Sunday, July 27, 2014

Why I Do Not Like Index Investing (Against All Conventional Wisdom)

The Cheerful Egg recently wrote a post about the main drawbacks of index investing. He is a HUGE fan of index investing though in case you didn't know, but let me see what points I can draw out from his post. He is trying to point of what is bad about index investing, so you can at least identify what are the bad points about it.

1) The market may not continue rising
2) Stocks may not be the best asset class
3) Everyone starts indexing
4) Lack of discipline to stick with it

His list of drawbacks are not really drawbacks of index investing specifically, they are drawbacks to investing in general. The only specific drawback of index investing that has a direct impact, rather than a secondary impact is point 3 - Everyone starts indexing.

Honestly, is that a problem? Yes, I think it is.

Indexing is the ultimate form of freeloading in a capitalist structure.

Don't believe me? The very same benefits of indexing are all the same benefits of freeloading!

"You don't have to think or spend a lot of money, you follow a simple plan and stick to it no matter what, and then ka-ching, you're rich."

Don't get me wrong, it works. Or shall I say, it has been working. And it probably still will work in the future to come. Which is absolutely why it is no wonder at all that ETFs (which primarily indexes benchmarks) are totally all the rage and have been growing to be an ever bigger monster.

My main points against index investing are:

1) Current indexing style is absolutely insane (market cap weighted)
2) Selling points of indexing fails to prepare the investor of the risks they are taking
3) Introducing weak hands to the world of investing can be more harmful than helpful
4) Everyone starts indexing

I urge anyone who owns an ETF or is a big fan of indexing to read that tiny short article that I posted up, as well as to look for interviews with Rob Arnott with him discussing his RAFI fundamental indices, so that you can know the beast that you are dealing with.

I have an extremely strong dislike for market-cap indices, whereby my dislike of it is all based on academic research as well as prudence and common sense once you break it down. I am not against indexing, it is a cheap and easy way to get diversified. I am however, against the current style of indexing and how it is being promoted as the simple, every-man solution to safely investing in the market (both stock and bond) and making it rich. The gross flaws of market-cap indexing have been masked by the (so far) bigger contributions to overall returns that selecting stocks as an asset class have played.

The Cheerful Egg's counter argument is that indexers give up Alpha, which is true. My concern is not about the Alpha, which all indexers (should) know that they have absolutely none, but it is with the very essence of the Beta itself. If 99% of investors are indexers, then what? Who follows who? I see this as just 3 blind mice.

Just ask yourself, if everybody does indexing and there are billions of dollars in the market just running around and chasing momentum, how can things end well for these investors? There will be a point in time when the current style of indexing will get broken, and I am sure that I will live to see that day happen within my lifetime. Until it is broken though, I will still invest my money, some through indexing, some through other means, but at least I understand what is under the hood of my car, so I will be better able to fix it when it breaks, or to know it is totally trashed and I should move onto my next (investment) vehicle.

What about you? Thoughts on index investing?

3 comments:

  1. Hope more and more people believe in STI ETF investing and as a group hoot on tua tua on monthly averaging strategy and stay long for the next 20 years.

    As supply in blue chips are limited, guess what happen for those who DIY in blue chips?




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    Replies
    1. Hi Uncle CW8888,

      Honoured to have you visit, I read your blog quite often!

      The STI ETF is the best choice we have here in sg, so I still support using it. It has a reasonable expense ratio and it gives easy access to the 30 blue chips, especially since some tickers like the 3 Jardine's are too expensive to buy on your own.

      What happened for those who DIY in blue chips?

      MH

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    2. Go Money. Got Honey for DIY in some blue chips.

      Delete

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