Here are some thoughts from the wonderful book The Bogleheads' Guide to Investing
1. There are no sales commissions.
2. Operating expenses are low.
3. Many index funds are tax efficient.
4. You don't have to hire a money manager.
5. Index funds are highly diversified and less risky.
6. It doesn't matter who manages the fund.
7. Style drift and tracking errors aren't a problem.
Good stuff! Very similar to the reasons I gave when I detailed why I like index funds.
For more thoughts on investing, see these links:
I agree with all of those but one, and that is number 5. It depends on how you define "risky". Does risky just mean the chance you'll lose money in a given year? Ir is how volatile the returns are? If risky simply means that over the very long term you are likely to see a positive return, then yes, history has shown us that is how the market performs. But if it is volatility or year by year returns, then I'd argue that individual index funds can indeed be risky.
In 1999 the S&P index funds were up abour 21%, the following year, they lost around 9%. Then in 2002, they lost 22% and turned around and in 2003 gained about 28%. That is volatile, and to many people, that means risk. During the same period in 2002 when the index was down 22%, most balanced funds that held around a 50/50 mix of stocks and bonds broke even or had minimal gains or losses.
Of course, this is only an issue if you have one or two index funds that make up your whole portfolio, that can create a lot of volatility, and you could accomplish a diversified portfolio with multiple index funds. But the point is, just because an index fund is diversified because it holds hundreds of companies doesn't alone make it less risky.
Posted by: Jeremy | November 14, 2006 at 09:24 AM