Index Funds

[Sheik]

Hopefully someone here with a degree in Economics or something can help me.

I am in high school and am looking to invest long term. I have discovered Index Funds and they seem very promising. Because the market on average gains roughly 10% - 11% a year and because Index Funds cover a whole bunch of companies they seem like a great investment. The two index funds that I have been looking at are Vanguard 500 Index (VFINX) and the Vanguard Value Index (VIVAX). Both these funds seem to have done poorly over the last year or two but I think they will go up and even if they continue to fail I have plenty of time to wait. So my questions are, Do these two funds look like decent investments? Is investing in Index Funds a god idea? And are there any good brokerages (hopefully ones with very low fees) to buy the funds from?

Thank You

[Kontiki]

A few random points:

1) There are many different index funds representing the many different indicies. You would need to decide which index you want to pin your hopes to (Dow Industrials, S&P 500, etc.). Personally, I'd say an index fund is a cop-out because you can often buy index participation units or just buy a basket of stocks that roughly (or exactly) mirrors a given index. This will save you from the management fees associated with funds.

2) For long-term growth propects (ie: retirement) you'd generally be better off with a growth or value fund of some kind (assuming you want to stay with funds at all). A well managed growth or value fund should outperform the general market.

3) With any fund, you need to have a decent manager. Look for someone who is well respected and has a good track record.

4) There is no one right way to invest, so specific advice is useless.

[MattyBoy]

I'm not legally qualified to advise you but...

If you want to choose between Vanguard 500 Index and Vanguard Value Index, you should expect the same long term returns from each, but more volatility from Value - so choose the 500. This is because value indices include a bias towards a particular style of stock, so they are less diversified than broad indices.

As for whether you should choose index or active managers, the question is "do active managers outperform enough to justify their higher fees?". This is a subjective question, but either way you go you must do all that you can to reduce the fees that you pay.

Personally, I doubt that US equity markets are inefficient enough to justify a premium of more than .4% per year for active (rather than index) managers.

Assuming you will leave this invested for a long time, I would go with say 70% Vanguard 500 (if low enough fees) and put the rest in global bonds and property somehow to provide some diversification.

[Adam Smith]

Broad-based index funds like the two you mentioned are a good way to invest in the market and still have a lot of diversification, which reduces risk. Vanguard is famous for having low management fees, which helps keep the money in your pocket instead of the management company's. You can buy Vanguard funds directly from the company (see www.vanguard.com), but you must be 18 years old to own any stock or mutual fund which buys stocks.

The growth of index funds is based on the premise that "you can't beat the market". It is pretty tough to beat the market, but some funds manage to. Take a look at Legg Mason Value Trust (LMVTX), which has beaten the S&P 500 eleven years running. The Clipper Fund (CFIMX) has a similarly impressive record. www.morningstar.com is a good site for general fund research.

The earlier you start investing, the easier it is to save for whatever goal you have in mind. With the time horizon you have the standard industry advice is to consider a more growth oriented fund, though growth funds have been doing pretty poorly lately. Whatever you invest in, it may be difficult to repeat the 10 percent per year average over the last few years. Eight percent would be pretty good these days.

Consider yourself fortunate that you have some money to invest at this stage in your life. Many people don't. Lastly, this advice is worth what you paid for it.

[Urban Ranger]

If you want to invest, do your homework and ignore people who show their faces on TV. Basically, do what Warren Buffet does. He follows two broad principles. He will buy in a company with these characteristics:

1. The stock has a good discount rate. That is, a stock that is underperforming.

2. The company has a good management team. Mainly you want operational people at the driver's seat, not financial types who play with various instruments but have no idea what the company actually do.

Buffet says he used to only follow one, but found out that, if a company has a bad management team, its stock might not go up as expected.

[Stuie]

Index funds are a good, stable investment. Make sure you're in it for the long term, though. If you're the type that wants to move money every time the market does something, look somewhere else.

There's lots of great info at vanguard.com explaining how to create an investment plan and such. Check it out and good luck!

[Hurricane]

Remember that the whole idea of index funds is that they follow the index no matter what happens. This means that the only way an index fund will outperform another index fund (not counting short-term volatility) is by being cheaper. Lesson: buy the index fund with the lowest costs.

[DanS]

"Lesson: buy the index fund with the lowest costs."

I would emphasize this. There is a surprising variation of costs for index funds. Everywhere from a small fraction of a percent for some S&P 500 funds up to 1% or more on some others.

Also, I agree with Adam Smith. 10-11% returns seems unrealistic at these prices. 8% or so is probably a more realistic goal.

[TCO]

Re: Index Funds

Originally posted by Sheik
Hopefully someone here with a degree in Economics or something can help me.

I am in high school and am looking to invest long term. I have discovered Index Funds and they seem very promising. Because the market on average gains roughly 10% - 11% a year and because Index Funds cover a whole bunch of companies they seem like a great investment. The two index funds that I have been looking at are Vanguard 500 Index (VFINX) and the Vanguard Value Index (VIVAX). Both these funds seem to have done poorly over the last year or two but I think they will go up and even if they continue to fail I have plenty of time to wait. So my questions are, Do these two funds look like decent investments? Is investing in Index Funds a god idea? And are there any good brokerages (hopefully ones with very low fees) to buy the funds from?

Thank You

Index funds are a good way to go. Look for high diversification (across sectors and countries if possible...or do it yourself by holding a couple indices). It sounds like you have lots of time, so I would weight your portfolio more towards common stocks and towards risk. You will suffere more volatility but over decades will be rewarded. Also, look VERY CAREFULLY at fees and loads and such. Oh...and tax implications.

[TCO]

Originally posted by Kontiki
A few random points:

1) There are many different index funds representing the many different indicies. You would need to decide which index you want to pin your hopes to (Dow Industrials, S&P 500, etc.). Personally, I'd say an index fund is a cop-out because you can often buy index participation units or just buy a basket of stocks that roughly (or exactly) mirrors a given index. This will save you from the management fees associated with funds.

The advantage is that transaction costs may be lower for a fund manager than for an an individual. Also, that your portfolio is kept in the index. Some people don't want to bother with that. And won't do it.

2) For long-term growth propects (ie: retirement) you'd generally be better off with a growth or value fund of some kind (assuming you want to stay with funds at all). A well managed growth or value fund should outperform the general market.

Market efficiency theory and emprical studies say that you will only be rewarded for higher beta (roughly volatility). Active management does not provide better returns on a risk adjusted basis. See the Journal of Finance.

3) With any fund, you need to have a decent manager. Look for someone who is well respected and has a good track record.

See comments to 2 above. Other than lookinf for honesty, don't worry too much about this aspect. Don't go to an active managed fund. In addition to the problems with market efficiency, active funds usually have higher transaction costs. You can always find some fund manager who got lucky last year or last 5 years, but as a group they won't do better than the market, and last years performance has no correlation with this year's.

4) There is no one right way to invest, so specific advice is useless.

Wrong. There are things you can learn. It is not an exact science. But there are things you can learn.

[TCO]

Originally posted by MattyBoy
I'm not legally qualified to advise you but...

If you want to choose between Vanguard 500 Index and Vanguard Value Index, you should expect the same long term returns from each, but more volatility from Value - so choose the 500. This is because value indices include a bias towards a particular style of stock, so they are less diversified than broad indices.

As for whether you should choose index or active managers, the question is "do active managers outperform enough to justify their higher fees?". This is a subjective question, but either way you go you must do all that you can to reduce the fees that you pay.

Personally, I doubt that US equity markets are inefficient enough to justify a premium of more than .4% per year for active (rather than index) managers.

Assuming you will leave this invested for a long time, I would go with say 70% Vanguard 500 (if low enough fees) and put the rest in global bonds and property somehow to provide some diversification.

Generally a very good post. I would only add a technical point that CAPM theory suggests beta drives return so you are unlikely to have a portfolio with same return/lower volatility except as a result of diversification. Once you are at the diversification limit, you can't go much further.

[MattyBoy]

Generally a very good post. I would only add a technical point that CAPM theory suggests beta drives return so you are unlikely to have a portfolio with same return/lower volatility except as a result of diversification. Once you are at the diversification limit, you can't go much further.

If you want to go further, there is the combination of diversification and gearing (leverage). That works best, as long as you keep your gearing to an appropriate level. But this is getting too theoretical unless you have a steady income to pay the interest.