Throughout the market boom years of 1997 – 2000, much was written about index investing. Again and again, investment writers would point out that the Standard & Poor 500 Index, an unmanaged fund, beat out something like 90% of all mutual funds. You could own a mutual fund that copied this index and the management associated fees were a fraction of what managed funds were charging. So, the theory goes, why bother with managed mutual funds when your odds are so much better using index funds.
What wasn’t discussed however was the actual make up and weighting of the index funds. They contained a large concentration of the hi-tech stocks. Managers may have been reluctant to buy stocks with huge premiums; and thus, in my view anyway, it is easy to understand why so many under performed the broad index funds. The high-tech phenomenon was a mania.
During this boom era was born the site www.armchairmillionaire.com and their related book, which promotes their investment strategy. According to this strategy, all the investor need do is invest regularly, and allocate the investment to three index funds, which mimic the following indexes:
The first invests in large cap stocks, the second small caps, and the third focuses on foreign securities. This allocation is recommended for purposes of diversifications and because these market sectors do not always rise and fall in tandem.
If you feel intimidated by investing, distrust financial advisors, and demand investments with the lowest transaction costs, then this book may just be your choice. It is filled with common sense advice about the importance of regular saving and investing, and, on those points alone is worth the read. While I generally dislike index investing over other alternatives, I do agree that given a long time span, say 20 years, it should produce good results.
Many claim that financial advisors dislike index investing because it eliminates the commissions they earn selling managed funds. That may have some truth for those advisors who work by commissions. Since I do not earn commissions of any kind, I can’t speak for that group.
I can tell you however that it makes far more sense to me to own the best stocks available, rather than a basket of stocks whose selection is based on size of the company. And owning the best can only be achieved through management; that is, by selecting among stocks, or selecting among managed stock funds. That unmanaged index funds were able to turn in superior performance for several years was due, in my opinion, entirely as a result of the tech stock mania. Many of the stocks that were included in the index funds were grossly overpriced at the height of that mania, and this gave indexes an “apparent” advantage over fund managers who may have been very reluctant to pay huge premiums for hi-tech flyers.
With so many mutual funds available, I expect that many index funds will continue to outshine managed funds. The best returns will come from managed funds however, and the trick of course is to find those diamonds in the ruff.
There are many roads that lead to financial freedom. How you get there is not nearly as important as that you get there. Indexing investing is one of those roads, and if you have patience and time, indexing investing as fully explained in this book may be just right for you.
PS The author’s website used to provide a month-by-month listing of actual performance based on their strategy. As of 7/1/02, this apparently has been discontinued. Their cumulative return as of that date, from 3/98, was reported on the site as being a negative –11.11%. A note on their site reads “Since we started the Armchair Millionaire Model Portfolio in March 1998, we’ve never undertaken the delicate task of rebalancing or altering the percentages of the portfolio’s holdings to match our “target” percentages. Now we are.” Sounds like management to me.
Personally, I think it a mistake to ride a declining market down... assuming of course, you even figure out that the market is indeed in a long term down cycle. So, I agree with the authors' defensive measures... taking the sidelines. Unfortunately, it contradicts the main premise of the book. And that for me would be embarrassing.