It’s important to read books and articles that make arguments that are at odds with your current thinking once in a while. Understanding counter-arguments is a good way to make sure your reasoning is sound. After all, I would never have stopped stock-picking if I hadn’t read about indexing with an open mind. With that in mind, I read an Investopedia article entitled “ 5 Reasons to Avoid Index Funds .” Here I go through the arguments made in this article. 1. Lack of Downside Protection It’s true that index portfolios do not prevent short-term losses. Just think of how much more money you could make if you could always trade out of stocks that were about to drop. The Investopedia article points to several strategies for making money when you know the market will drop. The problem is that you don’t know when the market will drop. As a matter of fact, most of the time that investors try to time the market, they end up making less than if they had just stayed invested in the ind...

Frugal Trader at Million Dollar Journey wrote a thoughtful post titled 5 Advantages of the Dividend Investing Strategy that caught my attention. He believes that both index investing and dividend investing are good strategies. I’m not sure if he intended his 5 advantages of dividend investing to be advantages when compared to index investing, but I’ll take them this way below. Let’s examine each of these 5 advantages: 1. Produces a Passive Income Stream for Life, and with Raises! Dividend stocks certainly produce passive income that tends to rise over time. However, indexing does the same thing. Dividend stocks produce bigger dividends, but indexes tend to produce bigger capital gains. So, I’d say that this advantage applies equally to both dividend investing and index investing. 2. Encourages Buying and Holding for the Long Term I suspect that this is where dividend investing has an edge over index investing, at least for some investors. No matter how you invest, it’s...

Long-time reader, Gene, asked the following good question. “Have you considered making a pseudo index fund by buying perhaps 15 large-cap stocks from each of Canada and the USA that would mimic an index? Not ideal for a growing portfolio, but for a relatively-stable account, and low commissions, it could save money on fees. Drawbacks are that it would be harder to increase or decrease holdings, and the savings wouldn't be huge over already inexpensive ETFs.” Gene is right that a carefully-run stable portfolio of stocks can cost less in fees than index ETFs. However, an important issue is how well such a portfolio would track its index. For an answer here, I turn to Meir Statman’s paper How Many Stocks Make a Diversified Portfolio ? Table 1 of this paper shows how the standard deviation of portfolios varies with the number of stocks you own. At this point, I need to diverge to a topic that few investors understand well: volatility losses. Consider a very simple example. In...

Rob Carrick points to the RBC Canadian Dividend Fund as an example that “shows why we need to reform the way investors pay for funds and advice.” He makes a number of excellent points about the problem of hiding the cost of advice in mutual fund MERs in the form of trailing commissions. However, I take issue with his claim that because this fund has beaten the S&P/TSX composite index over the past 5 years it “has been such a consistently good money maker.” The Canadian S&P composite index is not the right index for judging the RBC Canadian Dividend Fund. A more appropriate index would be the Dow Jones Canada Select Dividend Index. The iShares ETF based on this index, XDV, beat the RBC Canadian Dividend Fund by 1.1% per year for the past 5 years, which is very close to the difference in their MERs. Another possible index for comparison is the S&P/TSX Canadian Dividend Aristocrats Index. The iShares ETF based on this index, CDZ, beat the RBC Canadian Dividend Fund ...