I was at a meeting last week where I had to listen to this very pompous individual explain to me why active investing and the hedge fund industry were either dead or dying. Nobody knew it, except him. “His” ideas were just the same tired arguments that I hear all the time.
“You’ll save on fees, and you will still be able to match the S&P 500’s returns!” I obviously have many issues with the whole concept of passive investing and index investing, but I think what bothers me the most is matching the performance of some index. I believe that matching an index is lazy investing. Would I love to beat or match the S&P 500 when it is up over 20% for the year? Of course! Everyone is occasionally tempted by FOMO (fear of missing out). However, I certainly do not and will never aim to match any index that loses 30% or more a year.
“A great way to get around this is to diversify risk by putting your money in a mixture of index funds. Anybody who is worth their salt in investing knows that when the shit hits the fan, all stocks become correlated.”
This shit happened in August 1998, 2002, and 2008. It will happen again. Even if you have a mixture of stock index funds, you will still be losing money. Often, you’ll be losing a lot of money. That’s what happens when you buy “diversified” index funds that aren’t really diversified.
The market always makes up for its losses! Imagine if you were a few years away from retirement or you needed some cash during one of the awful bear markets we’ve had in the last twenty years. In 2008, I knew people that were down over 50%. Think about how long it takes to make up for a loss like that. The average yearly return for the S&P 500 is about 9%. I want (and need) an investment strategy that will protect me and make me money in every market environment. Hell, my clients expect me to make them money even if the S&P 500 is down.
The S&P 500 can’t be beaten in the long-run! People keep telling me this, but it just isn’t true. They’re not looking hard enough. Buy SPY and then run a covered call strategy on that SPY position over a 5-, 10-, 20-, or even 30-year period. What would happen if you used this “dangerous” derivatives strategy? You will see that you would out-perform the S&P 500 and lower the portfolio’s overall volatility. See, I just told you a safe and easy way to beat the “unbeatable” S&P 500.
Everybody’s switching to index funds! We’ve seen this show before. You need to question the herd, the media, and especially Vanguard when they are pushing one type of investment strategy. When you see articles on the death of an industry or an investing strategy, that’s usually a good time to buy. Remember 1999? The S&P 500 was considered unbeatable, and everyone was questioning the continued viability of value investing. Value-oriented fund managers went on to outperform the S&P 500 for most of the next seven years. Don’t repeat the mistakes of the past! Strive to be better at protecting the money that you have worked so hard to earn or be willing to pay someone to do it for you.
People who oppose index funds want to line their own pockets! Who doesn’t? When people are telling you something, you should never take it at face value. You need to examine their motives, do your own research, and make the decision that is best for you and your family. Bill Gross is beyond intelligent and great at what he does, but at the end of the day, Mr. Gross is a bond salesman. Naturally, he is going to tell you that bonds are the place to be. Former Vanguard CEO John Bogle is not some sort of secular saint. He is going to tell you that index funds and passive investing are the way to go because he sells index funds. I am sure he believes in his strategy, just as I believe in mine. Even as I write this, you should be questioning my motives too. Educate yourself about the highly unfavorable risk-reward profile of index funds today, then decide for yourself what is best.
Hedge fund managers underperform! My question is always: Underperforming what? An index that consists mainly of mediocre companies and has drawdowns of more than 40%? I want none of that and neither should you. It is unfair for anyone to compare a true hedge fund with an index like the S&P 500. A hedge fund should be hedged, which automatically makes it more difficult to beat any unhedged index that is having a good year. It is also naive to think that every investor is the same. I think it is almost malpractice to recommend Vanguard, Schwab, or any other index fund as a one-size-fits-all strategy for everyone. Each investor is different, has different goals, and has different family dynamics.
Hedge fund managers charge too much! Most investors don’t like losses. And guess what? We are willing to pay more to avoid large losses. If a hedge fund manager or your financial advisor tells you that their strategy will perform at a given level, and it doesn’t over a certain period of time, then you actually are paying too much. But if a hedge fund manager charges 2 and 20 and delivers the predicted gains at the specified risk levels, then you are paying the right price. Like any job in society, you are going to have bad, good, and great money managers. Your job is to find the best one, not to put up with whoever will give you the lowest price. An index fund is like someone who will work for pennies, sometimes does very good work, and occasionally sets fire to your business. Would you hire someone like that? You work too hard for your money and should never accept mediocrity when it comes to investing it!