Confessions of an Index Investing Skeptic — Introduction

Uncertainty is the only certainty there is, and knowing how to live with insecurity is the only security.
— John Allen Paulos.

Today I’m kicking off a new series on index investing. I’m going to run the risk of offending the hive-mind with this series, so let me preface it with a couple of reminders: I am not a financial professional. I do not have a degree in economics. I offer only the opinions of a guy who spends a lot of time thinking about these sorts of things. There are many extremely smart people with extremely impressive degrees who disagree with me, and I highly recommend reading what they have to say.

Now that that’s settled, I’ll just come right out and say it — I have grave doubts about the future of conventional index investing. My reasons for this are many, and each could sustain a lengthy discussion and debate. The following series of posts will discuss a few of them in broad strokes.

The Siren’s Call

Index funds have been touted for some years now as a sort of panacea. It’s hard to argue with their appeal. Wouldn’t it be great if your entire investment education could begin and end with buying equal proportions of 2 or 3 index funds, and rebalancing occasionally? Perhaps with a few tax issues thrown into the mix? I’d really like for that to be true. I just don’t think it is.

Don’t get me wrong, by the way. I’m not suggesting that the champions of index investing1 make that claim — not exactly, at least. Many of their adherents seem to, though. 2

The trouble is that many of the features that made index funds so good in the past, such as safety in diversification, piggybacking on efficient market pricing, and good historical performance, might not hold in the future. In fact, some appear to be breaking down already.

Here’s a quick sneak peak of some of the topics I’ll be getting into:

  • Rising correlations — diversification ain’t what it used to be.
  • The efficient market theory — it requires active investors to work.
  • Boomers retiring — the Great Grey Menace.
  • Economic growth — the exponential function revisited.
  • The fate of superpowers — this time it’s (not) different.

I’d like nothing more than to be proven 100% dead wrong on each of these points, by the way. I’ll be looking forward to the conversation.

In the meantime, why not subscribe to my rss feed to make sure you don’t miss the future installments?

  1. For the record, John Bogle is a hero in my opinion — a great champion for individual investors.
  2. Just try discussing the merits of an individual stock on a Web forum nowadays — you’ll get mobbed by people insisting that you’re an idiot for doing so.

4 Comments

  1. Oooo… You’re poking the giant slumbering bear with this one lol

    I too have had that voice in the back of my head nagging me that “this sounds too good to be true”. The theory behind it all is very solid and it’s even been proven over the past many decades so I’m always very interested in critical analysis of the theory. I even posted about this in the MMM forums but the general consensus seemed to be that if all main index’s crash and burn to 0…. well then no investment principle is safe so everyone loses.

  2. MBo

    Really enjoying your daily posts.
    I totally agree with the premise of your post. Conventional wisdom can lead everybody down the toilet together. The housing bubble and collapse is a pretty clear example of this. Better to get the discussion going on the risks and understand that investing does not guarantee a positive return. I would also be interested in your alternative investment ideas because my concerns resonate to other investment classes too, for instance bonds have nowhere to go but down, there’s huge inflation risk with cash (due to governments excessively printing money). Don’t mean to be a worrypants but it just seems like there is a mounting resistance to traditional investment growth.

    MBo

    • Sean Owen

      Couldn’t agree more. And I wish I could say I have a perfect set of alternatives in which I have complete confidence, but I don’t. I have some ideas about how to mitigate these risks, but I have no magic bullets to offer.

      What troubles me so much is how utterly convinced so many people are that index funds ARE a magic bullet.

  3. There is a huge difference between promoting the virtues of a concept and becoming a religious zealot. Most people fall into the latter camp – no matter which side of the argument they support.

    When ACME Corp is doing poorly, or XYZ country is tanking, and all the headlines are screaming sell. They listen to all of the so called ‘experts’ and financial pundits and sell. Its very hard to hide from the daily noise, and people get enraptured with the daily mechanisms and excitement of the market. Often to the detriment of their long term financial health.

    With index investing, it helps to break that cycle. It forces them to focus on the underlying point; ‘Do you think the countries economy will be better in 10-20 years than it is today? If so, then hold on and keep investing’.

    For the uninitiated or the financially insecure/illiterate, I believe that compared to other options, index investing IS the answer (or as you say, the magic bullet) to building longer term wealth. It’s what I’d make my mum do.

    Having said that, I see no reason why people with a stronger mental fortitude can’t invest normally.

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