Index Funds are Great, But Don't Avoid Stock-Pickers
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Index funds have gotten plenty of praise lately, some of it from me, as the Vanguard S&P 500 Index Fund , formerly First Index Trust, celebrated the 40th anniversary of its launch. It’s now the second-largest mutual fund in the country, behind only the Vanguard Total Stock Market index fund.
But such investing leaves a little pit in my stomach. Sure, index funds are a way to get a return that’s above average for all mutual funds. But they’re boring. Make that B-O-R-I-N-G. You’ll get dividends and capital gains (or losses) almost equal to what the index produces.
As a long-time investor, I still crave a little drama and excitement.
Even though I now use index funds—in fact, Vanguard’s total stock market and S&P 500 funds are my two largest stock investments—I still like the thrill of the hunt, even though it may be costing me money.
The logical approach is to stick with index funds. But picking stocks and actively managed mutual funds (as opposed to index funds, which are passively managed) is fun and occasionally educational. Provided, of course, that you have the inclination and the means to do research, and the ability to suffer worse-than-market losses without freaking out.
Part of my interest in individual stocks and active funds is generational. I’m 71 years old, and when I began investing in my late twenties, index funds weren’t available to the general public. I was in my early thirties when the Vanguard S&P fund was launched on Aug. 31, 1976, and for years, I paid no attention to index funds.
At Forbes magazine, where I was a senior editor in the 1980s, most of us snickered at index funds. We were writing about the likes of Peter Lynch, the legendary manager of Fidelity’s Magellan Fund, for years the best-known and most influential stock mutual fund in the country.
An aside: Morningstar told me that as of the end of August, Fidelity Magellan has the highest average annual return of any current stock fund that was active when the Vanguard S&P fund was launched. However, Magellan hasn’t been heard from much lately, and is now about a third the size it was at its peak.
Look, I’m not telling you to ignore index funds — or to choose individual stocks and active funds, rather than investing in the low-cost target date retirement funds that I hope are offered by the 401(k) plan that I hope your employer offers.
But looking at individual stocks and actively managed funds can be educational and fun, which index investing isn’t, in my humble opinion.
What I suggest you do as a newbie or almost newbie investor — again, if you’ve got the time and inclination — is to put the bulk of your assets into index funds or target date retirement funds (which we’ll discuss in a future column), and play a little bit with a small part of your portfolio.
If you do well, you can take victory laps and show off at parties or on social media. If you do badly, you can keep your mouth shut, and consider the amount by which you underperformed the market to be an educational expense. And that, my friends, is the bottom line.