Learning how to do anything the smart way is beneficial, and when it comes to investing, this stands especially true. Many people have tried their hand at investing everything from stock and bonds to real estate and other such illiquid assets.
Index or passive investing as it is sometimes referred to, is not necessarily a new way to invest, but it does seem to be more of an effortless way to invest. The general idea of it requires investors to invest in a few (three, four or five) low-cost mutual funds or exchange-traded funds also known as EFTs. The term ‘index funds’ are referred to this way because they are funds that are intended for wide diversification, which, if all goes well, means you as the investor will earn higher returns than others who spend their days seeking hot-stocks.
This way of investing, however, is not necessarily less expensive. It still requires a financial advisor, for which you will be required to pay an annual fee on top of the management fee (usually around 2.5 per cent). Indexing is by no means a ‘get rich quick’ scheme.
The concept is that inexpensive index funds have the potential to out-earn larger money managers. Over the last five years, Standard & Poor’s have continually concluded that approximately 89 per cent of actively managed large US funds didn’t make the mark on their S&P 500 index, while in Canada, 93 per cent of the equity funds did not keep up with S&P’s index. For this reason, many would agree that the proof is in the numbers.
Many investors feel that it is a waste of money to simply pay someone else to watch and chose mutual funds and stocks for you, especially as this is something you can do yourself. Many do not believe that investment advisors can beat the markets with any more (or less) luck than you can. It’s like hiring a plumber to turn on the tap and then paying him the extra fees for the water it allows the spigot to disperse. This process can go on year after year. Switching over to index funds as a way of investing may be a better choice for those who want to start smaller or even for those who are open to a new way of investing. It takes time, but those who do their investing this way swear by the results, and the savings.