Index vs. Managed

[not_so_new]

Hi gang

So I am not looking for "investment" advice exactly (not trying to break any rules, sorry if this post does).

I am switching jobs voluntarily and I have a pretty good chunk of money coming from vacation time (6 weeks) and some other stuff so I am going to get into the market a little heavier.

I don't want to lose my money but this extra money is not something I need to survive on right now. I can safely afford to do some investing and I don't mind being a little aggressive (which is the point, index funds seem pretty conservative..... not that this is a bad thing).

If "0" is the average non-investment citizen and "10" is a money manager I would say I am probably a 1 or maybe a 1.5. I know a few things about the markets and one of the things I know is that I don't know much (something I will strive to not forget). Another thing I also know, past performance is no indication of future results.

:)

The question is, for long term growth is it better to go with something like an index fund that isn't going to grow beyond the market or a managed mutual fund that has higher fees?

I am in it long term, I will probably keep it in the markets for retirement 20 to 25 years or so. It seems like, over the long haul the lower return on an index fund overtakes the higher returns of a managed mutual fund because of the fees?

Originally I was going to go with Fairholme but now I am thinking an index fund based on the S&P because I don't see things continuing on this trend, there are just too many undervalued companies out there.

Thanks for reading....

[drkitten]

The question is, for long term growth is it better to go with something like an index fund that isn't going to grow beyond the market or a managed mutual fund that has higher fees?

The managed fund will almost certainly not grow beyond the market, either -- especially over the long run. The number of mutual fund managers who have managed to beat the market for twenty years running can be counted comfortably on the fingers of one hand, and by your own admission, you don't know who they are. (Of course, no one knows who they are --- but a lot of people delude themselves into thinking they do.)

So go with the index fund.

[not_so_new]

The managed fund will almost certainly not grow beyond the market, either -- especially over the long run. The number of mutual fund managers who have managed to beat the market for twenty years running can be counted comfortably on the fingers of one hand, and by your own admission, you don't know who they are. (Of course, no one knows who they are --- but a lot of people delude themselves into thinking they do.)

So go with the index fund.

Thanks... kind of what I was thinking.

That is the point, it really looks like over the long haul most managed funds don't seem to do much better than the market and their fees lower the returns to the point that it's actually less than market.

So, from what I gather with index funds it's mostly a set it and forget it sort of thing right? Just put the money into a fund that looks solid (something like Fidelity, T. Rowe Price or E-Trade) then pick your poison (Wilshire, S&P whatever)?

Also, on a risk scale of 1 - 10 (1 being really safe - 10 being way out there) an index fund would probably be considered pretty conservative right? Not really high yield but pretty comfortable.... where in the scale would that be?

Thanks again Doc.

[drkitten]

Thanks... kind of what I was thinking.

That is the point, it really looks like over the long haul most managed funds don't seem to do much better than the market and their fees lower the returns to the point that it's actually less than market.

Yup.


So, from what I gather with index funds it's mostly a set it and forget it sort of thing right? Just put the money into a fund that looks solid (something like Fidelity, T. Rowe Price or E-Trade) then pick your poison (Wilshire, S&P whatever)?

Sort of. There's still the asset-allocation problem that you need to deal with. If you pick a small-cap index fund, for example, then you're probably in for a wilder ride than if you pick a large-cap fund -- and if you want a really smooth ride, then you probably want to pick both (and split your eggs among two baskets).

And depending upon your style, you may want to periodically re-adjust your asset mix. But if you just want a set-and-forget investment (which I do not generally recommend), then an index fund is one of the best/safest.

[bpesta22]

If you got 25 years, why not put some in real estate funds?

I had all my money in large caps til the crash, but I didn't sell. Instead, I switched all the new money going in 100% to real estate.

I figure the shares are cheap and the market will rebound, and if it doesn't, we got more to worry about than how we'll fund our retirement.

I suspect on a 1-10 scale of risk, I'm a 10.

You may also get better returns (or losses!) by focusing on a few stocks-- versus index crap. Perhaps pick some dow components you think are oversold buy / hold / get some dividends.

[Puppycow]

I think now is a great time to invest if you are investing for the long term. Not too much, a little bit each month. Stocks are already cheap but they might get cheaper. You can't predict the bottom so just buy an even amount each month. This is my current strategy. I've been investing each month for the last year, and I am losing a lot of money in the short term, but I'm sticking with it.

[Francesca R]

Index tracking equities aren't particularly conservative in any absolute sense, no. The spectrum runs from t-bills --> government bonds --> other bonds --> developed equities --> emerging market debt --> real estate --> emerging equities --> private markets (give or take).

Index funds are really only conservative relative to the indexes they track.

(However there are good reasons to believe that all the safe stuff is highly over-valued now which means it may lose a lot of value, just in an orderly non-risky way)

[not_so_new]

Thanks all, very helpfully.

Francesca, that makes sense and that has always been the way I thought of it (nice to see that I had that right in my head for the most part thanks).

As I said, I am not really looking for "conservative" because this is outside of the retirement money I am already investing and it's money that I can park and forget about.

As far as "private markets" go index funds are about the most boring I would assume right? I guess what I am saying is I am willing to take a little gamble for some higher returns but I don't want to be hanging it out on the cliff either.

Bonds are just way to safe for me and with the way things are going they might not be as secure as they once were? You never know what company that should be fine is going to take a dive right? I guess the same thing could be said about index funds though.

And I understand, like drkitten said nothing is really set it and forget it but I also don't have time to look into my investments every day or even every week.

It seems like bpesta22 is thinking what I have been, I think there might be an overcorrection in real estate right now but I have been too worried to get into it. Right now it seems as if the normal risk line that Francesca pointed out might be a little up side down, real estate might be the most risk right today perhaps?

Just thinking out loud, anyone who wants to join in please do. I am going to see my financial adviser next week and I want to approach her with some of my ideas to build a strategy.

Thanks again all.

[Francesca R]

By "private markets" I mean venture/LBO and other debt financed investment into non-public equity. It locks you in for extended periods and introduces a lot of issues not encountered in public equity such as vintage-year concentration and illiquidity premium. It is hard to get access to this in retail space but there may be some 40-act type of vehicles in the US that have a small allocation to it. Don't really know.

For real estate I tend to think of REITS with the underlying in office, industrial and retail (IE not "houses"). Commercial property in the UK has tanked really hard. Not so bad in the US yet.

[jimtron]

not so new, you might be interested in checking out the Boglehead's Forum (http://www.bogleheads.org/forum/index.php), if you haven't already. These are folks who follow the investment approach of John Bogle, the founder of Vanguard.

Here it is in a nutshell: http://www.bogleheads.org/wiki/index.php/Vanguard%27s_Investment_Philosophy

And here's a thread about creating a portfolio with only three or four funds:
http://www.bogleheads.org/forum/viewtopic.php?t=10413

P.S. I have no connection to Vanguard or the Boglehead forum, but this approach seems sensible to me.

[not_so_new]

By "private markets" I mean venture/LBO and other debt financed investment into non-public equity. It locks you in for extended periods and introduces a lot of issues not encountered in public equity such as vintage-year concentration and illiquidity premium. It is hard to get access to this in retail space but there may be some 40-act type of vehicles in the US that have a small allocation to it. Don't really know.

LOL... as I said, in a scale of 0 - 10 I am lucky if I am a 1 ish..

:D

Thanks, that makes sense now.

For real estate I tend to think of REITS with the underlying in office, industrial and retail (IE not "houses"). Commercial property in the UK has tanked really hard. Not so bad in the US yet.

It does seem to be holding up here in the US so far but time will tell.

Thanks again Francesca!

[not_so_new]

not so new, you might be interested in checking out the Boglehead's Forum (http://www.bogleheads.org/forum/index.php), if you haven't already. These are folks who follow the investment approach of John Bogle, the founder of Vanguard.

Here it is in a nutshell: http://www.bogleheads.org/wiki/index.php/Vanguard%27s_Investment_Philosophy

And here's a thread about creating a portfolio with only three or four funds:
http://www.bogleheads.org/forum/viewtopic.php?t=10413

P.S. I have no connection to Vanguard or the Boglehead forum, but this approach seems sensible to me.

Thank you Jim.

The more info the better... well until my head explodes. :shocked:

:p

I am still going to be working with my adviser before I do anything but, as I said I really want to know what my options are so I have a few ideas heading into this based on my risk tolerance.

That is a great link, lots of info. Thanks again.

[jimtron]

You're welcome!

From the John Bogle Wikipedia article, his investment strategy:

Bogle is famous for his insistence, in numerous media appearances and in writing, on the superiority of index funds (http://en.wikipedia.org/wiki/Index_fund) over traditional actively-managed mutual funds (http://en.wikipedia.org/wiki/Mutual_funds). He believes that it is folly to attempt to pick actively managed mutual funds and expect their performance to beat a well run index fund over a long period of time.
Bogle argues for an approach to investing defined by simplicity and common sense. Below are his eight basic rules for investors:


Select low-cost funds
Consider carefully the added costs of advice
Do not overrate past fund performance
Use past performance to determine consistency and risk
Beware of stars (as in, star mutual fund managers)
Beware of asset size
Don’t own too many funds
Buy your fund portfolio – and hold it



I used to think Motley Fool was a good site for investment advice, but I've since lost faith in them. Bogle seems very rational and pragmatic, and his Vanguard funds seem to often be very highly rated by independent sources.

[The Central Scrutinizer]

Hi gang

So I am not looking for "investment" advice exactly (not trying to break any rules, sorry if this post does).

I am switching jobs voluntarily and I have a pretty good chunk of money coming from vacation time (6 weeks) and some other stuff so I am going to get into the market a little heavier.

I don't want to lose my money but this extra money is not something I need to survive on right now. I can safely afford to do some investing and I don't mind being a little aggressive (which is the point, index funds seem pretty conservative..... not that this is a bad thing).

If "0" is the average non-investment citizen and "10" is a money manager I would say I am probably a 1 or maybe a 1.5. I know a few things about the markets and one of the things I know is that I don't know much (something I will strive to not forget). Another thing I also know, past performance is no indication of future results.

:)

The question is, for long term growth is it better to go with something like an index fund that isn't going to grow beyond the market or a managed mutual fund that has higher fees?

I am in it long term, I will probably keep it in the markets for retirement 20 to 25 years or so. It seems like, over the long haul the lower return on an index fund overtakes the higher returns of a managed mutual fund because of the fees?

Originally I was going to go with Fairholme but now I am thinking an index fund based on the S&P because I don't see things continuing on this trend, there are just too many undervalued companies out there.

Thanks for reading....

I'd buy the DJIA Index.

[drkitten]

I'd buy the DJIA Index.

Why DJIA?

It seems (to me) to be both more volatile than some indicies with larger baskets, and my understanding is that small-cap indices tend to give better returns than larger-cap. If you can get them both for the same management fee, I would expect small-cap to outperform over the next multi-decade period.....

[andyandy]

Personally I would only use a managed fund if I was planning to pay in a set amount each month, because if you are doing that as a private investor dealing costs are going to eat up a big chunk of your capital. If you have a big chunk of money you want to invest on a long-term buy and hold then you may as well track an index and save on commission fees.

I've only started investing for the last six months (only small-time :)), using both a self select Isa where I choose my own investments, and also paying a small amount each month into a managed fund. Currently both are down around 10%, so I'm doing as well as (or as badly as) the professionals. :)

[not_so_new]

Personally I would only use a managed fund if I was planning to pay in a set amount each month, because if you are doing that as a private investor dealing costs are going to eat up a big chunk of your capital. If you have a big chunk of money you want to invest on a long-term buy and hold then you may as well track an index and save on commission fees.

I've only started investing for the last six months (only small-time :)), using both a self select Isa where I choose my own investments, and also paying a small amount each month into a managed fund. Currently both are down around 10%, so I'm doing as well as (or as badly as) the professionals. :)


LOL

Pretty funny. I can see the headlines now, "You too can earn like the professionals in the markets."

So is this a good idea? I will be doing one large chunk now (well "large" is a relative term) and then probably like $1000 a month from here on out. Small potatoes for most but I don't want to lose it if I can help it and I would like it to grow at the best rate obviously.

Is it better to do a managed fund if I am reinvesting per month?

[bpesta22]

LOL

Pretty funny. I can see the headlines now, "You too can earn like the professionals in the markets."

So is this a good idea? I will be doing one large chunk now (well "large" is a relative term) and then probably like $1000 a month from here on out. Small potatoes for most but I don't want to lose it if I can help it and I would like it to grow at the best rate obviously.

Is it better to do a managed fund if I am reinvesting per month?

Are you in the USA-- if so, have you first maxed out your 401k (if you have one). It would make more sense to put that 1k a month in there as it's pre-tax and maybe employer matched up to some %.

[Francesca R]

Is it better to do a managed fund if I am reinvesting per month?I don't see what difference that makes. You pay the same fees on every penny invested regardless so phased investing doesn't change the active versus passive decision at all as far as I can see.

[grunion]

I agree with the consensus here. First off, minimize the tax implications of your investments, that is another kind of "fee" that will just skim any possible gains you make, both short and long term. That means taking advantage of 401K, Roth, 529, and other IRA terms. Then, unless you feel very confident in one particular company or sector, look at no load funds that are well diversified. I wouldn't go with DJIA, pick a broader index.

No sense paying either the IRS or some fund manager (whose strategy may or may not coincide with yours) vig on your money year after year.

[Francesca R]

Tax advantage or not, pension saving is fundamentally different in that you can't get the money back until some designated retirement age, and you also bear legislative (regulatory) risk on what the prevailing government might do with the rules in that interval.

[roger]

So is this a good idea? I will be doing one large chunk now (well "large" is a relative term) and then probably like $1000 a month from here on out. Small potatoes for most but I don't want to lose it if I can help it and I would like it to grow at the best rate obviously.Not really. If you are buying ETFs, you just have to pay the brokerage costs. Discount brokers can make that just $3-4 dollars a pop. If you have enough money in your account, you can even buy for free. In contrast, it is free to put money in a mutual fund, but they usually have lock up periods. If it is a managed fund, then you are paying fees on top of that. If you are doing $1000/month, your brokerage costs will be around 0.3-0.7% of your investments. You're lucky to get buy with 1% fees in managed funds, and that's yearly, not a one time expense.

If you are talking ETF vs an index fund, then look at the expenses for each. Realistically, in either case you are only talking chump change for fees.

[roger]

Tax advantage or not, pension saving is fundamentally different in that you can't get the money back until some designated retirement age, and you also bear legislative (regulatory) risk on what the prevailing government might do with the rules in that interval.Here, here, Francesca. I saved and saved and saved, and then wanted to buy a house (a financially reasonable thing to do). Government say "no, we know better than you, you can't have your money without paying us a huge penalty".

So it sat there, went through a market crash, and I still can't touch it to put it in investments that I really want to.

[Francesca R]

Yes I'd love to be buying an annuity right now (which is what you are compelled to do with the majority of your stash in this country when a pension matures) what with nominal and real gilt yields on the floor and the Bank keeping them there with its seventy-quantitative-five-easing-yards.

Personally I under-save into retirement vehicles for this reason. (NOT investment advice)

[roger]

Also, they are not tax free, just tax deferred. Do you anticipate more or less income when you are retired? It could easily be more if you have been investing for the last 40 years. I personally expect my investing to supplant my salary. And what are the tax rates going to be when you retire? Who knows? You could end up with less income, but more taxes.

I used to invest the maximum allowed under law, but no more. But you have to make your own assumptions about performance of your investments vs whatever is available in your 401K, tax rates X years into the future, do DCF of the current taxes you pay, etc. 401Ks make a lot of sense for some situations, but it is by no means a slam dunk, IMO.

[Francesca R]

Agreed the only advantage of tax deferral is if your effective rate is lower later. Pension saving used to be exempt from ACT (dividend tax) but that was torpedoed by the current government rather early in my working life.

And who are we kidding--everyones tax rate will be 50% plus in a few years and indefinitely thereafter, to pay for the current cleanup.

(Still not inv adv)

[grunion]

I agree with those opinions. My point was for long term strategies, tax advantages should be factored in as part of the earnings. If it could get you into a lower tax bracket now when you're raking in the dough it could be worth some of the restrictions you mention. When you retire and draw the money out you won't be making as much so the tax won't be as painful, one expects. And in a lot of companies, 401K contributions also give you free money.

I also have taken a bath with a lot of the money I have not been allowed to touch. My kids' college funds are now worth quite a bit less than the cash I put into them, sigh. Would it make more sense to have never opened the 529s at all? Maybe. Maybe I would be more likely to get some financial aid when the time comes if I don't have any assets put away for that. But I really had hopes that my kids wouldn't have to rely on the vagueries of financial aid when it came time to pay for college - that it would be a combination of scholarships that they earned due to their sheer brilliance and the shrewd financial planning of their dad. But so much for that plan. Since I'm laid off now I have to stop socking away that money every month anyway.

I like to think it would have done better under my direct control but who knows. I'm not much of a trader.

[not_so_new]

I like to think it would have done better under my direct control but who knows. I'm not much of a trader.

Me either.....

The problem I have with a 401k is the fact that I have to tie the money up for a long period like Francesca said.

I am in it for the long haul but if something happens with my job I want to be able to take the money back out to live on. I know that I might lose some, most or all of it if the markets keep going south but if I need it in a pinch I want to get to it without penalties.

Still seems like index funds are the way to go for me.... I think.... :confused:

[andyandy]

I don't see what difference that makes. You pay the same fees on every penny invested regardless so phased investing doesn't change the active versus passive decision at all as far as I can see.

Well for example, if you just put a lump sum in an index tracker you might be paying 0.5% management fee. For a managed fund it might be 1.5%. But if you are personally investing into your own portfolio for each month you are also going to have to factor in dealing charges. Let's say these are £10 per transaction. If you are putting less than £1000 a month then this is going to eat up more than 1% in additional charges. So if you wanted to simply drip feed a few hundred pounds on a monthly basis you would be better off with a managed fund where all your dealing costs are wrapped up in their management fee.

[The Central Scrutinizer]

Why DJIA?

It seems (to me) to be both more volatile than some indicies with larger baskets, and my understanding is that small-cap indices tend to give better returns than larger-cap. If you can get them both for the same management fee, I would expect small-cap to outperform over the next multi-decade period.....

30 stocks is a large enough basket for me.

I don't know about which other indices might outperform it. I'd have to look into that. I'd be surprised if many indices outperformed it over any 20 year period.

[bpesta22]

Some pension plans let you borrow money at very low interest rates.

Is the penalty for early withdrawal 10%? That seems steep, but how does it compare to investing after tax money in a non-qualified plan?

If your tax rate's 15%, wouldn't that be 1-.15 less buying power for every dollar self invested versus put into a 401k? Plus, the self invested money gets taxed again if the investment increases in value. Plus, if there's an employer match, one is throwing away money by not investing up to that match in the 401k.

Also, I think the comment made above that the 401k reduces the current year's income (and therefore taxes) is an overlooked point.

[roger]

Well, I can borrow from mine, and the interest I pay goes back to me. In fact, that's part of how I paid for my house. But, of course, the government is telling me what to do. Right now cash flow is tight - I'd rather not be paying back that money (even though the market is so low it is in general great that I cashed out when the market was high, and am buying back in at 50% lower). But big brother knows better.

The penalty for early withdrawal is on top of taxes. So you are going to be paying high taxes (you sold, and will have to report that as capital gains), plus the extra penalty.

Like I said, you have to run the calculations. My employer puts in 6% no matter what I put in. It almost always makes sense to match your employer, if they do matching funds. But you have to figure it out. being forced to buy craptacular mutual funds with 2.5% management fees and a 5% front load vs being allowed to make your own buys, or index funds are two very different scenerios.

For me it makes sense not to max out my 401K, based on broad assumptions. As always, those assumptions could prove to be wrong. For another person the 401K is the best thing going. For another person personal investing would be better, except they keep taking the money out to buy boats and other toys (the big reason for all the 401K rules in the first place - big brother 'protecting' you). That person should probably also invest in their 401K.

But you have to figure it out for your situation. Write up a spreadsheet, plug in some numbers, see where you end up at retirement based on different assumptions.

[Francesca R]

But you have to figure it out. being forced to buy craptacular mutual funds with 2.5% management fees and a 5% front load vs being allowed to make your own buys, or index funds are two very different scenerios.Erm, yikes. Charges like that on pension contributions through a work-sponsored scheme are a shockingly horrendous deal. I hope that was hypothetical. It is more common for OEICS with a company's pension wrapper to be free of all fees in my experience.

[Francesca R]

Well for example, if you just put a lump sum in an index tracker you might be paying 0.5% management fee. For a managed fund it might be 1.5%. But if you are personally investing into your own portfolio for each month you are also going to have to factor in dealing charges.Eh? Now your talking about three options including self-selection. I think the question was whether a managed fund was better than a passive fund for regular phased contributions, but not for a one-time investment. To which the answer seems to be that the entry timing does not affect the comparison. (Does it?)