In the previous post, I started to examine some of the reasons fund managers give against leaving their funds and investing in an index. Here are a couple more.
Argument #2: Our gains are more intelligent.
Some of the arguments given by active stock pickers amount to saying that their returns are somehow better than the returns on an index fund because of some vague attribute like intelligence, precision, or global-mindedness. This raises an important question: would you rather make a 10% return intelligently or 12% mindlessly? I’m not advocating investing without thinking, but what matters ultimately to your financial future are results, not the process.
Argument #3: Some people need their hands held.
The argument here is that some people need advice, and if they try to manage their own money they might get nervous and sell at a bad time. There is a lot of truth to this. Many people do panic and sell near a market bottom when they would have been better off just holding on. However, there are two problems with this argument.
How much should people pay for this “steady hand”? If you have $200,000 invested in mutual funds with an average management expense ratio (MER) of 1.5%, then you are paying $3000 every year to have your hand held. You might consider finding some cheaper way to avoid getting panicky and making poor decisions.
Just because you are invested in actively managed mutual funds does not mean that you automatically have someone there to stop you from making rash decisions. Many people own mutual funds in a self-directed account and are able to trade in an out of funds without the benefit of a friendly expert to calm their nerves. Fund managers may try to hold on to stocks that have dropped in price, but some of the fund’s investors will sell out of the fund forcing the manager to raise cash by selling stocks.
I will continue with more of these arguments used against indexing in the next post.