Thursday, October 15, 2009

Update: reduced index fund

If you are a first timer, please read the following pieces first. It will provide you with important background information.
1. Why I created this blog?
2. How am I going to operate this blog?

I sold 61.943 shares VIIIX at 100.1 on October 14, 2009, when Dow first settled above 10, 000 since October, 2008. I bought 481.028 shares DODIX at $12.89 using the proceeds. I paid no commissions or transaction fees for these transactions are in my 401K account. I generally don't like mutual fund. Please take a look at this post: Sell Your Mutual Fund! The following is my general view on index fund.

The case against index fund

After my speech on "Sell Your Mutual Fund", I was stopped by a fellow member asking my opinion on index funds. I didn't have time to contemplate and elaborate since I am usually very hungry after the toastmaster meeting. I am writing the following piece to give my viewpoints on index funds.

First of all, paying an index fund is against my moral principle. An index fund, by definition, is a fund holding all of the securities in the index, in the same proportions as the index regardless of market conditions. The manager of an index fund, therefore, spends no time or any other resources, adds no value but collects a fee. Since the manager has no overhead, puts in no efforts and adds no value, usually he or she collects less management fee percentage wise comparing to actively managed equity funds. Some argue lower fee is an advantage of index funds. However, to me, paying any fee at all for no effort, no value added is morally wrong.

Secondly, anyone in this room with enough money can easily outperform an index fund. Just buy everything in the index in the same proportion. Replace holdings whenever the index committee announces its decision. Since you don't need to pay yourself a management fee, over time you will do way better than any index fund you can find. Piece of cake. For those of us with limited resources wanting instant diversification, we are doomed to do way better. Just buy Berkshire Hathaway, or any other similarly managed conglomerate. We get solid business, strong balance sheet, skilled management and most importantly, the lowest paid CEO and Chairman in Fortune 500. Remember, you don't need to do all the profitable trades in the world to be rich.

Last but not least, an index fund gives you a false sense of security. An index fund is a basket of stocks. With so many stocks, it is unlikely you know any one of them very well. The big blackbox approach hides behind the diversification assumption most people accepts as gospel. People blindly settles for mediocre results. I don't know if any people needs 500 stocks to diversify. Furthermore, most index funds are cap weighted meaning they are more overvalued than general funds when index is at its highs.

In summary, I don't like index fund. I only buy an index fund when I don't have better options.

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