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Investing in index funds has been lauded around here, but the goodness of that strategy revolves around its consistency in returning 10% over ten to twenty year

by noahlt 16y ago

Investing in index funds has been lauded around here, but the goodness of that strategy revolves around its consistency in returning 10% over ten to twenty years. This graph makes index funds look much less consistent! Does this graph debunk the index fund strategy, or am I missing something?

borism 16y ago
the goodness of that strategy revolves around its consistency in returning 10% over ten to twenty years and why would that be "the goodness" of index fund strategy? who told you that? "the goodness" of index funds is that they're low cost and diversified (sometimes) - so more of the returns stay in your pockets, not get handed over to fund managers. return of the over-all stock market has little to do with it!
Huppie 16y ago
It's actually interesting that they already account for dividends and taxes. Usually if people talk about a 10% return, they are talking about pre-tax returns. I remember seeing a 'rolling S&P500 results' page somewhere but can't remember exactly where, [0] is what a quick search comes with. As you can see in graph [1] there was quite a dip for everyone investing for a period of 20 years between 1974 and somewhere around 1994. That is a 30 year period of a total of 80 years measured with bad returns. [0]: http://allfinancialmatters.com/2007/06/12/sp-500-rolling-period-total-real-returns/ http://allfinancialmatters.com/2007/06/12/sp-500-rolling-per... [1]: http://allfinancialmatters.com/Graphics/S&P50020-YearTotalChartBig.GIF http://allfinancialmatters.com/Graphics/S&P50020-YearTot...
mjs 16y ago
The two green squares are 7% annual return or greater, so you can be in the beige somewhere and still be getting decent returns. It does seem somewhat difficult to end up on a green square though--there aren't that many of them and there are even fewer long runs.
dschobel 16y ago
Index investing isn't predicated on 10% returns nor was it ever a guarantee of such returns. Index investing is simply the theory that the markets are efficient and reflect all possible information on a security and that you're not smarter than the market. Think of it this way-- buying a stock is a way of saying "the market is wrong, I think $COMPANY is worth more than the price at which it is trading". Unless you have information which the market does not (the next Apple product will be a flop, etc) this becomes, by definition, a speculative position. Index investing is a way of opting out of the highs and lows of stock picking and still take part in the general growth in a market/sector/<whatever the index cover>. The story merely points out that for some timespans, the growth of the US markets was crap and that (unsurprisingly when you think about it for a second) returns have varied substantially over the past 50 years even for long time-spans. TLDR; if you think the US economy will keep growing and don't think you're smarter than marketɫ, index investing is probably still a really good way to go. ɫ hot tip: you're not
- borism 16y ago
  this is a good point on efficiency of the market, however it is not correct conclusion that you cannot find companies in that market that are not better performers than others - obviously there are companies in S&P500 or any other index that perform better than others for any given period of time. But if you focus on particular set of companies (tech for example) your risk increases since your diversification decreases. Given your own example, obviously AAPL outperformed market for the past decade. Whether someone could have predicted that is a different question though.
- maigret 16y ago
  Yes... Told differently, index fund is great because basically their cost difference with a managed fund are similar to the difference in return. Take a managed fund costing 0,5% a y more than the index fund, the managed one will have to do .5% better, which is not always the case. Take on top of that the very high fee for buying managed funds (up to 5%), and index funds suddenly gets interesting, especially if you want to invest for a few years only. Compared to single stocks, index funds can be more expensive but they offer some more reliability as the diversification is higher (at least for small investors)
paraschopra 16y ago
Well, index funds are lauded over choosy stock-picking for providing on an average similar returns without the hassles of active portfolio management. I have never heard anyone arguing that index fund strategy ensures consistency of returns year after year.
maayank 16y ago
meta-comment: I honestly don't understand why you are voted down. This is a very valid question. Maybe it's a stupid question, I don't know. I just know that I entered the comments thread here at HN after reading the article specifically to ask this question but the OP beat me to it. Does this comment adds redundant noise to the conversation? Really? If you have a good reason to disagree with the subject matter (indices seem less attractive that purported) please share it with us in the comments, I know I'd be genuinely interested.
- yummyfajitas 16y ago
  It is probably being voted down because the question is based on a false premise: "the goodness of that strategy revolves around its consistency in returning 10% over ten to twenty years" I would have voted it down before seeing your comment. But apparently this particular misconception is more common than I thought, so perhaps debunking it is actually useful.

by noahlt 16y ago

borism 16y ago

the goodness of that strategy revolves around its consistency in returning 10% over ten to twenty years and why would that be "the goodness" of index fund strategy? who told you that? "the goodness" of index funds is that they're low cost and diversified (sometimes) - so more of the returns stay in your pockets, not get handed over to fund managers. return of the over-all stock market has little to do with it!

Huppie 16y ago

It's actually interesting that they already account for dividends and taxes. Usually if people talk about a 10% return, they are talking about pre-tax returns. I remember seeing a 'rolling S&P500 results' page somewhere but can't remember exactly where, [0] is what a quick search comes with. As you can see in graph [1] there was quite a dip for everyone investing for a period of 20 years between 1974 and somewhere around 1994. That is a 30 year period of a total of 80 years measured with bad returns. [0]: http://allfinancialmatters.com/2007/06/12/sp-500-rolling-period-total-real-returns/ http://allfinancialmatters.com/2007/06/12/sp-500-rolling-per... [1]: http://allfinancialmatters.com/Graphics/S&P50020-YearTotalChartBig.GIF http://allfinancialmatters.com/Graphics/S&P50020-YearTot...

mjs 16y ago

The two green squares are 7% annual return or greater, so you can be in the beige somewhere and still be getting decent returns. It does seem somewhat difficult to end up on a green square though--there aren't that many of them and there are even fewer long runs.

dschobel 16y ago

Index investing isn't predicated on 10% returns nor was it ever a guarantee of such returns. Index investing is simply the theory that the markets are efficient and reflect all possible information on a security and that you're not smarter than the market. Think of it this way-- buying a stock is a way of saying "the market is wrong, I think $COMPANY is worth more than the price at which it is trading". Unless you have information which the market does not (the next Apple product will be a flop, etc) this becomes, by definition, a speculative position. Index investing is a way of opting out of the highs and lows of stock picking and still take part in the general growth in a market/sector/<whatever the index cover>. The story merely points out that for some timespans, the growth of the US markets was crap and that (unsurprisingly when you think about it for a second) returns have varied substantially over the past 50 years even for long time-spans. TLDR; if you think the US economy will keep growing and don't think you're smarter than marketɫ, index investing is probably still a really good way to go. ɫ hot tip: you're not

borism 16y ago
this is a good point on efficiency of the market, however it is not correct conclusion that you cannot find companies in that market that are not better performers than others - obviously there are companies in S&P500 or any other index that perform better than others for any given period of time. But if you focus on particular set of companies (tech for example) your risk increases since your diversification decreases. Given your own example, obviously AAPL outperformed market for the past decade. Whether someone could have predicted that is a different question though.
maigret 16y ago
Yes... Told differently, index fund is great because basically their cost difference with a managed fund are similar to the difference in return. Take a managed fund costing 0,5% a y more than the index fund, the managed one will have to do .5% better, which is not always the case. Take on top of that the very high fee for buying managed funds (up to 5%), and index funds suddenly gets interesting, especially if you want to invest for a few years only. Compared to single stocks, index funds can be more expensive but they offer some more reliability as the diversification is higher (at least for small investors)

paraschopra 16y ago

Well, index funds are lauded over choosy stock-picking for providing on an average similar returns without the hassles of active portfolio management. I have never heard anyone arguing that index fund strategy ensures consistency of returns year after year.

maayank 16y ago

meta-comment: I honestly don't understand why you are voted down. This is a very valid question. Maybe it's a stupid question, I don't know. I just know that I entered the comments thread here at HN after reading the article specifically to ask this question but the OP beat me to it. Does this comment adds redundant noise to the conversation? Really? If you have a good reason to disagree with the subject matter (indices seem less attractive that purported) please share it with us in the comments, I know I'd be genuinely interested.

yummyfajitas 16y ago
It is probably being voted down because the question is based on a false premise: "the goodness of that strategy revolves around its consistency in returning 10% over ten to twenty years" I would have voted it down before seeing your comment. But apparently this particular misconception is more common than I thought, so perhaps debunking it is actually useful.