Why index fund invest or not? (part I)
There is some very good discussion going on recently about whether investing into index fund (S/P) long term is a good investment idea. It is a very big topic and I just want to share some of my thoughts. My thoughts are definitely not completed, so comments or criticism are very much appreciated and welcomed.
Since the past track shows investing into S/P index fund have around 10% annual yield for the past 30 years, it is reasonable to think it has a good chance to be a good investment method for future. But before we jump into that conclusion, let’s look at why the track record for the past 30 years (or longer) occurs at the first place. If we understand why it happened, and we think those conditions which make it work will still exist for the next 30 years, we will have more confident when do use this method. So we will not invest our hard earned money “blindly”.
In my personal opinion, there are three main reasons that make investing into S/P index fund works for the past.
1) S/P index fund is a good investment instrument for the past, meaning for the past it grows its value at an acceptable pace for the long term. S/P 500 stands for arguable 500 best public-traded companies (mainly in US) at every certain period of time of the past and those companies represents the leaders in different business areas. I believe the true reason behind the success of S/P index fund (or for the companies it represents) is the US business system. This system encourages business competition in a fair and honest environment to provide good goods or service products to the society. If you look around the world in the past (or even now), this is the most sophisticated system ever built. That is why US economy has been a leader in the world economy. The good proof of this is that US won the Cold War against Russia, not using its bullets or missiles that much. Although there are problems (some cases very big problems) in the past with this system, like recessions, company scandals..., this system amazingly fixed those problems quickly and keeps going forward after temporary pullback. That is the #1 reason why S/P index can grow at a good pace for that past. But we also need to remember that when this system was in its infant or child age, it required a lot of intelligence to recognize the edge this system would eventually have. If it were as obviously as it is today, much more people would have been much richer now by investing into S/P index fund. Do we need the same intelligence (if not more) to evaluate whether it is still going to work the same way in future?
2) Since stock market has volatility and it is up and down all the time. Most people lack the wisdom of timing the market, so investing using dollar cost average is arguably one of the best ways to avoid catching the market volatility at the wrong direction and to overcome the common mistakes people would easily make in stock market. So if you consistently put in money into S/P index fund in the past, no matter whether market is up or down, you will have relatively low cost base for the investment.
3) Investing into S/P index fund requires relatively low trading cost. And if you buy and hold it for these years, you tax consequence will be smaller for the current tax law encourages long term investment.
For those three reasons I can think of (you all might have more), I think when you do S/P index fund invest in the past, you are investing into a growing investment instrument using low investment cost base with low investment overhead (fees and tax). No wonder it would be working nicely for you! You could do it either blindly or wisely in the past, that is not important as long as you keep doing it, because it worked!
If we agree with the analysis above and we want to know whether the same investment method will be working in future for us, we need to look at those factors at current situation. I will be writing some more of my thoughts on that later.