Friday, September 27, 2013

Why I invest 80% of my assets in Index funds ?



Why I invest 80% of my assets in Index funds –
The one thing that, as an investor can possibly control in investing world is your costs/fees. It is the fees that you pay for ownership. More the costs, less the money you have and vice versa. 

What is an Index fund -
You probably would have heard this 100 times, here is one more time - index fund is a fund that invests and tracks a performance of a particular index Eg – S&P 500, Russell 2000, bond index etc. It holds all the stocks in that particular index based on certain criteria. Since it tracks a particular index, it is passively managed removing the manager/team who selects/picks stocks for the fund. Because of this, costs are extremely low to manage a fund compared to active managed funds.

To me, advantages of owning an Index fund –
  1. You automatically beat 70% of actively managed funds. Even if you pick a fund which is in top 30%, it is almost impossible to beat the index for years. A fund can beat the index this year and next year it might not. This will save you a lot of time. 
  2. Lower fees which will translate into 1000’s of dollars over time.
  3. It allows you to be committed to your investments no matter how markets perform. It takes emotions out of investing. 
  4. You own a piece of entire stock market. You are well diversified. 
  5. Peace of mind. You don’t have to worry about your investments when you sleep. 
  6. Taxes are low because of low turnover ratio. Index funds have turnover ratio less than 5%. 
  7. No investing experience required. 
  8.  I’m happy with whatever the general markets returns are.

Disadvantages of index fund –
  1. Index funds do not carry the potential to outperform the market. Which I’ve explained above and totally acceptable. 
  2. No voting rights on shares. I don't think this is a major factor. I’m a little investor and my votes probably would count like a drop in an ocean. So I don’t care if I don’t vote on my shares.  
  3. Top 50 companies would  comprise of about 40-50% of the index depending on what index you choose. This is a double edged sword. It has advantages and also disadvantages.
Feel free to comment !!