The Case for Indexing

As I've said before, I'm an investor in index funds. My reasons: good performance, low cost, and little headache/supervision. As such, I loved this article from Kiplinger's titled "The Case for Indexing". Here's what it's about in a nutshell:

The author of A Random Walk Down Wall Street discusses the merits of indexing -- and why low-cost index funds should be the core of your stock investments.

Sounds good to me! Here are the specifics of what he recommends:

A portfolio with a stock portion consisting of 75% Vanguard Total Stock Market Index (VTSMX) and 25% Vanguard Total International Index (VGTSX) will serve most investors far better than chasing after better returns with active fund managers, much less trying to pick stocks on their own.

If you work hard at it, which we do at Kiplinger's, I still believe you can find managers who will beat the indexes. But finding such mangers is, as Malkiel puts it, "like finding needles in a haystack." And even then you have to monitor their funds closely.

Nowadays, Malkiel argues for a so-called core and satellite approach to constructing a portfolio. Indeed, this is the approach many of the best financial planners employ.

The core, say 80% of a portfolio, is index funds. For the satellites, you look mainly for funds whose results are largely uncorrelated with the market as a whole. So when the market is going down, at least some of these funds may do well.

The satellite funds may be quite volatile individually. But added to a portfolio, they can actually reduce overall risk -- so long as they zig when the market zags.

Sounds like a solid plan to me. They go on to give even more specifics:

What satellites does Malkiel like? He's a long-time fan of emerging markets, particularly China. After a torrid run, though, he warns to expect volatility.

Still, 5% in an emerging-markets fund may be a good move. Excelsior Emerging Markets (UMEMX) is one of the best.

Malkiel is bullish on Vanguard Health Care (VGHCX). Pharmaceuticals have been laggards for years now, and manager Ed Owens is as good as they come.

He also likes Vanguard Primecap Core (VPCCX). It's a relatively new fund, but Vanguard Primecap, run by the same team, has been a longtime top performer. This fund acts more like the market than the others, but it's still a winner.

Malkiel warns investors to be leery of hedge funds. Not only are fees sky high, but he says that returns aren't nearly as good as the industry boasts, partly because bad funds fold, often without reporting results.

For the core of your investments, though, Malkiel makes the same case he first made more than 30 years ago: Stick to low-cost, widely diversified index funds.

Well, I've got the core covered for sure in my portfolio. I need to reconsider the rest and evaluate what the best option is for me. What about you? What do you think of this strategy?

Comments

[DS Dan]

I never understood how proponents of total US market indexing (ie let the market, not a human, decide how much to weight each individual stock) could also dramatically, manually underweight (ie let a human, not the market, decide) international market indices. IIRC, to have a true "world index," you would have to hold 50% US total index fund/50% total international index fund

[Big Steve]

Don't care for Total Stock Market, which is 70% large cap anyway. So basically I have 1/2 Primecap Core (as mentioned in article) and 1/2 Windsor II for my large cap coverage. One is blend, the other value. Also have separate mid and small.

[Vlad Patryshev]

So, any fresh advice? Should have bought gold in 2006?