What are Index Investment Funds? What the experts say
Posted: Thu Dec 12, 2024 3:12 am
Index investment funds have become one of the most popular instruments within the investment community.
Not in vain, in Europe, passive management has made an important place for itself within the main investment strategies, to the point of displacing active management as the predominant one in some fund categories.
However, index funds also have their detractors. Those who believe that they are not a panacea and that, in certain circumstances, they can even be counterproductive. There is no clear opinion on this matter and, therefore, we have set out to confront the two most common positions among experts.
Table of Contents
The advantage of index investment funds: simplicity and low costs
The drawbacks of index mutual funds
They fail to withstand bear markets
Bad stocks are added to the portfolio
With index funds we are assuming a high opportunity cost
Passive management is, in practice, also active
The advantage of index investment funds: simplicity and low costs
The strategy of index investment funds is to follow an index, no more and no less. To do this, the managers select the assets that make up the index, and in the same proportion, or chinese overseas africa database in a similar proportion. It is a simple investment philosophy, since the composition of the portfolio is determined by the securities that make up the index.
Its main objective is not to beat the market, but to achieve the same profitability as it. For many experts, this strategy is the one that offers the best results and calls into question the work of active fund managers.
The reason is that, generally speaking, around 90% of investment funds fail to beat their benchmarks over 10 years, and this percentage is even higher as the investment horizon increases.
To this we must add the impact of commissions.
Since the manager's job is limited to selecting already given assets, their management is much simpler and, consequently, they can offer cheaper investment products.
This results in higher returns for investors, especially when compared to more expensive investment funds.
Index Funds Investment Guide
The drawbacks of index mutual funds
They fail to withstand bear markets
Despite the advantages of index funds, this type of product also has its detractors.
The most common view, especially among those who own individual stocks or invest in actively managed mutual funds, is that index funds do not prevent bear markets.
However, the data do not seem to support this view.
Vanguard published an analysis in 2018 on the performance of active managers during bull and bear markets, showing that less than half of active managers managed to improve the performance of the index.
That is to say, it is a half-truth, because not everyone achieves this important objective.
Bad stocks are added to the portfolio
The second drawback of index funds is that, according to most of their detractors, they include both good and bad stocks in their portfolio, and it is not possible to separate one from the other.
In theory, the active manager would be able to identify only the good stocks. That is, those companies in which it is worth investing your savings.
In theory, some index funds contain some companies whose growth is limited by their future earnings prospects.
However, the fact that, in general, they are sufficiently diversified instruments means that, in practice, the performance of some shares is offset by others to obtain a more than acceptable return in the long term.
With index funds we are assuming a high opportunity cost
Proponents of active management argue that with index funds, investors are missing out on an excellent opportunity to increase their wealth, especially if they choose the right stocks or managers instead of holding entire indexes.
But this theory is at odds with reality when comparing active management with index funds. According to the SPIVA report, prepared by S&P Dow Jones , the vast majority of actively managed funds were unable to beat their benchmark over time periods of 1, 3, 5 and 10 years.
Passive management is, in practice, also active
In practice, index funds also follow a certain active management.
Active management is still required to choose the product and the index zone, as well as to schedule regular contributions and rebalance if the investor so desires.
However, it is a much simpler strategy to automate than active management, which often depends on our intuition and can change over time depending on events that occur in the financial markets.
Not in vain, in Europe, passive management has made an important place for itself within the main investment strategies, to the point of displacing active management as the predominant one in some fund categories.
However, index funds also have their detractors. Those who believe that they are not a panacea and that, in certain circumstances, they can even be counterproductive. There is no clear opinion on this matter and, therefore, we have set out to confront the two most common positions among experts.
Table of Contents
The advantage of index investment funds: simplicity and low costs
The drawbacks of index mutual funds
They fail to withstand bear markets
Bad stocks are added to the portfolio
With index funds we are assuming a high opportunity cost
Passive management is, in practice, also active
The advantage of index investment funds: simplicity and low costs
The strategy of index investment funds is to follow an index, no more and no less. To do this, the managers select the assets that make up the index, and in the same proportion, or chinese overseas africa database in a similar proportion. It is a simple investment philosophy, since the composition of the portfolio is determined by the securities that make up the index.
Its main objective is not to beat the market, but to achieve the same profitability as it. For many experts, this strategy is the one that offers the best results and calls into question the work of active fund managers.
The reason is that, generally speaking, around 90% of investment funds fail to beat their benchmarks over 10 years, and this percentage is even higher as the investment horizon increases.
To this we must add the impact of commissions.
Since the manager's job is limited to selecting already given assets, their management is much simpler and, consequently, they can offer cheaper investment products.
This results in higher returns for investors, especially when compared to more expensive investment funds.
Index Funds Investment Guide
The drawbacks of index mutual funds
They fail to withstand bear markets
Despite the advantages of index funds, this type of product also has its detractors.
The most common view, especially among those who own individual stocks or invest in actively managed mutual funds, is that index funds do not prevent bear markets.
However, the data do not seem to support this view.
Vanguard published an analysis in 2018 on the performance of active managers during bull and bear markets, showing that less than half of active managers managed to improve the performance of the index.
That is to say, it is a half-truth, because not everyone achieves this important objective.
Bad stocks are added to the portfolio
The second drawback of index funds is that, according to most of their detractors, they include both good and bad stocks in their portfolio, and it is not possible to separate one from the other.
In theory, the active manager would be able to identify only the good stocks. That is, those companies in which it is worth investing your savings.
In theory, some index funds contain some companies whose growth is limited by their future earnings prospects.
However, the fact that, in general, they are sufficiently diversified instruments means that, in practice, the performance of some shares is offset by others to obtain a more than acceptable return in the long term.
With index funds we are assuming a high opportunity cost
Proponents of active management argue that with index funds, investors are missing out on an excellent opportunity to increase their wealth, especially if they choose the right stocks or managers instead of holding entire indexes.
But this theory is at odds with reality when comparing active management with index funds. According to the SPIVA report, prepared by S&P Dow Jones , the vast majority of actively managed funds were unable to beat their benchmark over time periods of 1, 3, 5 and 10 years.
Passive management is, in practice, also active
In practice, index funds also follow a certain active management.
Active management is still required to choose the product and the index zone, as well as to schedule regular contributions and rebalance if the investor so desires.
However, it is a much simpler strategy to automate than active management, which often depends on our intuition and can change over time depending on events that occur in the financial markets.