If You're Not Warren Buffett, Index Funds are for You

Yahoo Finance lists nine retirement killers as follows:

1. Cracking your nest egg before retirement.
2. Spending your retirement money way too early.
3. Having no clue about how much to save.
4. Spending your retirement savings too fast.
5. Not giving a hoot about asset allocation.
6. Letting Uncle Sam eat your retirement.
7. Depositing your retirement in your fatty deposits.
8. Paying too much for help.
9. Retiring permanently when you really just needed a break.

But the part of their list that stuck with me was what they had to say on #5:

You basically have two choices: You can be a master stock-picker like Warren Buffett or Peter Lynch and try to find the next Wal-Mart. Or you can broadly diversify your assets, mostly via low-cost index funds such as Vanguard Total Stock Market (VTSMX). This way, you enjoy hefty exposure to giants like Apple, CVS Caremark, and Medtronic as well as to mid- to small-sized growth firms such as Priceline.com and SanDisk. But until you've established your skill at finding great investments, keep the bulk of your assets in a broadly diversified, regularly rebalanced portfolio.

Then, of course, there's the TIME and SKILL factor. Who has the time to devote to becoming an excellent stock picker? And who even can develop the skill to do it if they do have the time. Mutual fund managers and their armies of researchers have loads of time every day to spend finding the best stocks and many of them can't beat the averages after expenses. What makes the average investor think he/she can?

Just another reason I stick with index funds.

Comments

[Ron@TheWisdomJournal]

Or you could invest in Berkshire Hathaway. Even with their outrageous share price, there are funds that mirror what he does and allow you to invest much smaller amounts.

Amen, Brother. Could not have said it better myself. Now, if I could only get my mother-in-law on the same sheet of music. To each his own, but she's convinced she's somehow better than me by letting UBS manage her accounts all while they charge her a 2% mgmt fee...little does she know that she has to consistantly beat the market by 2% a year to come out of ahead.

[Matthew]

I'm about 200 pages into the Boglehead's Guide to Investing. It's a great book. I am new to investing and index funds are definitely the way to go.

[Kyle]

While I do agree that index funds are best for 99% of investors, I disagree with the statement towards the end that individual investors can't beat the market since professional mutual fund managers can't. In reality, the small individual investor has advantages the mutual fund manager can only dream of. A small asset base allows the individual to be nimble, concentrate positions in just 3 or 4 of the most promising ideas, and buy any stock along the market cap spectrum. Professional managers, by contrast, are often cornered by their fund's mandage. They can only invest in large-cap growth or mid-cap value stocks, for instance. And they have far too much money to concentrate on their 3 or 4 best ideas. They NEED an army of researchers because they are forced to own 100 or 200 different stocks, the vast majority of which the manager is well-aware isn't a prime investment candidate in the first place. Small investors don't have that problem. But besides that small quibble, I agree. Index funds are best.

[Tim@DailyMoneyTips]

I agree with Index Fund Investing. I've been telling myself for several years to invest in Index Funds but it wasn't until about 6 months ago that I finally made the transition to Vanguard and now my IRA's and Roth's are all in Index Funds balanced between Vanguard Total Stock Market Index (VTSMX), Vanguard Total International Stock Index (VGTSX), and Vanguard Total Bond Market Index (VBMFX).

I do agree with Kyle but the key here is Index Funds are good for 99% of investors.

[Kyle]

Well I'm about 80% in index funds myself so I don't put my money where my mouth is. Just sayin'.

[7million7years]

Hedge your bets: Index Funds are a great low-cost LONG-TERM saving strategy (don't even think about investing a penny in these will less than a 3 year to 10 year outlook) while you are getting your financial education.

If you have the inclination to invest directly in stocks, as Kyle suggests, then get yourself a hold of Rule # 1 Investing by Pete Town and see what you can learn from that.

Don't forget that stocks are only ONE of the ways to make money: most long-term MEGA-WEALTH has come from: real-estate and businesses.

[Rick Blaine]

Warren Buffett is not a "stock-picker." He buys enough shares to elect members of the Boards of the companies that he invests in. His share-power makes him a de facto active manager of these companies, influencing their direction. Please, let's stop adding him to the index vs. actively-managed funds discussion.

[FMF]

Rick --

Actually, Buffett added himself to the index fund discussion:

http://www.freemoneyfinance.com/2007/08/warren-buffet-r.html

[rwh]

Just yesterday I read an interview in the NY Times with the manager of Yale's endowment (up 28% in the most recent fiscal year). He was opposed to individual investors owning individual stocks. His rationale was the typical person doesn't have the expertise nor the research capacity of an investment firm and should instead focus on asset allocation.

He recommended 30% domestic, 15% foreign, 5% emerging market stocks; 20% in real estate, 15% each in government bonds and TIPS.

I think you could do all of that with index funds.

He specifically criticized the approach of Jim Cramer on TV.

You can read the article at:

http://www.nytimes.com/2008/02/17/business/17swensen.html?ref=yourmoney

[FMF]

RWH --

I have a post coming up on that within the next few days.