Publication: Investor's Notebook
THE WORST FORM OF INVESTING EXCEPT FOR ALL THE OTHERS | |
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Investor's Insight - January 16, 2007
"A Digest of Investment Opinion From the
World's Leading Financial Advisers"
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THE WORST FORM OF INVESTING EXCEPT FOR ALL THE OTHERS
by Scott Burns
Q: Like you, I believe investing in index funds is a
better way for individuals to invest. I was just about
to start investing in index funds in my retirement
accounts when I came across an old article by Gregg
Wolper (Morningstar, 2/21/06) titled "The Hidden
Drawback of Indexing." Wolper said that, "Believe
it or not, index funds are, in effect, momentum
players."
Although he did not discourage readers from investing
in index funds, his concerns seem valid. I would like
to know your opinion on the concerns raised in the
article. I would also like to know whether it is the
right time to jump into index funds at the peak of
the market when most index funds are loaded with over-
valued stocks. -- J.L., by e-mail
A: Winston Churchill once said: "No one pretends that
democracy is perfect or all-wise. Indeed, it has been
said that democracy is the worst form of government
except all those other forms that have been tried from
time to time." The same statement could be made of
index funds as a form of money management. They aren't
perfect, but they are better than all the other forms
that have been tried.
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While Gregg Wolper is correct -- there is a built-in
momentum element in market capitalization-based index
funds -- it has never been so great a problem that
broad index funds haven't outperformed the majority
of their managed competitors.
We live in an imperfect world. What we try to do as
investors is work with the tools that give us the
best results at the greatest efficiency. To me what
is truly amazing about index funds is that a tool
with such visible limitations has so easily and con-
sistently beaten the majority of managed funds over
not years but decades.
You buy an index fund to avoid stock selection risk.
You also buy an index fund to avoid market timing
risk. You buy the asset class as a whole and use
the best tool yet created to capture its returns --
and its risks. When you ask whether it is "the right
time to jump into index funds at the peak of the
market when most index funds are loaded with over-
valued stocks," you are expressing an opinion
about stocks, the market and the future. Opinions are
something index investors try not to have -- because
they are usually wrong. Overvalued stocks and over-
priced markets often continue to rise. Undervalued
stocks and underpriced markets often continue to sink.
We can be entertained by all those who have opinions
about the value of stocks and the level of the market.
But we should never forget that it is entertainment,
not a visit to the Oracle of Delphi. Skeptics need
only endure a few minutes of James Cramer's "Mad Money"
to get a visceral understanding of opinions as enter-
tainment.
When you become an index investor, you rest in the
benign assurance that you will capture the market
return of many asset classes. You also accept a his-
torically verifiable idea: Flawed, vain, violent and
covetous human beings, on balance, collectively manage
to create more value than they destroy.
Q: I am 60 years old and retired, with 80 percent of
my savings in the stock market. Of that amount, about
40 percent is in alternative investments sanctioned by
one of the largest financial firms in the world.
Should I be looking to move that money into safe in-
vestments such as CDs? If so, how does one do that when
the FDIC insures only $100,000 per bank per customer?
With my net worth, I'd be running all over town looking
for banks. Yes, I know that's a good problem have!
-- E.K., by e-mail
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A: Unless you do a great deal of hunting, you will find
that U.S. Treasury obligations generally yield more than
bank CDs of the same maturity. If you visit
www.banxquote.com, for instance, you will find that the
national average yield on a five-year CD is currently
3.91 percent. Visit www.bloomberg.com and you'll find
that a five-year Treasury obligation yields 4.70 percent.
People with large portfolios -- those who have to worry
about the limits of FDIC insurance -- get the best credit
quality in the world with U.S. Treasury obligations. You
can buy them through investment firms like Fidelity or
Vanguard. You can also buy Treasury obligations directly
at www.easysaver.gov.
You can discuss this issue or any other topic in the new
Investor's Insight forum. Check it out here...
Investor's Insight Forum
(Investor's Insight reflects the opinions of experts. It does
not recommend any specific investments, and no endorsement is
implied or should be inferred. For more information, contact
the individual firms cited).
COPYRIGHT 2006 UNIVERSAL PRESS SYNDICATE
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