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What Would Have Happened Had You Invested in an Index Fund?

47 points by thebear 12y ago

thrush 12y ago
Was a bit difficult to parse at first glance. Was the answer in favor Buffet's advice?
- diogenescynic 12y ago
  Yes, Buffett's advice gained $9,309 more over a 5-year period.
  - lsc 12y ago
    Heh. The first thing you learn when you back-test stock-trading algorithms is "Give me any investing strategy, and I will find you a five-year period where it does well." Which isn't to say that I think you can outperform index funds... I don't; but the answer, it looked to me, was 'sign up for the GreaterThanZero web app and run the model yourself.'
    - diogenescynic 12y ago
      Agreed, but in this case it looks like he was responding to Buffett's quote: >My advice to the trustee couldn’t be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard’s.) I believe the trust’s long-term results from this policy will be superior to those attained by most investors—whether pension funds, institutions or individuals—who employ high-fee managers. Then he compared his 401k results with the Vanguard Target 2040 fund. Seems pretty straightforward.
themartorana 12y ago
Companies come and go, especially tech stocks and whatnot. Buy a single share of the DJIA at 13k in 2007, see it drop to 8.5k, wait a couple of years and - wait - it's at 16,500. It's a 27% return in 6 years, which isn't great, but considering the crash, you're still up. That said, I don't know much about investing. But index funds seem to me (completely useless when it comes to investing) one of the safer bets if I'm going to be in the market at all.
- Consultant32452 12y ago
  The reason why index funds are better is because they're generally managed by a very simple computer algorithm which means very very low fees compared to actively managed funds. If you look over the lifetime of someone's 401k it's really shocking how much is eaten up in fees. Also, over long periods of time you're generally not going to beat the market. What you pointed out about the DJIA having lots of fluctuation, particularly during crashes, is why it's important to keep investing a little every paycheck. That way when stocks are low you're buying more shares. It's a sale!
leorocky 12y ago
I'm not sure the post ever answers the question given in the title. It gets very detailed, but it's a pretty muddled, unclear answer at best about something related to benchmarks.
- pcrh 12y ago
  Here's a comparison between Berkshire Hathaway and Vanguard for the past 10 years: https://i.imgur.com/yHVY0qP.png https://i.imgur.com/yHVY0qP.png (data from morningstar.com). Overall, very similar, but if you went in and out of the funds at different times you might have had a different net result.
infecto 12y ago
Article did not have a very clear answer. Its more powerful to look at the alternative to index investing. First of all lets be clear that true index investing balances your equity/fixed portfolio based on age or some risk profile. As for alternatives, close to all money managers do not beat the market in the long term. There are exceptions but the vast majority are not going to beat it. So outside of index based investing my options are very limited. If most hedge funds lose to the market, how am I going to beat it? Might as well just settle for index investing and balance my fixed/equity ratio. No time wasted and in the long run most likely will come out ahead.
zalzane 12y ago
why does buffet suggest 10% in short-term gov bonds? is it a security/diversity thing?
- thebear 12y ago
  Probably for liquidity, but I don't know for sure.
- akadien 12y ago
  That is probably another example of where his policy doesn't apply to most of us. My guess is that their is more than enough cash such that 10% in short-term gov bonds would throw off sufficient income for his wife to live very comfortable while the 90% in the equity index is most invested for growth of capital (even though it throws of dividends, too).
- saryant 12y ago
  I'm not sure about Buffet's advice, but John Bogle (founder of Vanguard) recommends bonds so that you can rebalance your portfolio to your desired asset allocation when stocks are down by simply selling some bonds to free up capital. So if you have 90% stocks and 10% bonds but the market takes a dive and now you're at 80%/20%, you can sell enough bonds to bring you back to a 10% bond allocation and use those funds to buy more stocks.
akadien 12y ago
This article does not address Warren Buffett's advice at all. Instead, it compares two target date funds, one active and another indexed. Not really apples to apples.
dsrguru 12y ago
This read much more like an advertisement for GreaterThanZero's services than an article whose conclusion actually addresses the title's question, but the author seemed to do a good job accounting for the differences between Warren Buffet's estate and a regular, living person's money (namely that the person sometimes needs to spend it). Actually, come to think of it, I don't think the author explained why Buffet's estate should be treated as if withdrawals will never be made from it, but I assume it's because the 10% of his money that will go into short term savings bonds is still a ridiculous amount of money and should be sufficient to cover any expenses in the foreseeable future.
ChristianMarks 12y ago
MarketRiders has been providing similar advice to invest in low load index funds and EFTs for some time [1]. The real issue is that if you are paying 2% fees or if the account is being churned (or both), you're getting screwed. Suggestion: show all calculations. 1. http://marketriders.com http://marketriders.com
WalterBright 12y ago
My father once told me that the secret to successful stock market investing was to start investing a long time ago. It's not as trite as it sounds - what he meant was start investing as a young man, and keep adding to it.
- wikwocket 12y ago
  Like the old proverb: "The best time to plant a tree is 20 years ago. The second-best time is now."
tempestn 12y ago
If you're going to invest in index funds (and you should), don't pick the S&P 500. Why invest in 500 stocks when you could use the vanguard total market index instead, and invest in essentially the entire US market, with a management fee of 0.05% per year? Also, there's no need to take on unnecessary risk by concentrating investments in the US. Better to put a good portion in a broad ex-US fund as well. Vanguard has a good option there too, of course, but there are certainly others as well. Also, if like me you're outside of the US, these all come in ETFs that can be bought anywhere and have similarly low fees.
- thebear 12y ago
  Indeed, investing in just the S&P 500 would be an example of poor diversification: you'd limit yourself to US large cap stocks. By recommending the S&P 500, Warren Buffet is saying, implicitly, that he believes in US large caps to the extent that he does not even want to diversify.
  - tempestn 12y ago
    I would give him the benefit of the doubt and assume he was simply picking an index everyone has heard of. But regardless, yes, it would be poorly diversified.
Lightbody 12y ago
Worth calling out: if your money isn't tax sheltered (IRA or 401k) then an index fund will be worse than buying those individual stocks. That's because with individual stocks you can sell the losers from time to time, buy a similar replacement (ex: Coke for Pepsi) to avoid the wash rule, and harvest a bunch of capital losses to offset future gains. Proper tax management is a HUGE part of this and is almost always overlooked in these kinds of articles.
- JeffL 12y ago
  Doesn't that assume that you have enough money to properly diversify without the transaction costs being too much as a percentage? If you are going to buy 500 stocks to get the same diversity, then at $10 per trade fee, that's a lot of money. Seems like for most people, there would be a tax management/diversity trade off. I would think that a combination of individual stocks and index funds would probably be good for most people.
- cperciva 12y ago
  if your money isn't tax sheltered (IRA or 401k) then an index fund will be worse than buying those individual stocks. ... as long as you're handling sufficiently large amounts of money that you don't lose the difference on trade commissions. Rebalancing my ETF portfolio costs me $60 (6 ETFs, $10/trade), but rebalancing a portfolio consisting of the 2000 individual stocks and bonds in those ETFs would be insane.
  - Lightbody 12y ago
    Absolutely right. It helps that you don't really need all x000 stocks since a diversified subset (say 100) will be very close to index performance and still yield the harvesting benefit.
  - jordanthoms 12y ago
    You may want to look at Vanguard as a broker - trading Vanguard ETFs through them is free.
- thebear 12y ago

47 points by thebear 12y ago

thrush 12y ago

Was a bit difficult to parse at first glance. Was the answer in favor Buffet's advice?

diogenescynic 12y ago
Yes, Buffett's advice gained $9,309 more over a 5-year period.
- lsc 12y ago
  Heh. The first thing you learn when you back-test stock-trading algorithms is "Give me any investing strategy, and I will find you a five-year period where it does well." Which isn't to say that I think you can outperform index funds... I don't; but the answer, it looked to me, was 'sign up for the GreaterThanZero web app and run the model yourself.'
  - diogenescynic 12y ago
    Agreed, but in this case it looks like he was responding to Buffett's quote: >My advice to the trustee couldn’t be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard’s.) I believe the trust’s long-term results from this policy will be superior to those attained by most investors—whether pension funds, institutions or individuals—who employ high-fee managers. Then he compared his 401k results with the Vanguard Target 2040 fund. Seems pretty straightforward.

themartorana 12y ago

Companies come and go, especially tech stocks and whatnot. Buy a single share of the DJIA at 13k in 2007, see it drop to 8.5k, wait a couple of years and - wait - it's at 16,500. It's a 27% return in 6 years, which isn't great, but considering the crash, you're still up. That said, I don't know much about investing. But index funds seem to me (completely useless when it comes to investing) one of the safer bets if I'm going to be in the market at all.

Consultant32452 12y ago
The reason why index funds are better is because they're generally managed by a very simple computer algorithm which means very very low fees compared to actively managed funds. If you look over the lifetime of someone's 401k it's really shocking how much is eaten up in fees. Also, over long periods of time you're generally not going to beat the market. What you pointed out about the DJIA having lots of fluctuation, particularly during crashes, is why it's important to keep investing a little every paycheck. That way when stocks are low you're buying more shares. It's a sale!

leorocky 12y ago

I'm not sure the post ever answers the question given in the title. It gets very detailed, but it's a pretty muddled, unclear answer at best about something related to benchmarks.

pcrh 12y ago
Here's a comparison between Berkshire Hathaway and Vanguard for the past 10 years: https://i.imgur.com/yHVY0qP.png https://i.imgur.com/yHVY0qP.png (data from morningstar.com). Overall, very similar, but if you went in and out of the funds at different times you might have had a different net result.

infecto 12y ago

Article did not have a very clear answer. Its more powerful to look at the alternative to index investing. First of all lets be clear that true index investing balances your equity/fixed portfolio based on age or some risk profile. As for alternatives, close to all money managers do not beat the market in the long term. There are exceptions but the vast majority are not going to beat it. So outside of index based investing my options are very limited. If most hedge funds lose to the market, how am I going to beat it? Might as well just settle for index investing and balance my fixed/equity ratio. No time wasted and in the long run most likely will come out ahead.

zalzane 12y ago

why does buffet suggest 10% in short-term gov bonds? is it a security/diversity thing?

thebear 12y ago
Probably for liquidity, but I don't know for sure.
akadien 12y ago
That is probably another example of where his policy doesn't apply to most of us. My guess is that their is more than enough cash such that 10% in short-term gov bonds would throw off sufficient income for his wife to live very comfortable while the 90% in the equity index is most invested for growth of capital (even though it throws of dividends, too).
saryant 12y ago
I'm not sure about Buffet's advice, but John Bogle (founder of Vanguard) recommends bonds so that you can rebalance your portfolio to your desired asset allocation when stocks are down by simply selling some bonds to free up capital. So if you have 90% stocks and 10% bonds but the market takes a dive and now you're at 80%/20%, you can sell enough bonds to bring you back to a 10% bond allocation and use those funds to buy more stocks.

akadien 12y ago

This article does not address Warren Buffett's advice at all. Instead, it compares two target date funds, one active and another indexed. Not really apples to apples.

dsrguru 12y ago

This read much more like an advertisement for GreaterThanZero's services than an article whose conclusion actually addresses the title's question, but the author seemed to do a good job accounting for the differences between Warren Buffet's estate and a regular, living person's money (namely that the person sometimes needs to spend it). Actually, come to think of it, I don't think the author explained why Buffet's estate should be treated as if withdrawals will never be made from it, but I assume it's because the 10% of his money that will go into short term savings bonds is still a ridiculous amount of money and should be sufficient to cover any expenses in the foreseeable future.

ChristianMarks 12y ago

MarketRiders has been providing similar advice to invest in low load index funds and EFTs for some time [1]. The real issue is that if you are paying 2% fees or if the account is being churned (or both), you're getting screwed. Suggestion: show all calculations. 1. http://marketriders.com http://marketriders.com

WalterBright 12y ago

My father once told me that the secret to successful stock market investing was to start investing a long time ago. It's not as trite as it sounds - what he meant was start investing as a young man, and keep adding to it.

wikwocket 12y ago
Like the old proverb: "The best time to plant a tree is 20 years ago. The second-best time is now."

tempestn 12y ago

If you're going to invest in index funds (and you should), don't pick the S&P 500. Why invest in 500 stocks when you could use the vanguard total market index instead, and invest in essentially the entire US market, with a management fee of 0.05% per year? Also, there's no need to take on unnecessary risk by concentrating investments in the US. Better to put a good portion in a broad ex-US fund as well. Vanguard has a good option there too, of course, but there are certainly others as well. Also, if like me you're outside of the US, these all come in ETFs that can be bought anywhere and have similarly low fees.

thebear 12y ago
Indeed, investing in just the S&P 500 would be an example of poor diversification: you'd limit yourself to US large cap stocks. By recommending the S&P 500, Warren Buffet is saying, implicitly, that he believes in US large caps to the extent that he does not even want to diversify.
- tempestn 12y ago
  I would give him the benefit of the doubt and assume he was simply picking an index everyone has heard of. But regardless, yes, it would be poorly diversified.

Lightbody 12y ago

Worth calling out: if your money isn't tax sheltered (IRA or 401k) then an index fund will be worse than buying those individual stocks. That's because with individual stocks you can sell the losers from time to time, buy a similar replacement (ex: Coke for Pepsi) to avoid the wash rule, and harvest a bunch of capital losses to offset future gains. Proper tax management is a HUGE part of this and is almost always overlooked in these kinds of articles.

JeffL 12y ago
Doesn't that assume that you have enough money to properly diversify without the transaction costs being too much as a percentage? If you are going to buy 500 stocks to get the same diversity, then at $10 per trade fee, that's a lot of money. Seems like for most people, there would be a tax management/diversity trade off. I would think that a combination of individual stocks and index funds would probably be good for most people.
cperciva 12y ago
if your money isn't tax sheltered (IRA or 401k) then an index fund will be worse than buying those individual stocks. ... as long as you're handling sufficiently large amounts of money that you don't lose the difference on trade commissions. Rebalancing my ETF portfolio costs me $60 (6 ETFs, $10/trade), but rebalancing a portfolio consisting of the 2000 individual stocks and bonds in those ETFs would be insane.
- Lightbody 12y ago
  Absolutely right. It helps that you don't really need all x000 stocks since a diversified subset (say 100) will be very close to index performance and still yield the harvesting benefit.
- jordanthoms 12y ago
  You may want to look at Vanguard as a broker - trading Vanguard ETFs through them is free.
thebear 12y ago