Index Funds

[I received a question on investing in index funds from a reader; what follows is my personal opinion on index investing.]

Q: I was interested in stocks before but decided against it coz (Warren) Buffett and Jim Rogers mentioned in their works that index funds is good enough.

What's your opinion on index? and the American guy who popularised it? (i forgot his name). I read that he is quite a trailblazer.

A: In my opinion, for a person who holds a day job and who does not have the time to investigate individual investments in detail, index funds are a good option because they take the need of having to worry about investments off the investor's hands, and typically have much lower management fees than actively managed mutual funds. In addition, most mutual funds underperform the indexes, so if you stick your money in the index fund you are more or less guaranteed to beat the majority of investors who invest in mutual funds (and possibly who try to manage their investments on their own).

However, being an index investor requires patience and discipline because there will be periods where the broader market moves sideways and there will be periods where there is a latest fad e.g. internet/biotech/oil/China etc. where u see certain sectors booming and outperforming the market. These are times when the index investor needs to shut off the noise and just sit on his investment and not be tempted to sell out of his index investment and join the fad. This can be difficult especially when hear of people making money in short periods while your fund is only moving conservatively.

Rest assured, however that the disciplined index investor who has the patience and discipline to stick to his plan will eventually outperform the investor who chases market fads and who follows the herd to whatever is the 'hottest' investment at the period of time.

A good way to manage this tendency to want to be 'in' on what the crowd is doing, or if you are interested in doing some active trading, is to set aside a small portion of money that you can afford to lose. Meanwhile, the money that you need for the long term purposes such as children's education or retirement etc. should be kept safely in your long term index investment and not be touched. This will enable you to indulge in your natural tendency to want to gamble but at the same time protect you. I personally have read about professional fund managers who have their own small 'gambling' fund in order to prevent their gambling tendencies from doing any damage to their main fund.

As for the guy who popularised index investing, I believe it was John Bogle. I have a lot of respect for John Bogle and I believe he is the authority on index investing; he founded the Vanguard Group which manages index funds and other investments.