We Should Buy Index Funds Instead of Stocks Even If We Can Beat the Market

by David@MoneyNing.com · 11 comments

stock marketMany of us that frequent personal finance sites are passive investors. We buy index funds because we aren’t convinced that anyone can outperform the market in the long run. However, some of us still buy stocks because we believe beating the market by taking on more risk is possible. Some of us fail, but even if we succeed, we should buy index funds.

Why? Our goal is to become wealthy and not beat the market. Many of us feel that our money will grow faster if our returns are better. While this is certainly true, imagine how our attitude towards money is affected when daily fluctuations are high. Some of my stocks are pretty volatile, so I look at my performance daily (buying more and selling shares when needed). Recently, the value of my portfolio changes more than $1,000 per day at least 30% of the time. That means that I could be $1,500 richer one day, and $3,000 poorer the next.

Let’s say today’s move was $3,000 to the down side. Why would the $5 dollar Starbucks coffee feel like anything? Losing $3,000 and $3,005 is pretty much the exact same thing. Now on the brighter side of things, $5 is nothing when it means gaining $1,500 and $1,495 for one day.

I can really see this happening to myself. Iā€™m starting to lose my attitude to save. When my portfolio loses money, I feel like another couple bucks isn’t much. When it gains money, I feel like I can afford it. This means that every time I feel this way and spend money, Iā€™m losing the opportunity to save and grow it. Little things add up, and although we may be able to beat the market for years, we might still lose because we have lost all the extra opportunity to keep funding our investment accounts.

Slow and steady wins more ways than one.

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  • Haydn says:

    This is such a neglected aspect of passive index investing. Even if you can beat the market by investing in individual assets yourself, it still might not be in your best interests to do so because of stress and the time commitment required.

  • NoRoboGuy says:

    I think markets are pretty efficient. As they say, even a blind squirrel may find a nut sometimes, but ultimately there is no free lunch. If you are using index funds to time the stock market, you have to be right twice on every trade. You have to know not just when to exit, but when to get back in.

    If you found a way to do that consistently, please post your secret here, so we can all get rich.

  • Copa America 2015 says:

    I think you can beat the market. I think it happens a lot. You can be a value investor without utilizing index funds. Thanks for share your every single post. Really so much helpful for a business start up.

  • Mark says:

    This is exactly the point we try to drive home when we meet with plan participants. Unfortunately, most participants don’t follow our suggestions and take the “tip” from their co-worker that their specialty fund is up 37% YTD. Usually the party is over at that point.

    – Mark

  • C.C. Collins says:

    As an individual investor with less than, say $20,000,000, to put to work you can beat the “market”. Which market leads to a whole different discussion.

    Let’s assume that the Nasdaq 100 is the “market” we desire to beat. Discussions about whether or not you beat the market are always based on
    the market’s progress in ONE direction, UP.

    On the other hand, you can invest/trade in TWO directions if you are willing to use inverse funds like the ETF symbol QID. Actually it’s a double inverse
    fund with great liquidity and you can participate in the short side of market with buy transactions only, gaining leverage but using no margin. This is a real plus where certain accounts prohibit going short.

    Timing makes it possible to beat the market and as an individual investor you stand a much greater chance of growing your account(s) as opposed to the poor track record most professionals have to offer you. I know, I was in the industry.

    Always seek and participate in financial self education. You can become your best financial advisor.

  • MoneyNing says:

    Raj: There are many people that can beat the market. There are just many more people that don’t. Good luck with your investments and I hope you are one of the people that are better than average.

    Randall: It’s often very hard to separate everything. You are special so cherish that talent.

  • Randall says:

    I don’t feel (personally) that the two are related; The urge to save vs. the desire to invest. I invest in mutual funds rather than stocks, but that $5 Starbucks coffee still hurts. It’s kind of the “Penny Wise, Pound Foolish” but in reverse. I pay careful attention to the investments, but take MORE care in buying stuff.

  • Raj says:

    I think you can beat the market. I think it happens a lot. You can be a value investor without utilizing index funds.

    I recommend reading the Intelligent Investor by Benjamin Graham.

  • MoneyNing says:

    Carl: Great testimonial for index funds. šŸ™‚ I think they are great and something that works for 98% of people out there. However, I bet 98% of people buy stocks since it is more exciting.

  • Carl says:

    Very few people can actually beat the market on a regular basis. Even professional investors (active mutual fund managers) on average underperform the index funds mainly because they charge fees for their efforts.

    The main reason I would choose index even if I could do better (and I cannot) is that the stock market should be a long-term fire-and-forget type investment, not a speculation. If you invest actively, you are always preoccupied with the market and there is always an itch to make a trade. Even if the trade is sound, you lose some money on commissions and fees.

    I think of my stock funds with a 30 year horizon. I hope to structure my finances so I will not need to touch my shares. I rather spend time with my family or work on my career than fret and worry about stock price. That I think is the true beauty of the index fund.

    • Brian Kehm says:

      Totally agree. With a long-term buy and forget investment strategy, you will outperform most other investors. It eliminates emotional trading and reduces trading fees that eat away at long-term returns.

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