Are Index Fund Investors Smart, Lazy or Both?
In 2022, $12.5 trillion was invested in index mutual funds and exchange-traded funds – roughly 43% of all investments in stock and bond funds. Despite this rather impressive number, some of my more critical cohorts still accuse me of lacking the confidence (or perhaps, ambition) to pick individual stocks in an effort to outperform the market. Do I? Since I’m not a credentialed financial advisor, the answers (observations) I give are strictly my opinion.
Smart, Easy and Lazy?
I confess I am a bit slothful when it comes to the chore of researching individual stocks. But I can’t blame this on old age. I’ve been investing in broad-based index funds since the early 1980s.
My research – and lack of stock-picking acumen – back in those olden days led me to what I call my “dare to be average” conversion. In short, based on a review of other folks’ research, I saw the long-term potential of being satisfied with a broad market rate of return. The greatest appeal of this research data was that this “easy” approach to investing also appeared to be the “smart” approach, at least for smaller investors. And how often do we run across approaches in life that offer both smart and easy options?
Joe Average's Advantage
In today’s up-to-the-millisecond world, available technology in the canyons on Wall Street instantly incorporate new information on individual stocks and bonds. How can "Joe Average" compete with sophisticated rivals who have such overwhelming advantages?
That’s why John Bogle’s broad-market index fund…made available by Vanguard to Joe in 1976…completely changed the game for the little guy. It saved time doing research on a myriad of individual assets, saving brokerage commissions and avoiding worrisome headaches, while allowing Joe to spread his limited investment dollars across the broad market.
Perhaps because I’m a purist at heart (or I truly distrust my ability to pick stocks), I’ve taken a cautious approach to the ever-growing popularity of exchange-traded funds (ETFs) or mutual funds that track subsets of a limited slice of the market. To be transparent, I do own funds to complement my index fund investing, but I still suffer the uneasy probability that I’m defeating the purpose of indexing (i.e., investing in the broad market).
Let’s face it, the more narrow one’s choices are, the more similar that individual’s approach is to individual stock-picking. When making narrow choices, I simply don’t believe that Joe Average is able to consistently make winning choices. Nor do I believe that investors have the ability to select with any particular exactitude individual industries or market subsectors that will consistently outperform the broad market.
Curiously, according to Bloomberg, there are now more indexes than stocks, which means that we have corrupted the definition of index investing to the point that selecting among this myriad of narrow indexes is little more than a form of individual stock-picking.
An important lesson learned by long-term investors is that prices at any point in time are invariably wrong; and that none of us are clairvoyant enough to know whether they are too high or too low at any fixed point in time. Yes, market bubbles are identifiable, but the timing of when they might burst is impossible to predict.
Some of today’s biggest declines belong to many of those companies with huge market capitalizations: Meta (Facebook), Alphabet (Google), Microsoft, Amazon, Tesla, etc. Is this worrisome? Yes. Particularly when I think about my Total Stock Market Index Fund investment, which automatically overexposes my portfolio to these large cap companies that make up such a large percentage of the current market. But research shows that indexing works for those investors patient enough to stay the course.
So keep the faith, indexers.