No one likes to be told theyíre stupid. No one likes to hear that they arenít smart enough to do something, especially when that something is done by millions of people every day. At the same time, however, no one wants to do something that they arenít qualified for and could cause them harm.
I donít fix my car when thereís a problem because I simply donít have the expertise. Nobodyís going to call me stupid because I donít know how to do a wheel alignment, not to mention the fact that I donít have the proper tools and equipment.
I donít think youíre stupid for seeking out experts when a problem is beyond your field of knowledge but I bet you, and I know many others, do just that when it comes to investing.
You see buying a stock is easy, and while you donít feel dumb sending your car to a mechanic, if I told you that you donít know enough to buy stocks, you would probably be insulted. But you shouldnít be. I admit that buying stocks, and doing well at it, is beyond me. Itís not that Iím not smart enough, itís just that I havenít had the proper training and I donít have access to the proper tools and equipment. Iím smart enough to fix cars but I havenít been trained and so to me thereís no difference between that and chemical engineering.
Donít feel bad because it turns out that even professionals arenít very successful when it comes to buying and selling stocks. The people whose job it is to make money in stocks, Iím thinking specifically of mutual fund managers, arenít very good at what they do either. It turns out that over a ten year period, any ten year period, 80% of all actively managed mutual funds fail to beat the stock market average. Thatís like your mechanic only fixing your car 20% of the time. Iíd get a new mechanic.
But lucky for mutual fund managers, they arenít paid to beat the market, they get paid through, fees and commissions, as long as people buy their product regardless of their ability to make them any money. And people do buy because the marketing is good. They convince you that youíre a ďsmart investorĒ and that their fund is different than the rest. They do this by showing you short term returns. Yeah maybe they had a few good years with returns of 8%, 20% and 4% while the stock market average was down 1%, up 10% and down 2%. But over a longer period of time I bet they didnít beat the average at all.
Do you really have the time to research whether this stock or that one is a good investment? Do you have the same level of access that the professionals do to attend annual meetings or hold conferences where CEOs and CFOs are available to answer your questions?
Even with this level of access and sophisticated analysis, the professionals fail more often than they succeed. So whatís an investor to do?
Well the obvious choice is to reduce costs (less trading) and reduce fees. Index funds are a good fit in both cases as you can completely eliminate trading costs by making your purchase through the fund company itself rather than through a brokerage and you arenít going to get any lower fees than an index fund. Index funds have the added benefit of matching the overall market a benchmark that 80% of actively traded funds canít beat. Youíre not stupid and thatís exactly why youíre confident enough to put most of your investable income into index funds.
Now I donít want to kill the dream entirely so, if you have enough money invested in the indexes and are getting itchy to try your luck in other places, then by all means take a small amount of money and try your luck with individual stocks, other types of mutual funds or any of the other products the investment industry says can make you rich. But only invest a small amount of your overall portfolio and only an amount youíre willing to lose entirely.