There are many different ways someone can get their foot in the door when it comes to investing. One of those options is by investing in index funds. Many popular investors preach index fund investing as the best way to invest, and it is without a doubt an investment method that has stood the test of time. However, not everyone chooses to invest in index funds. Why is that?
Not everyone wants to invest in index funds because this type of investment is at the mercy of the market. Index funds mimic market indexes, meaning it’s a passive process that’s not actively managed. Some investors find betting that the stock market does well over time is too risky for them.
Of course, there are other reasons everyone doesn’t invest in index funds. So, keep reading as I take you through these reasons and explain a bit more about index funds.
IMPORTANT SIDENOTE: I surveyed 1500+ traders to understand how social trading impacted their trading outcomes. The results shocked my belief system! Read my latest article: ‘Exploring Social Trading: Community, Profit, and Collaboration’ for my in-depth findings through the data collected from this survey!
Table of Contents
Why Some People Don’t Invest in Index Funds?
While certain aspects of index funds appeal to investors, index funds aren’t without their drawbacks. As outlined earlier, index funds are set to mimic market indexes. These types of funds aren’t actively managed and are considered to be long-term investment vehicles.
Index fund investments are based on the idea that the stock market, as a whole, will continue to perform well over time. Listed below are the most prominent reasons that keep index funds off some trader’s portfolio:
Index Funds Use a Passive Investing Strategy
One of the factors that make index funds so appealing also lends itself to a significant drawback. The passive investing approach means there’s no reactive approach.
Thus, investors are at the mercy of the market, riding the ups and downs.
Any index fund investor must remember that an index fund is a long-term investment, and the expectation is to hold the money and watch it grow slowly over time.
With Index Fund Investing, You Can’t Ride on Trends
If a stock is undervalued or overvalued, the investor cannot take advantage of these trends. Thus, an overvalued stock may bring the portfolio’s value down, and the investor can’t do anything about it.
Index Funds Are Set Portfolios
While some investors would prefer to alleviate the stress of choosing where to invest, other investors prefer to research and invest in specific companies based on the brands, management, company morals, or various other reasons.
Overall, index funds limit the investors’ choice.
Index Funds Aren’t Aggressive Enough
Index funds aren’t aggressive enough for all, as some want to see gains quickly.
Financial experts tend to advise investors to invest aggressively while younger and more conservatively as they near retirement age. Some argue that index funds prevent realizing other opportunities that could yield faster results.
Advantages of Index Funds
Index funds are an ideal choice for both novice and average investors. They’re appealing due to low costs, low turnover, and diversification of portfolios. Research shows that fund managers may not be worth the price, as they often fail to outperform the market.
Generally speaking, index funds tend to outperform traditional mutual funds.
Index Funds Have Less Overall Risk
Index funds carry less risk overall, as the likelihood of losing 100% of investment is extremely slim. This is partly due to the diversification of securities within the index fund.
Some contain hundreds or thousands of publicly traded companies.
Index funds generally go against the ever-popular ideology “buy low, sell high.” Instead, they’re more “invest and hold” strategies and are considered a near-guaranteed success.
Index Funds Are a Simple Way To Invest
The overall appeal for many who choose to go the index fund route is simplicity. Index funds do not require a great deal of time or knowledge. The companies within the portfolio are non-negotiable, thus there is no need to research where to invest.
These funds are, in many ways, no-fuss, hands-off investments while also being relatively stable and predictable.
What Exactly Is an Index Fund?
An index fund is a portfolio of stocks or bonds that mimic the financial market index’s composition and performance. A financial market index, simply put, is an index for measuring the value of a portfolio within a specific market. Each index uses its own set of calculations to determine its value.
There are 3 major indexes in the United States:
- S&P 500
- Dow Jones Industrial
- NASDAQ Composite
Index funds are a type of mutual fund but different from traditional mutual funds.
While mutual funds are actively managed, meaning a fund manager makes decisions on the allocation of assets in the fund, index funds are passively managed.
Thus, traditional mutual funds are associated with high fees, and there’s generally a higher investment requirement. One of the more popular mutual funds, Vanguard 500, requires a minimum of $3,000 to begin investing.
The purpose of mutual funds is to beat the market.
Index funds, on the other hand, strive to match the market performance. The risk of buying and selling shares is removed. Since an index fund portfolio is passively managed, investors pay lower management costs.
Because index funds consist of well-diversified investments, they create a low risk for loss.
Why Many People Don’t Invest At All?
According to a study of 2500 people conducted by Bankrate (link in article sources):
- 39% of adults have no money invested in the stock market.
- 56% of those reported not having money to invest.
- 32% stated they didn’t understand investing.
However, there are far more reasons people don’t invest.
Some other reasons involve general misconceptions regarding the stock market. For instance, some believe that investing is too risky. A fear of volatility keeps them from investing, and they are uneducated in low-risk investment strategies.
Some people chose to take other approaches. Let’s look at those now.
Savings Accounts
Some believe that contributing to a savings account is sufficient.
While having a savings account is essential for having access to cash in case of an emergency and shouldn’t be substituted solely for investing, it should be noted that the national average interest rate for savings is a mere 0.06% as of August 2021.
They Want to Earn More Money First
Still, others say that they intend to invest later when they earn more. Financial experts argue that this is a missed opportunity. Further, experts state that investing earlier allows the investor more time to recover from any potential market lows.
When Did Index Funds Start?
Index funds started from the scrutiny of mutual funds’ high costs yet low yield. Financial experts such as Princeton professor Burton Malkiel, MIT professor Paul Samuelson, and investment consultant Charles Ellis grappled with mutual funds’ issues.
Ironically, Vanguard 500’s founder, John Bogle, introduced the first index fund for the public, First Index Investment Fund, in 1976.
Many in the finance community balked at Bogle’s newest undertaking.
Soon, other companies began to follow Vanguard’s lead. By the mid-1990s, index funds gained a strong foothold as they allowed individual investors access to the stock market.
Today, three well-known index funds track S&P 500:
- Schwann S&P 500 Index
- Vanguard 500 Index Fund
- Fidelity 500 Index Fund
Warren Buffett’s Big Bet on Index Fund
In 2007, Warren Buffett, a successful investor, bet that an index fund would outperform a traditional mutual fund. He invested $1 million in an S&P 500 stock index, and another $1 million was to be handled by Ted Seides.
A hedge fund manager at Protégé Partners, in hand, selected an actively managed fund. The bet was a term of 10 years.
Buffet proved to be correct. Less than a year before the end of the bet, Tom Seides conceded. Buffett’s index fund had earned $854,000, while the funds assigned to Seides gained $220,000.
In the end, the winner was Girls Inc. of Omaha, a charity that Buffett donated the bet’s earnings to.
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Conclusion
Overall, index funds aren’t inherently all good or all bad. It has found its place in the realm of finance and investing, much to the chagrin of naysayers in 1976.
As proven by Warren Buffett in 2017, one can have success investing in index funds with the caveat that it’s a long-term strategy.
These funds appeal to many, from novice investors to those unfamiliar with investing to busy individuals to seasoned investors due to ease and return on investment. Further, index funds aren’t as sensitive to the volatility of the market.
BEFORE YOU GO: Don’t forget to check out my latest article – ‘Exploring Social Trading: Community, Profit, and Collaboration’. I surveyed 1500+ traders to identify the impact social trading can have on your trading performance, and shared all my findings in this article. No matter where you are in your trading journey today, I am confident that you will find this article helpful!
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