The Educated Love Index Funds

Here's another post to add to my collection of all the people who love index funds. This time it's "finance professors - the experts who analyze markets and teach future mutual fund managers how to build portfolios". The piece also has a few other insights into what finance professors think/do. The details:

About two-thirds of the professors, in fact, have the bulk of their assets in index funds, the low-cost baskets that essentially own the entire market. These academics more or less practice the basic lesson of modern portfolio theory: Diversification is the key to holding down your risk and maximizing your returns. That leaves a third who have gone astray, however.

There are two important bits of learning embedded in Wright's survey data.

First, whenever anyone tells you that research "proves" a novel method of investing is a market beater, bear in mind that the professor behind the paper is most likely an indexer who has never road-tested his theory in the real world of trading costs, taxes and other expenses.

Second, remember that even many of the people who know best can't resist chasing hot stocks, so you have to control your behavior in advance. Put 90 percent of your money in low-cost index funds and lock yourself in by adding a fixed amount every month through an electronic transfer from your bank.

To me, this information is simply another reason why I love index funds.

Comments

[Traciatim]

I don't understand why the research didn't change focus on what they do and rather focus on if the performance of the indexers was equal or greater than the performance of the investors. I didn't read the research, just the article, but it sure would be interesting.

[Traciatim]

I don't understand why the research didn't change focus on what they do and rather focus on if the performance of the indexers was equal or greater than the performance of the investors. I didn't read the research, just the article, but it sure would be interesting.

[Will]

Investing in index funds is the cornerstone of any sound wealth building plan. I was reading Get Rich Slowly's review of Kiyosaki's latest book (I forgot the title) but the author says in his book that diversification is not a good thing. Yet diversification is precisely why (besides minimal fees) index funds have been beating the crap out of actively managed funds for decades now.

The funny thing is that he does admit to holding part of his money in index funds. He also owns real estate, does seminars, publishes books, invests in precious metals and other ventures (and all that is public knowledge, he even mentions it in his books). If that isn't diversification, I don't know what is!

Count me in as an index fund lover!

[sow]

Here's what I believe Kiyosaki means when he says don't diversify (my interpretation from reading books in his series). I think he believes in diversifying when it comes to investing in different vehicles such as real estate, metals, businesses, etc. But, I think he doesn't promote diversification to minimize risk and losses especially in the stock market.

If you have ever played his game Cashflow, you'll realize that the road to wealth isn't in accumulation, but cashflow. The way to win in the game is to velocitize your money, and then buy assets that will cashflow. So, he doesn't promote buying stocks, mutual funds, cds, etc. to just hold and accumulate. He buys them low, and sells them high quickly. That way you get the money out and you can buy an asset that will cashflow for you.

One thing I've learned is that the rich don't let their money sit. They turn those dollars more and more to make money and cashflow.

[Nation]

Pure Index funds are great for large categories, but terrible for small categories.

Paul Winkler ( http://www.PaulWinkler.net ) has presented this very well on his radio show ( podcast feed: http://www.paulwinkler.net/upload/feed.xml ).

Basically, with small cap, you have more businesses who move out of the index, compared to large cap. With Large Cap, you have both less number of companies and most stay around.

With small, when the board says "this company is now a midcap", with an index all the small cap indexes *must* sell within a small period of time. This forces the price that they can sell at down.

Now, a mutual fund that follows an index, but is not bound by the index, can take advantage of a longer sell time, and when the price goes back it can sell, or even before the board announces.

::: Point - indexes are not best for all asset classes.

Now on to Kiyosaki & diversification.
I know of three reasons he might say what he says, two lines of logic:
1. most mutual fund are actively managed, are all about generating investment (ie more money added to fund), and tend to be investing in the same thing. For example, most of the American Funds Family Funds invest in the same companies.

2. He wants you to have more education and more control.
He is more anti-give your money to someone else and let them invest "for you"

3. The power of focus.
It's kinds like the idea of "focus on your strengths" ... If you have the knowledge and ability to have great returns in this one area, then focus on it and not focusing on all your weaknesses.