That’s the issue in a USA Today financial column — how can you tell whether your broker is doing a good job for you? For people who are trying to play the markets, that’s a real issue. Is a stock touted by the broker a good deal?
For people following a sensible strategy of “buy and hold index funds,” that’s never a worry. You’re typically buying from a no-load source such as Vanguard or Fidelity. And you’re not trying to figure out what’s good or what’s bad — you’re just buying a little piece of all of it. For more on this strategy, go look at this.
It’s really this simple: The more you know about financial markets, the less you will try to play them. The less you know about financial markets, the less you should try to play them. Playing financial markets is a losing game for most of the half-informed people who try, and only a winning game for people with inside information or superior trading access.
Reasons just keep mounting up to follow a simple stock market strategy of buying and holding index funds. There was a one-day “wild ride” on the major stock exchanges May 6, 2010. Stocks lost hundreds of points in minutes and then regained most of the loss in minutes. None of this caused distress for long-term buy-and-holders. Day-to-day fluctuations don’t matter much when you’re in the market for the long term. In fact, by making some investors more afraid of stock risk, these short-term swings can increase the overall return to holding stocks. The long-term return to holding stocks is so high that it’s referred to by researchers as the “equity premium puzzle.” The implication for the average investor? Buy and hold!
Much has been made of transactions involving Goldman Sachs and big-dollar investors who lost big-time.
That has very little to do with the individual investor. Those were all big players taking big risks — and, unfortunately, it seems many of them didn’t know what they were doing.
This site’s recommended strategy, “buy and hold index funds,” has the great advantage of being understandable. You’re holding a little bit of every major stock in the economy. You’re not betting on one sector to grow or collapse. If the economy does well, you do well. Add this to the list of reasons for index funds: They’re not a synthetic CDO, whatever that is.
I’m sometimes asked, “What should I hold in my 401k plan?” Of course, my answer is “index funds” — tilted more toward stock index funds if you’re young, bond index funds if you’re old. My book explains some simple rules of asset allocation.
But what if your employer’s 401k doesn’t have index funds? Two answers: (1) Invest in the most broadly diversified mutual funds you can choose from. They’ll perform about like index funds. (2) You may have increasing opportunities to invest in index funds. This article in the Wall Street Journal points out that more companies are insisting on having index funds available to their employees.
Another good reason for indexing: When “market professionals” make a bet on a part of the market to outperform the rest, they’re often wrong. Here’s a Wall Street Journal article on why bond mutual funds let investors down. In short, “Most intermediate funds held far fewer of the safest bonds than were in the index.” And if you held a fund based on the index, you weren’t making a gamble on which bonds would do the best (an ill-fated gamble, it turned out). My favorite bond index fund: The Vanguard Total Bond Market Index fund.
A popular, but flawed, way of trying to benefit from the ups and downs of the stock market is to sell out at the top and buy in again at the bottom. This is known as “market timing” and it’s very difficult to make any money doing it.
The problem is that no one knows when a bottom or top occurs until long after the fact. Therefore, when the stock market rallied in March, unless you were already holding stocks you were too late to buy in at the bottom. How do you react to all this? My favorite strategy is “buy and hold.” If you don’t try to sell out at the top you don’t have to worry about when to get back in. My prediction: Within two years, the stock prices of March 2009 will look extremely attractive. “Market timers” will kick themselves for not having gotten back in then.
One warning: If you “buy and hold,” there will be times when you wish you had sold out. It’s not for the faint of heart. However, for those willing to stay in the market long term, the rewards can be substantial.
Add this to the list of reasons why “buy and hold index funds” is a relatively good investment strategy: It’s not a Ponzi scheme.
A bit of explanation: In a Ponzi scheme, a shady operator takes in money, claiming to invest it. It pays off handsomely at first, it seems — but the payoff is illusory because it comes from scamming in new investors. Their money pays off the first investors, but now the Ponzi operator has to go find still more investors to keep up the appearance of a good return.
A Ponzi scheme was limited to scamming small-time ill-informed investors, or so we thought until Bernard Madoff was caught in a $50 billion Ponzi scheme that took in wealthy upper-crust clients. And that brings me to the point. If you buy and hold reputable index funds you can expect to make money over the long haul. You will have some bad years, like 2008. But you’ll never lose it all to a scam.