The personal finance blog world is all about index investing. Rightfully so as indexing provides a cheap, efficient, easy and profitable method of investing for the long run. Up until recently, my investing style has been a mix of indexing, stock picking and short term trading. However, after learning more about the benefits of indexing, the portion of my portfolio that is indexed is growing.
However, that is not the intention of this post. Not every strategy is perfect, not even the much coveted index investing. As I tend to enjoy stirring the pot a little, lets point out some of the pitfalls of index investing.
1. No Downside Protection
For indexers who are mostly equities over the past year, it’s more than likely that your portfolio has had some wild swings and is very volatile. The great thing about indexing is that when the markets go up the herd follows, however, the herd also is forced to follow when the markets tank.
2. No Control Over your Holdings
The index investor is at the mercy of whatever stocks that are the largest in any particular market. This can potentially lead to over priced stocks having a larger weighting on the index. Does anyone remember when Nortel was the largest stock on the TSX?
3. An Indexed Portfolio will Always be Average. Never Better, Never Worse.
If you’re like me, your aim is to “beat” the market not just float with it. Even though very few investors “beat” the market, an index investor will never do so. Even though the markets are generally efficient, there are always stocks out there that are oversold and under priced relative to their financial fundamentals. These stocks usually come roaring back much quicker than the index once the market realizes the pricing error.
4. It’s Boring.
This is probably the weaker of all the arguments, but it’s true, index investing is boring! If you’re the type that revels in digging in research, watching the markets, and investing when you think the time is right, then index investing is not for you. With index investing you set it and forget it making very few changes on an annual basis.
As stated above, this post is meant to be the devils advocate to the popular index investing strategy.