Why I Don’t Like Investing in Index Funds?

One of the key suggestions that many people suggest is to put your money consistently in an index fund and watch your money grow over time. One example of such an index fund would be the S&P 500. The average return of S&P 500 historically has been around a 10 percent rate of return. More recently the average return of the S&P has been around 8 percent. The suggestion of putting your money in an index fund is often times given because the common theory is that an individual is not likely to beat the S&P 500. Most times an individual doesn’t have the correct temperament to beat an index fund. A lot of times individuals work with the crowd and buy at the wrong time or sell at the wrong time. These mood swings of the individual investor makes it such that it’s often times recommended to just invest in an index fund.

While the investment advice of consistently investing in an index fund such as the S&P is sound advice, it also has one major flaw. The major flaw in the advice to invest in an index funds is that an individual that invests in an index fund has to concede that they are not able to beat the S&P over long periods of time. In other words one has to concede that they are happy with just being average. Another way of putting this is that a person who concedes to investing in an index fund has zero opportunity of having an above average return in the stock market. The difference in being average and being above average from a stock market return perspective is huge. A person that is average in the stock market doubles approximately every 7 years. A person that is above average and doesn’t buy index funds can double every 2.5 to 5 years.

Let’s look at the following example below:

Joe invests 10k in the S&P Index at a 10 percent rate of return. Joe also adds $275 every month consistently

After 20 years Joe will have approximately 265k dollars

Malcolm invests 10k in his own self created portfolio at an above average 20 percent rate of return. Malcolm also adds $275 every month consistently.

After 20 years Malcolm will have approximately a little more than 1M dollars. Meanwhile, Joe has a respectable 265k dollars.

The simple decision by Malcolm to not concede to being average made it such that Malcolm has made 785k dollars more than Joe in 20 years. Both Joe and Malcolm invested a total of 76k over a 20 year period but Malcolm vastly outperformed Joe by choosing not to be average. In fact by the time that Joe does finally make it to the 1 million dollar mark 13 years later, Malcolm is now at 11 million dollars. They both invested the same initial amount and both continued to invest the same monthly amount. The only difference here is that right up front Joe conceded to being average by investing in an index fund while Malcolm did not. Malcolm hand picked his own stocks, essentially created his own basket of stocks and held them for long periods of time. The decision to not invest in index funds made it so that Malcolm doubles every 3 to 4 years while Joe doubles ever 7 years.

The flip side of this story is that for every Joe and Malcolm in the stock market there is a David. David also invests in the stock market for 20 years but David jumps in and out of the stock market, never really commits to long term investing and after 20 years either he makes nothing, loses money, or doubles at a much slower rate of return than Joe. The David’s of the world is the primary reason that a lot of people including Warren Buffett recommend that individual investors invest in index funds. Warren Buffett himself though knows its better to be Malcolm. Buffett only plans to put money in an index fund upon his own death.

There is no or very limited circumstances where right up front I will concede to being average. Average is not that great of a word. Lets always try and be above average. Let’s be Malcolm. The Malcolm method of investing is the method that I personally used to get into the black 2 percent. Had I used Joe’s method of index investing I would have conceded hundreds of thousands of today’s dollars and millions of future dollars by agreeing up front to be average. Every time we agree to be average up front we are potentially giving up a huge part of our future. This is the primary reason why I do not like investing in Index funds and have never done it with the exception of 401k’s where one is given limited options. Know yourself and determine which method Malcolm or Joe works for you. Try not to spend too much time being David.

Malcolm Investing Definition

An investor in the stock market who does not invest in index funds and averages above average returns over a long period of time. A Malcolm investor buys individual stock and creates their own basket of stock holdings over time. Malcolm investors use a buy and hold strategy. Malcolm Investing is an aggressive form of investing.

Readers:

Do you invest in the stock market? Are you Malcolm, Joe, or David thus far in your investing career. What are some of the reason you have chosen your particular investment strategy?