Is Index Investing The Answer?
While there are some great money managers, the reality is, most of them underperform the S&P 500 index. By definition, the majority cannot be above average. For the most part, inistitutional investors are the market. While I think there is a place for index funds in everyone’s portfolio, if you are willing to put in a little extra effort, I think you can do better. If you had put all your money in the S&P 500 on January 2000, ten years later, at the end of December 2009 your compounded annual return would have been -2.7% (yes, that is a minus sign). If you think there are some companies that are simply better managed and have great products and prospects than the average company, then why not invest a portion of your portfolio in those companies? In fact, with the Risk/Return Calculator I have developed, and make available for free on this website, you should be able to find great stocks which outperform the index, at times with less volatility than the market. This is the best of both worlds. High returns, low risk – the holy grail of investing.
For the same 10 year period starting in January 2000, if you had invested in C.H. Robinson stock (CHRW), you would have made 20.9% compounded annually, but at twice the volatility of the S&P. Johnson & Johnson would have earned you 5.4% annually including dividends for about the same volatility as the S&P. So if you are a long term investor, go ahead and own a broad index, but why not super-charge your portfolio with a few great stocks? Even index investing evangelist John Bogle says 5% of your portfolio could be in what he calls the “funny money”, or actively managed, account.
The legendary money manager, Peter Lynch, made a strong case for individuals to own common stocks. He argued that the individual investor has numerous advantages over professional money managers. The individual investor has a lot more freedom than the professional. You don’t have to explain why you are buying or selling to a board or to your clients. No one is going to fire you if you have a bad quarter. You are not restricted in the sectors or countries you invest in. You can own one stock or a 100. You can even choose to stay 100% in cash for however long you want. In short, you should be thrilled you are not a professional investor. Lynch’s classic One Up on Wall Street is a book I highly recommend.
Part 1 – Investment Risk
Part 2 – What is a Low Risk Investment?
Part 4 – A Free Tool for Identifying Low Risk, High Return Investments