice are often more important than what you actually pick.
Having other people manage your finances may be problematic if the fiduciary responsibility has been misplaced as you have pointed out.
When you go to a lawyer or an accountant, you do not question their advice, largely because they have been positioned as a services experts rather than sales folk.
Properly diversified portfolio will carry you through the ups and downs in the market, because it hedges your risk against those fluctuations. And for that kind of portfolio, you need a bona fide, unbiased expert's advice. The kind of advice that is currently NOT available to mid-networth market, and the kind of advice that the rich are paying a premium to obtain.
The article pointed out that the financial services is broken and investing in broad index is a band-aid solution,
but wouldn't it be more appropriate for us to have a solution that solves the problem rather than the one that patches it?
What? Index funds don't steal the dividends from you, they contribute to the performance or are paid out.
Generally look at the performance index to evaluate returns, NEVER NEVER the price index, please.
The total return of the S&P 500 from January 1999 until now is 47.7%, or 2.91% per annum (EDIT: had incorrect numbers!). Not a good return, but you also picked one of the worst dates.
Please also note that the price and dividend returns ADD UP. You don't need to choose between one or the other.
You are completely correct. You should always look at the performance. In fact, you should be focused on your own performance.
I was merely displaying the parts of that performance and illustrating that one part of it is far more volatile and the other is less so. Knowing that fact alone, if you had invested in divindend paying securities and focused on the cash flow of the economy, you would have been personally better off.
Not all stocks pay dividends. Not paying attention to that can bring you closer to the -1.5%/an and farther from 4.9%.
>>Not a good return, but you also picked one of the worst dates.
I have picked the current situation. We can talk about historical rosy times in the market, but that is somewhat beside the point. This is our current reality.
With worst date i mean 1999. Well I guess 2000 would have been worse. It's a question of luck which date is good.
And no, picking the stocks with more dividend yield is NOT a strategy that is guaranteed to work, because these are usually low-growth companies. Now the market assessment of growth is unlikely to be right for all companies, but it's likely to be better than that of most people.
> S&P 500 Price has returned -1.5%/annum on price alone since 1999
This is a selective endpoint, creating bias in the result. 1999 was an outlier peak, so of course measuring from 1999 will show minimal returns. Measure from 1988 or 1995 or 2003 or any of the vast majority of possible years, and you'll see significantly positive return for stocks.
I'd just like to note, that anyone who starts saving for retirement at 45 isn't likely to have a great outcome. If they started in 1999, yes they got a rough deal, but that's what happens when you start 25 years too late. Index fund or great advisor isn't the problem here.
Not always. If you were 45 and entered the market in 2008, you'd be in a great shape now, probably better than a 20 year old who entered the market in 1999.
This is only possibly true if the 20 year old made his sole contribution in 1999. The more reasonable case is the 20 year old made his first contribution in 1999, and now has 13 years of contributions plus gains.
It's highly unlikely that 3 years of gains from 2008-present would outstrip 13 years of contributions + gains + reinvested dividends.
The S&P 500 is not "the market". It's certainly a better representative of the U.S. market than the Dow Jones Industrial Index (which has just 30 stocks) but it has nowhere near as many stocks as the Wilshire 5000. Not to mention none of those give you any international exposure.
And the the other question is, yes the S&P had a rate of -1.5% but considering the crashes of the past decade, would you be lucky to achieve -1.5% return rather than something much, much worse?
Yes, the S&P is diversified in the stock portfolios. What I meant was diversify into things like fixed income vehicles, first mortgage securities, real estate income trusts etc.
And yes again, most investors came out much worse over the past decade that -1.5%, but even the theoretical return is dismal enough to illustrate the point.
Negative returns, while a simple concept, can be a real jaw dropper for many a DIY investors. If you invest $100.00 and lose 10%, you'll have $90. But $10 out of $90 is 11%. So you'd need to return more in the positive just to make your money back. And the greater the negative return, the greater the positive required. If you lost 20%, you'd need 25% etc.
Could you elaborate on why that is the best thing for most people?
Also I did not say people should do their own research, I actually said the opposite, that even having done that most people will generally be their own worst enemies when it comes to investing as they are unable to remain impartial about their own money. I'm also admitting it can be hard, even impossible to get good advice at for a fee that makes sense. However the lack of the right service does not mitigate the need for it.
Could you elaborate on why that is the best thing for most people?
Because the evidence for "Mutual funds, in aggregate, underperform the market by precisely what they charge in fees; past performance of mutual funds does not predict future results; no more fund managers beat the market than would be suggested by random chance; capital flows into mutual funds are virtually invariably poorly timed to surge after they have made their gains, hurting fund performance" is incredible. It's, um, shoot, I need an analogy... you know how science suggests that cigarettes might not be a good thing health-wise? That conclusion is tentative next to "actively managed mutual funds are a poor investment vehicle."
Index funds are virtually structurally guaranteed to outperform actively managed funds for any given equivalent investment classes, because index funds also underperform the market by fees, but their fees are about 100 ~ 250 basis points lower. Over someone's working life, that turns into "Your retirement account is several times as large as your neighbor who used actively managed mutual funds."
Just some alternative thoughts that are sort of nuanced, but no one talks about for some reason:
1) Synthetic ETFs could pose serious problems and most investors are not familiar with the difference between them and physical ETFs nor are they aware if they even have them in their portfolio. This is a quick read that summarizes part of the problem:
2) How do you choose the correct ETF. How do you choose between emerging markets nd US, etc. Picking a broad market ETF is probably safest, but there is even a variety of those with different features.
4) Compared with no load funds, ETFs can be expensive due to trading fees. Obviously if you buy and hold great quantities of money it isn’t an issue, but it should be considered in your investment.
Presumably patio11 is talking about both, and if he isn't, many people who read this will assume he is. The tracking error issue can still come up with index funds, the differences between them are minimal:
Why it's the best for most people? Because study after study shows that generating alpha (excess returns that are not attributable to buying stuff with debt, basically) is _hard_. And if the risk is too high, just buy more US treasuries and less stocks.
Just a few days ago I read that Bain Capital's nice 20-30% returns were mostly based on leverage in a favorable market environment... I think there are a few people who really are good at choosing market segments or individual stocks, but you or your advisor-for-hire are not likely to be them.
And if the risk is too high, just buy more US treasuries and less stocks.
US treasuries can carry high levels of interest rate risk if their duration is long. In otherwords if the maturity is really long, 10 years+, and interest rates go up, the principal value of your treasuries will fall dramatically.
Now, you can wait it out, but that won't help you in the long term when the market is paying out 10% and you are getting 0.25%.
Just a few days ago I read that Bain Capital's nice 20-30% returns were mostly based on leverage in a favorable market environment... I think there are a few people who really are good at choosing market segments or individual stocks, but you or your advisor-for-hire are not likely to be them.
Bain did this by taking companies private, then re-IPOing them. They are a private equity company and to my knowledge do not choose stocks and market segments like mutual funds do.
If you have huge exposure to technology through your career, it might make sense to underweight technology in investments. Maybe not as reasonable in the case of technology, but if I worked in something like print publishing, I'd probably not want much additional exposure to print publishing for my retirement.
Tobin's mutual fund theorem states that all investors should do their best to buy the market, and that risk-seeking investors should add leverage, while risk-averse investors should hold more cash.
For high-net-worth individuals, it's usually not worth actively managing most asset classes, but it might be worth scouting talent to run private equity, venture capital, and tech stocks, all of which are areas where the top quartile investors substantially outperform the bottom quartile.
For non high-net-worth individuals, it's almost never worth actively managing any asset class. The costs of management equal or exceed the probable excess returns.
It's not exactly rocket science either: Just buy the broadest index you can cheaply get. The MSCI World is probably a good candidate for that. The whole market is likely to be less volatile over the long run than any given segment.
Sure, if you want to do your research, maybe you'll end up thinking that a certain market segment is more attractive than another. But don't claim that all people must do this.
Having other people manager your finances is problematic, because that other person is not likely to have your best interests in mind, especially not if his income from this comes from kickbacks.
It's simple really.
Just. Buy. The. Market.