Passive approaches: Matching the market with low costs
10 yrs ago - S&P was at 877 points. On the 29th it hit an all time high at 2948 points. A 1000 dollar investment would be worth 2361 dollars today. No management. No sleepless nights. Low fees.
The US represents 43% of world market cap. Arguably it is safe, secure, diversified and long term.
Every investment guru has their own strategy to invest: some will recommend actively managed funds some will tell you to go with an annuity and finally some swear only by day trading and Elliott Waves theory.
But today let’s discover what are indexed funds, why they are considered passive investments and what are some of the key advantages.
The definition of an Index Fund:
“An index fund is a type of mutual fund with a portfolio constructed to match or track the components of a financial market index, such as the Standard & Poor's 500 Index (S&P 500). An index fund is said to provide broad market exposure, low operating expenses and low portfolio turnover.” Investopedia.
Investing into an index fund or also known as a tracker fund is considered a passive approach. You put your money on a monthly basis and forget about it.
The world’s champion of Index funds and also considered the most successful investor in the world, Mr. Warren Buffet. In his will his instructions clearly state: “My advice to the trustee could not be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund.”
Why does the most influential active investor of our time suggest an S&P tracker? Because statistically 90-95% of the active fund managers over the last 15 years have not been able to beat their index benchmark.
Index funds have arguably a few advantages:
- Low fees;
- Tax efficiency (lower taxes).
Taking a long-term approach to investing and using the dollar-cost-averaging or otherwise said being able to buy the same dollar amount on regular intervals of an investment is a traditional and safe investment strategy.
This will create a long-term average that will be less volatile than putting a lump sum into an index and be at the mercy of market swings.
An example of an investment strategy is to select a tracker fund for each major market and use the weighted average of the markets in terms of world market capitalization*. For example the U.S. market represents 43% of the world market cap. If you have USD 1000 to invest, only allocate USD 430 into an S&P and allocate the rest to the weighted average of the other major markets.
You will find that most of the so called managed funds of large funds and banks have exactly the same strategy but will sell it to you at a premium and propose it to you as an active, managed solution.
Always look into the multi-asset diversified solution before investing, it might turn out to be a fund that has the exact same strategy as above but for which you pay an unnecessary management fee per year.