I’m caught in a hurricane of a week. My kids are on Easter break, my parents are in town and most importantly I’m getting ready for my 40th birthday bash this coming weekend.
Now it’s really important for me that my friends meet and have a good time. I used to work for MSCI - Morgan Stanley Capital International - one of the major index fund data providers and a few of my friends who work on index funds will be at the party.
I was doing my research for this post to convince those of you who don’t know much about index investing to investigate, when I came across a quote by William Sharpe - a super duper famous professor of finance at Stanford (more on him some other time).
He writes: “The people running index funds are dull but they are cheap. They only need to know the names of securities in a market and the number of shares outstanding. You would not want to be stuck at a cocktail party with one of them” - Prof W. Sharpe
I don’t agree that my index fund creating friends are boring. But yes, boring can be very good when it comes to investing. Index investing is simpler to execute and simpler to understand.
Warren Buffett - the most famous investor of our century is 85 years old. He is still going strong though is coming to the end of his career. He is an active share/stock/company picker and one of the best in the world at that. When he goes, he knows his personal wealth that he is leaving his wife and family will have to be managed properly. So what has Warren Buffett decided on - given that he has access to the best investment managers in the world and could park his money with anyone who would be happy to take it. His will stipulates on his death his money should be put in index funds - it should be managed passively without trying to beat the market.
Here’s a link to Warren Buffett’s actual words which several articles have paraphrased or given excerpts, but I think it’s worth reading the whole page in his own words (page 20). http://www.berkshirehathaway.com/letters/2013ltr.pdf
What is indexing or index tracking? Buying the whole market and being “passive” about which companies you select. Buying shares in a fund that is automatically invested in a set of companies selected by market cap, industry etc. Basically you don’t pay someone to choose outperformers for you, you just buy a basket of companies in the space you decide. Example: Buying the the Vanguard 500 Index Fund buys you the share performance of the 500 largest companies in the US. Buying an Information Technology index fund will buy a share of the largest info tech companies in the world if you feel that is a sector that will grow.
What are the advantages? Low cost: Since you’re not paying for stock picking “talent”, index funds are much cheaper in terms of fees Plug and play: It's the easiest way to follow the world economy without having specific knowledge or expending effort getting to know individual companies. It’s a good entry point for people who aren’t looking to beat the market.
What are the disadvantages? It will never beat the market as you are buying the whole market. If everyone indexed, markets wouldn’t function properly. Goes up and down with the market - it doesn’t eliminate market anxiety or stress. You hold good companies and bad. Even if you know a company has fallen on tough times, if it’s part of an index you hold, you hold that company.
Who are some major providers of index funds? Vanguard and Blackrock. Disclaimer: I chose these because they are the biggest players. As of the date of this blog post, I have no affiliation with them.
What is the next step to find out more? If this has piqued your interest, try the book from John Bogle the person who brought index investing to the mass market: “The Little Book of Common Sense Investing”.
By the time you get my next post I would have gone over to the dark side --- I will be 40 years old -- but still bringing you ways to rethink “boring” investing.
Have a great week!
Disclaimer: I used to work for MSCI - Morgan Stanley Capital International - and still have good friends who work there. Any discussion of indexes will be coloured by this experience.