Index vs Actively Managed Funds

[Stein]

Just wondering who is a fan of Index Funds vs funds actively managed by someone?  No, this isn't a follow-up from the market timing debate, IF you decided to buy, what do you typically buy?

Myself, I have turned from active to index funds almost exclusively.  After reading a few books by Bogle (Vanguard founder), it really makes sense to me to seek the lowest cost way to invest.  This article also makes a pretty strong argument for regression to the mean.

http://finance.yahoo.com/news/How-The-Smart-Money-Turned-usnews-13808633.html

In particular, Bill Miller beat the market for 15 straight years, probably a record.  He got hammered so bad this year that his 10 year average return is now in the bottom 25% of all mutual funds.  Pretty much is a poster case for not being able to beat the average long term.

[chris]

Active. I gave my money to Peter Schiff last year.

[Jack Crabb]

Vanguard S&P 500 Index.  Set it and forget it.

Some fund managers can/will beat the index.  However, it is more a matter of luck.  The index posts better returns than the majority of fund managers.  The index does it at a lower cost.

Brian Preston, the Money Guy, had some interesting comments in his podcast a year or so ago.  The few large cap stocks are closely watched and the market is very efficient at pricing the stocks very close to value.  Therefore, paying a fund manager to run a large cap fund does not make much sense because there is no inefficiency to exploit for higher than market returns.  Small cap and mid cap stocks, however, are not as efficient so better than market returns are possible.

Of course, there is also the instance where the economist is walking down the street and sees a $5 bill on the sidewalk.  He does not pick it up because in an efficient market, someone would have already picked it up before him.

[Allerion]

I use a combination of index funds and individual stocks.

My overall mix is about 90% stocks.
I have a small percentage in a balanced index that buys stocks and bonds and self-corrects to maintian a 50/50 mix.
I keep 1-2% in TIPS (Treasury Inflation-Protected Securities) just as a hedge against hyperinflation.  This is a highly questionable decision but when you look at cases where inflation runs away at least this should preserve enough wealth for me to eat.
I keep about 5% in cash equivalents.
Also, about half of my total wealth is OUTSIDE of retirement accounts and as I get older I expect that to be a larger percentage.  I don't want to end up in the situation some people I know are in where they have to take forced distributions from their 401k, pay taxes on it as ordinary income, and then they turn around and buy stocks with it again.

Most of my individual stocks are what I would call conservative dividend-paying stocks such as Pepsi and Unilever.
My biggest losers that I still hold are Goldman Sachs and Sears Holdings...oh and Royal Carribean Cruise Lines (OUCH).

I do own and continue to buy REITs despite expecting a decline in housing prices.  I expect rental rates to be strong or even climb since everyone getting foreclosed on has little choice but to rent for the next decade or so.

So to get to the point....Index funds are my preference. 

[Fib Posure]

In my opinion, index investing is really just another form of active investing. An index fund is only as good as the index it uses, and when you choose a specific index you are actively managing your investments. For example, if you invest in an index ETF that tracks the S&P500, you are actively choosing the S&P500, which is simply a group of large companies in America. You are completely ignoring small companies, foreign companies, real estate, and commodities. Of course, you can buy index ETFs for all these. My main point is don't put all your faith in one index.

Vanguard S&P 500 Index.  Set it and forget it.

No foreign investments? Why so much faith in America?

Of course, there is also the instance where the economist is walking down the street and sees a $5 bill on the sidewalk.  He does not pick it up because in an efficient market, someone would have already picked it up before him.

Not to mention the fact that if markets were efficient, Warren Buffett would be broke. During the dot com boom, worthless companies went up. This is clearly not efficient. But maybe in the long run an argument for efficiency can be made.

[Jack Crabb]

In my opinion, index investing is really just another form of active investing. An index fund is only as good as the index it uses, and when you choose a specific index you are actively managing your investments. For example, if you invest in an index ETF that tracks the S&P500, you are actively choosing the S&P500, which is simply a group of large companies in America. You are completely ignoring small companies, foreign companies, real estate, and commodities. Of course, you can buy index ETFs for all these. My main point is don't put all your faith in one index.

Vanguard S&P 500 Index.  Set it and forget it.

No foreign investments? Why so much faith in America?

The S&P500 is a little more than "a group of large companies."  3M, GE, Boeing, Time Warner, etc. are not just large companies in America, they are large companies in the world.  Many are unique in the world, Adobe, Apple, Disney.

I am actively ignoring small caps, foreign stocks, real estate, etc. for a couple reasons.  First, they are relatively less efficient markets than the S&P500 companies.  The S&P companies are actively monitored by analysts, press, etc.  Everything there is to know is known in near real time.  Foreign companies do not have the accounting/reporting requirements that US companies have.  Real estate is a small market and not diversified.  Second, you will get all the performance there is to get from an S&P index.  There is no need to pay for management/research.  Management/research is essential for small caps, real estate, etc. to be any near profitable.  That cost reduces the investment return.  Even then, the index beats the majority of the actively managed funds.  Third, it takes a substantial amount of money to meaningfully invest in all the foreign, large, small, etc. investments.

What do you mean no foreign investments?  I have used MS Windows, drank Coke and Bud, and seen Ford/GM/Caterpillar vehicles/machinery around the world.  US companies have a foreign presence in a ways that no foreign company has in America.

I have so much faith in America, because I haven't found another country to put faith in.  When the US has a cold, the rest of the world gets the flu. 

Go down the list from Argentina to Zimbabwe and the US economy comes out ahead of them all.  I think the world consensus confirms that.  Lots of people still trying to come here.  Not so many here trying to leave.

[Fib Posure]

By investing in American businesses because of the belief that American companies are more transparent, etc I think is a form of active investment since you are actively selecting one country. In a way that active investors research a company and invest based upon that research, you can research countries and invest based upon the research.

The efficient market hypothesis claims that any information you gather on companies has already been priced in, so even if you find information that suggests that, say, McDonald's will do well, then the price of McDonald's shares will have already gone up too high for the shares to be worth it. The same thing can apply to country. If we assume efficient markets, if there are features in the American economy that make American companies superior, this would be priced in automatically and American companies become overvalued.

It is true that American companies invest outside the country. But there are still risks in investing only in one country. There may be laws specific in the US that affect only US companies. For example, specific antitrust laws or corporate welfare laws may reduce the competitiveness of US companies.

Investing in commodities like precious metals can help if there is inflation or stagflation. I remember in mid 2008 when petrol and food prices went up. So far the price of silver seems to move with the price of oil and food.

[Hardtack]

Active. I gave my money to Peter Schiff last year.

Here's a good video of Peter predicting the coming recession. Be sure to watch all of the other talking heads belittling him.

http://www.liveleak.com/view?i=b0a_1232747931

[Hunted]

Here is a good article about Peter Schiff's predictions.

http://money.cnn.com/2009/01/20/magazines/fortune/okeefe_schiff.fortune/index.htm?section=money_latest

Make sure to read the last two paragrahs.  Being right didn't help him make money.

[Geoff]

I don't think "set it and forget it" is ever good advice.

How much did you lose in your 401k with this advice? 

At the beginning of 2008, my 401k suffered three consecutive quarters of loss.  It wasn't a big loss, but more then I'd like to see, and I moved all of my money to the most conservative fund available to me.  I have since recovered and am heading in the right direction again.

I know that my other thread about Series I Bonds ended up rather negative, but I must reiterate that they are a fantastic investment.  Take a look at this chart from the below website.  He compares a fixed monthly investment in both Series I Bonds and a Vanguard 500 indexed fund.

http://www.savings-bond-advisor.com/i-bonds-versus-the-stock-market/

This chart speaks for itself.

There is no one who cares about your money as much as you do.  So, the best thing you can do is to manage your own money.  Don't rely on someone else to do it.  Jack has even talked about this in the podcasts.

[Jack Crabb]

How much did you lose in your 401k with this advice? 

Don't know, don't care.  This is 40-50 year money.

"Set it, and forget it" is good advice, especially for the majority of investors who consistently buy high and sell low.  For those who monkey around with selling one fund to chase another, you need to factor in income/capital gains tax consequences, loads, fees, etc.

I know that my other thread about Series I Bonds ended up rather negative, but I must reiterate that they are a fantastic investment.  Take a look at this chart from the below website.  He compares a fixed monthly investment in both Series I Bonds and a Vanguard 500 indexed fund.

They must not be that fantastic.  From the URL webpage you provided, "At any rate, no matter what this graph says, don't buy Savings Bonds expecting to outperform stocks."  I want the higher performance of stocks.  And, I want the lower management costs of an index fund.

Also from the webpage, "Because of the ongoing financial crisis and recession, if you need to cash your stock investment now you'll not only get back less than the I bond investment, you'll get back less than you put in." 

I don't need to cash out for another 15-20 years.  Money put into stocks needs to be committed for at least 7 years, if not more.  If I need the money for a down payment on house next year, I will pass the stock market and the bond market, and go to a money market account or CD.

I am managing my money.  After considering all the information that I care to consider, buy and hold index funds provides the best outcome for my circumstances.

[ModernSurvival]

"Active Management" is a myth in the mutual fund world, there is something called that but calling a turd a diamond won't make it sparkle. 

Say you are in a mid cap stock fund.  Your manager can buy and sell mid cap stocks, he can't buy or sell anything else and HE CAN'T go to say 80% cash during a pending downturn, wait it out and go back in.  He can't do what really should be done.  The fund with come with parameters such as "no more then X percent of any one company", "no more then y% in cash", "no company over or under a certain size", etc.  He then manages within those rules and will go to jail if he does not.

THIS IS WHY YOUR 401K, IRA, SEP, etc just went down 40% in value since last year.  Mutual funds have a place but if all your investments are in them you are subject to the whims of the economy. Right now just about any fund is break even from 10-13 years ago!

Financial advisers paint a picture of fund managers being investing experts handling your money as if it was their own.  IT IS A LIE, they legally can't do that.  So in August when everyone knew (and they knew folks) that the crash was coming like a freight train, your manager (index or active) had to sit and take it in the face!

[chris]

Initially buying a stock gave you a dividend. People bought a stock and received a divended on a regualr basis. That was the point of owning a stock. Many stocks now don't pay any dividend. This is bad. It means the makrket, and your portifolio can be EASILY manipulated. Say you own 10 shares of a stock that doesn't pay a dividend. How do you make money off that stock? You make money, or lose money, when that stock is sold and the difference between the price and what you paid are subtracted. If the stock has gone up, then you make money. And vice versa. The point of IRA's and 401{k_'s was to get peopel to move money pre-tax into the stock market. Themore money going in, the more money HAS to be invested in the stock market. For the reason's Jack pointed out.

What happens if a fixed quantity of goods (stocks) is now being chased by more money? The prices will go up. That doesn't mean the company is performing better, only that more people are bidding up the price of the stock. This is how you get P&E ratios in triple digits. The "benefit" of IRA's and 401K's has not been to the saver/investor, it's been to the guys on Wall Street. The constant influx of moeny has raised the prices of stocks, and held them there, far beyond what the companies deserve.

The result is a transfer of wealth, from the saver/investor to the Wall Street fund managers and bankers. I'll stop here, the rest of the theory would be considered tin-foil hat by most people. 

[Jack Crabb]

Kinda, sorta.

Agreed that fund managers must operate within the defining parameters of the fund they manage.  And, agreed that funds are limited by the SEC and the fund's definition regarding holdings.

However, whether active fund management is a turd or diamond depends on which way you are defining turds and diamonds.

The Wilshire 5000 is the broadest index of equities in the U.S.  Investors get the "most average" returns.  Fund managers assert that through their research, analysis, tossing of chicken bones, etc. that they can put together a subset of stocks that is smaller than the Wilshire 5000 but with a higher rate of return at lower risk. 

An example is the Janus 20 fund that is limited to 20 to 30 stocks.  If they only have a couple dozen different stocks, then the managers better pick very carefully.  For a time, Janus 20 was going pretty good.

Managers have a higher likelihood of finding the diamond in the rough in the smaller cap stocks.  For example, a management team may look at several different gold mines.  They will look at labor relations, the quality and rights to ore, production costs, etc.  For small companies, that one team may be the only interest in the company.  On both a qualitative and a quantitative basis, the team should be able to select one gold mine over the other.  Nonetheless, the team has still picked a gold mine and remains subject to the larger market/economy.  Hopefully, they may have either picked the biggest winner or the least loser.

Bill Miller at Legg Mason, Peter Lynch at Magellan Fund, and Warren Buffet are just a few examples where a managed fund has not only beaten the corresponding indexes (at least for some period of time), but also lead their respective investment categories.  So, they could be legitimate diamonds. 

The successful managers also become a victims of their own success.  Money pours in as new investors try for a piece of the action, and there is no desirable place to invest it.  The fund managers have to put it somewhere.  That is why you see new, small funds on the cover of Money magazine post above market rates of return but over time the rates of return return to the mean.

Turning to the turds, 75% or so of the managed funds lose to their corresponding index fund.  To be blunt, those managers have shown themselves to be turds during a time when their clientele could have done better with an index.

Everything is subject to the whims of the economy.  One cannot get outside the economy.

[ModernSurvival]

Yea Mike that is all well and good but when the ENTIRE market is about to decline the sheep that own these funds think a fund manager will

1.  Dump the stocks
2.  Wait for the drop
3.  Buy the stock back

This is in fact what should be done and it is about impossible to find a fund that lets a manager move with any flexibility on cash holdings.  Why?  Mutual funds are really a scam.  Hard to accept I know but in the broad sense they are designed to pump massive amounts of wealth into the market and hold it in there as long as possible. 

On some levels funds are one of the best things to ever happen for individual investors but in many ways they are far more a curse.  They have been sold to people quite simply as something they are not.  You can "pick the best companies" for any fund and still loose the ass of the investor when the entire market tumbles 40% in 3 months time.  Beating your average right now means loosing 30%! vs. loosing 45%, etc.

99% of people that own funds today don't understand a single aspect of what we have been discussing here, that is why I call mutual funds a scam.  Funds are a useful investment for what they are designed to be but they have not been explained to the general population as what they really are. 

The smart money moved out of stocks in June-August this year.  Sure dumping it in 07 was even smarter but it wasn't a sure thing in 07 that a crash was coming, anyone who didn't see this coming in the summer of 08 was either dim or simply did not want to see it.  One nice thing about the podcast is I am on record with this before it happened.  I practically begged people to get out right up until the crash.  Go back and listen to shows in August, 

[Jack Crabb]

Agreed that managers are constrained and the investors "pay the price" as it were.  However, that is the investors' fault.  Every major fund company has a money market fund.  Out of stock and into cash is as easy as a phone call.  There is an old saying that if you think the price of education is high, you should look at the cost of ignorance.

If mutual funds are a scam, what is the alternative?

What is wrong with putting wealth into the market as long as the investor is paid for his investment, i.e., capital gains and dividends?  Several years ago, there was a comparison among several different nations about the investment needed to create a job.  The US was something like $50k.  Japan was even higher.  That is part of the reason why Japan started offloading manufacturing jobs to the US.  The cost of producing a Japanese citizen could not be recovered through employment in factories.  However, a lot of countries require a lower investment to create a job.

I am glad to say that I have listened to every show starting back in July a few days after the first one was posted on iTunes.  I know on several occasions you recommended to get out of the market.  What indicators are you looking for to advise getting back into the market?

[ModernSurvival]

Agreed that managers are constrained and the investors "pay the price" as it were.  However, that is the investors' fault.  Every major fund company has a money market fund.  Out of stock and into cash is as easy as a phone call.  There is an old saying that if you think the price of education is high, you should look at the cost of ignorance.

If mutual funds are a scam, what is the alternative?

What is wrong with putting wealth into the market as long as the investor is paid for his investment, i.e., capital gains and dividends?  Several years ago, there was a comparison among several different nations about the investment needed to create a job.  The US was something like $50k.  Japan was even higher.  That is part of the reason why Japan started offloading manufacturing jobs to the US.  The cost of producing a Japanese citizen could not be recovered through employment in factories.  However, a lot of countries require a lower investment to create a job.

I am glad to say that I have listened to every show starting back in July a few days after the first one was posted on iTunes.  I know on several occasions you recommended to get out of the market.  What indicators are you looking for to advise getting back into the market?

The alternative to funds is to not use them as your sole source of investing first of all.  Additionally it is to own a portfolio of solid stocks rather than a shot gun approach to a sector when the market is primed to grow.

On this question, "What is wrong with putting wealth into the market as long as the investor is paid for his investment", plenty when the INVESTOR IS LIED TO and told that the fund manager is active in moving between stocks, when he is not and is given the image that the fund manager can protect the investment, when he not only doesn't but can not.

Last on this question, "What indicators are you looking for to advise getting back into the market?"  Nothing that will happen any time soon!  If you are in stocks this year you better be buying select individual stocks, funds are a death sentence this year.  2% from an ING Direct CD will out perform most any fund this year.  The 4.5% you could have locked in when I said to go to cash most certainly will, the 7.5% I am currently getting with a major portion of my investments for 2 years in Australian Bonds that I recommended long ago most certainly will.  Right now if I had cash I would either,

1.  Buy single stocks with good advice and a well versed investment knowledge only if I could stand the risk
2.  Buy gold/silver investments
3.  Just hold cash
4.  Buy hard long term goods that are well priced right now

You could not get me to buy any fund from anyone right now today!  Pardon me but screw that!  There isn't a single indicator or anything at all good for our economy in the next 12 months.  What am I waiting for?  Well I will know it when I see it, I have no idea what it will be right now.  It will be something that demonstrates a return to the underlying fundamentals.  Something that shows the real property market is in some type of recovery.  It may or may not come!  This may be the end of our modern economy or it may just be a temporary down turn.  I don't know yet, one thing is for sure, when/if anything really turns there will be many indicators, just as there always has been.  Know this when/if I see a turn, I will go on record but short answer if I was sitting on cash now, I would do one of or part of all four items mentioned above and nothing else.

[Stein]

Bill Miller at Legg Mason, Peter Lynch at Magellan Fund, and Warren Buffet are just a few examples where a managed fund has not only beaten the corresponding indexes (at least for some period of time), but also lead their respective investment categories.  So, they could be legitimate diamonds.

I just read an article about Bill Miller falling off his horse.  I guess his 10 and 15 year returns are now below market average due to a bad bet.  That, along with what I read from John Bogle, really point me to low-cost index funds.

I also read an article about a study of Morningstar ratings.  In a nutshell, the funds rated 3 stars last year do better in the next 12 months than those rated 5 stars.  The star rating is a backward indicator only and has no real indication of what will happen in the future.

Jack makes a good point about investor ignorance.  The transition from defined benefit to defined contribution is well underway - and in the past for many including myself.  Most people haven't realized that they are the ones now responsible.  Pick up a book, tune in and learn about what you are buying isn't as popular as Monday Night Football.  Simply reading a prospectus, fee sheet, holdings summary or the like gives you a good idea about what you are buying.  It isn't rocket science to figure out what a bond is, how government bonds work or finding good CD rates but virtually nobody does it.

There are some real deals in the stock market now.  GE is paying 11.2% dividend and they seem to be wanting to keep it that way.  Their finance division is the shits but they can't produce wind turbines fast enough.  Microsoft is paying 2.6% and is sitting on about $20 billion CASH with virtually no debt.

I only buy single stocks with a small amount of the egg and just for fun.  I consider it gambling.

[Jack Crabb]

All good points.  Not much to add but "ditto."

[tallfoo]

Despite the state of the stock market right now, index funds on average get better returns than actively managed funds.  Enough said.

[ModernSurvival]

Despite the state of the stock market right now, index funds on average get better returns than actively managed funds.  Enough said.

I highly suggest you read the entire thread.  Enough said, 

[FreeLancer]

Just wondering who is a fan of Index Funds vs funds actively managed by someone?  No, this isn't a follow-up from the market timing debate, IF you decided to buy, what do you typically buy?

Myself, I have turned from active to index funds almost exclusively.  After reading a few books by Bogle (Vanguard founder), it really makes sense to me to seek the lowest cost way to invest.  This article also makes a pretty strong argument for regression to the mean.

Vanguard founder and father of retail index investing, Jack Bogle, died today, so I found the oldest forum post that mentioned him.

I owe a lot to him, especially the buy and hold mindset that has paid off handsomely over the last decade.

Apologies to the other Jack, but I’m glad I listened to Bogle.

[David in MN]

Vanguard founder and father of retail index investing, Jack Bogle, died today, so I found the oldest forum post that mentioned him.

I owe a lot to him, especially the buy and hold mindset that has paid off handsomely over the last decade.

Apologies to the other Jack, but I’m glad I listened to Bogle.

He will be missed. He wrote the introduction to my copy of The Intelligent Investor and I have found his value and dividend approach very helpful. I take no shame as an active trader in admitting I hold Vanguard funds. I have also mirrored some of his funds by buying the 10 holdings at times. Bogle wisely saw the problem with mutual funds is the load and single handedly fixed the industry. Sucks that I'll have to pass on to have a beer with him; he was on a short list of heroes.

[Captain Obvious]

S&P500 index is probably best for most people.  Throw in a bond fund and maybe a foreign markets fund and that's probably all you need.  But most S&P500 companies are already global so I don't see much of a need to pay the higher fees associated with foreign funds.  If the U.S. market goes down compared to the rest of the world, KO will still probably be selling drinks overseas so in my opinion you already have global exposure if you have KO.

Personally,  I'm a fan of dividend growth investing because I'm much more interested in a steady source of growing income as opposed to hoping the market maintains itself when I finally get to my retirement years.  If 2008-09 happens all over again and it happens to be my first year of retirement, I'd be PISSED.