What is "Indexing" or "Index Investing"?
"Indexing" is a passive form of fund management that has been successful in outperforming most actively managed mutual funds. Index investing involves buying one or more index funds.
An index is a group of stocks or bonds used to measure the performance of a particular market. For instance, the S&P/TSX Composite includes approximately 250 companies traded on the Toronto Stock Exchange (TSX), and it’s considered a measure of the entire Canadian stock market.
What's an Index Fund?
An index fund consists of stocks, weighted to produce a return extremely close to that of the overall market. This is in contrast to an actively managed fund where the goal is to (usually unsuccessfully) strategically pick stocks that are believed to outperform the market.
So much time, money and energy is spent trying to beat the market, when statistically it is quite difficult to do so over a 10 year period. Buying the market itself has proven quite reliable in the past at effectively growing an investment.
What are Exchange Traded Funds (ETFs)?
Exchange-traded funds, or ETFs, are similar to index mutual funds in that they hold a portfolio of stocks or bonds and track a specific index. Unlike mutual funds however, ETFs are bought and sold on an exchange, like stocks usually through a discount brokerage.
While there is usually a commission to buy and sell (similar to trading stocks), ETFs typically have lower annual fees. There is also a much wider selection, offering investors access to all kinds of assets (stocks, bonds, real estate, precious metals, currencies etc...)
How does this strategy beat the professionals?
To many beginner investors, the idea that Index Investing could beat most professional money managers may seem highly unlikely. But the truth is, Standard & Poor’s reports that over the five years ending in 2013, only 22% of actively managed Canadian equity mutual funds delivered higher returns than their benchmark index, 12% in the US and for international equities, it was just under 14%.
More recently as of June 2017, only 17.62% of US funds outperformed the index during the previous five-year period. That’s according to SPIVA Scorecard data from S&P Dow Jones Indices.
So the idea behind Index investing is that rather than paying money managers high fees to try and beat the market (recall mostly unsuccessfully), Index Investors simplify the process by aiming for market returns at the lowest possible cost.
Why does my advisor hate Index Investing?
An important life skill is the ability to identify biased information. Usually when someone has something to gain for supplying you with information, you should always consider the potential for it to be biased in their favour. Indexing strategies are used by the most sophisticated fund managers in the world (and advocated by Nobel laureates https://www.ifa.com/12steps/step2/).
Yet, many financial advisors are dismissive of the idea - well, this makes logical sense as advisors often make their money from commissions on the investment products they sell to you. In addition, while there is copious amounts of data indicating fund managers statistically cannot beat the market over an extended period of time, there will always be people who believe they can outsmart the market and sell you reliable market-beating returns.
Many investment firms don’t offer index funds as a product because they are not profitable enough for their business model.