Confessions of an Indexer

I have a confession to make.  In my corporate life, I was an investment professional.  I spent a lot of time analyzing stocks and making recommendations of what to buy and sell.  But today, I hold all of my savings and retirement money in index funds (and ETFs).  This may be surprising to many, since I spent many years cultivating my stock picking talents and I was well compensated for that work.  There are two key reasons why I invest in index funds: expenses and emotions.

From an expense standpoint, index funds are very attractive.  Compared to an actively managed fund, some index funds charge about 1% less in management fees.  This adds up.  Over 10-years this would mean that an active manager would have to beat the index’s dumb computer by 1% each year. Or roughly (without compounding) by 10% over the period.  And while many managers and stock pickers can have a great year or 2-3 years, I have seen very few managers that can consistently beat the index year after year without taking excess risk.

The second reason that I invest in index funds are emotions.  In my post on the Myth of Buy and Hold, I explored the challenge of managing your own blood, sweat and tears hard-earned savings.  In particular, what is challenging is going against the wave of media euphoria in a bull market and gloom and doom in a bear market.  In typical bear markets, the reason people underperform is that they tried to bottom-fish too early and are tapped out of cash to reinvest when markets trend further down.  In addition, most people become more risk averse as negative economic news increases and end up holding too much cash when the market turns around.

So, there you have it.  My name is Lizzie, and I’m an indexer.  I trust a dumb computer, set to fixed rules, over an emotionally-charged human (including myself).

see more at this week’s Carnival of Personal Finance