7 Index Fund Myths

A great post over at The Dough Roller about index funds and some common myths. Some stuff I didn't know - worth taking a look if you are a beginning investor or even if you think you know everything there is to know about index funds.

Even the simplicity of index fund investing, which appeals to be as a novice investor, is more complicated than I thought.

I Am an Investor

As of this morning I am the proud owner of 92.034 shares of Fidelity's Four-in-one Index (FFNOX) purchased at $27.18 per share. I finally reached the $2,500 minimum necessary for a retirement account to buy into this fund, which I decided upon after some lengthy research. I wanted to go after an index fund that tracked the S&P but unfortunately the one I really want, the Spartan 500 Index Fund (FSMKX), has a minimum buy-in of $10,000 (with a gorgeous 0.10% expense ratio!).

So I put my $2,501.72 into FFNOX for now, and I plan on this being my sole IRA investment vehicle until I can sell out and buy into FSMKX. The cool thing about FFNOX is that it is comprised of four funds: FSMKX, the Spartan Extended Market Index Fund (FSEMX - with at least 80% of assets in the Dow Jones Wilshire 4500 Completion Index), the Spartan International Index Fund (FSIIX - tracks the performance of foreign stock market indices), and the U.S. Bond Index Fund (FBIDX - tracks a mix of U.S. bonds).

FFNOX has a nice expense ratio of 0.23%, which works for me for now. It's also got me diversified within a single fund, with 70.30% of the fund in U.S. equities, 15.40% in international equities, and 14.30% in investment grade bonds. While I don't think these asset allocations are exactly right for me at this point (too heavy on bonds, which should be minimal considering my age and investment horizon) they are fairly diverse within this fund, and should help temper the volatility of the fund over time - right?

The main thing is that now is the first time I can actually say: I am an investor! An impecunious one, for sure, but an investor nonetheless. I own a piece of American (and international) business! This is very exciting for me.

Now...the boring part. Keep investing every month for the next 30 years, don't touch my investments aside from tweaking asset allocations and watch my retirement nest egg grow (hopefully).

Learn to Love the Bear!

A great article by Jason Zweig in this weekend's Wall Street Journal. It's titled, "Stop Worrying, and Learn to Love the Bear." Zweig's main point is that bear markets provide the best investment opportunity for the prudent investor, and that wise investing, like losing weight, is simple, but not easy. It's boring and relies on consistent investment and discipline over decades - simply invest every month in low-cost index funds that track the market and a century of stock market data is on your side in terms of expected returns over the long term. Stay the course and ignore the market fluctuations - if anything, down markets represent the time when you should be putting more money into the market - stocks are on sale!

Reading this in addition to countless other articles and opinions reflecting this philosophy (one which men such as Bogle and Buffett espouse, especially for the average investor) just confirms what I've been feeling - I am actually excited to be beginning my investing career when stocks are at bargain basement prices. I will gladly watch the S&P continue to drop over the next few months!

Active or Passive Investment?

Although I am just getting my feet wet in the ocean of saving and investing, I have been spending and plan to continue to devote much of my spare time to learning about all aspects of finance. I am currently laying the groundwork for future endeavors, but one issue that I've seen crop up a few times in my reading is active vs. passive investment management. I came across this excellent article in San Francisco magazine, by way of the invaluable Get Rich Slowly, describing the value of the index fund over traditional stock picking and managed mutual funds.

As I understand it (an admittedly rudimentary understanding), active stock management is when one invests in individual stocks and monitors the market daily, anticipating the optimal times to buy and sell stock for maximum returns. This active management also manifests itself in the form of mutual fund managers who observe the market on behalf of their clients - taking significant fees to do so. Everyone from stock brokers to financial advisors to investment house managers profits extraordinarily from this system.

However, the relatively recent (as of the early '70s) rise of the index fund is a direct assault on the classic system of stock investing. Index funds basically take a stock index like the Dow Jones or Standard and Poor's (S&P) 500 and buy stocks in the proportions in which they exist in that index, assuming that, for the most part, a given stock price is an accurate reflection of the value of a company. The fund follows the ebb and flow of the entire market, and rather than trying to select individual stocks to beat this natural expansion and contraction, it relies upon historical precedence that the stock market generally rises in value over time. This method is very passive - so much so that it can be managed by computer for a tiny fee, rather than a team of exorbitantly-paid financial services people. And with very rare exceptions, mutual funds do not outperform index funds. Considering the fees and expenses involved with some of these high-performing mutual funds, index funds seem like a wise investment indeed.

Read the entire article, it's fascinating.

Also, a great post at The Simple Dollar explaining how index funds work.