January 6, 2017

Why you should not invest in an index fund

Why shouldn’t long-term investors buy stock index funds?

First of all: Index funds are a good solution for long-term stock saving. However, they usually aren’t the best solution. The best solution is to manage your own, passive, long-term stock portfolio.

Why is this the case? There are three reasons why index funds aren’t the best solution for you.

First: Index funds cost money. If you give your money to a professional investor, he will charge fees of 1% to 2%. Even if you’re only saving a few thousand per year, it will amount to a few hundred thousand after 30 years, as much as a small house.

Index funds might be cheaper, but they still cost about as much as a nice car over time. Would you prefer to have this car in your own garage or in the garage of your index fund manager?

Second: Index funds have worse returns. You might not be aware of the fact that the stocks in an index fund are weighted. That means that if the price of a stock goes up, it receives a bigger share on the index fund. In other words, you will hold a larger number of expensive stocks than cheap stocks. This will eat up a part of your returns.

Third: Index funds carry risks. If you invest your money in an index fund, you don’t own the actual stocks, but rather a financial product. This is called counterparty risk.

If the index fund has a problem, you have a problem as well. If you buy and manage the stocks yourself, you don’t have this problem.

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