When the stock market is doing well, index investing usually takes a back seat. People are often tempted into stock picking when the market is on an upward trajectory. But that's dangerous for most people. It’s extremely unlikely that you will beat the market year after year. Here’s why you should consider using index funds to invest your retirement savings:
You probably can't beat the market. Some people are able to achieve higher returns than the stock market overall for a couple of years. But it’s extremely difficult to beat the market consistently over the entire time span you are saving for retirement. Even professional fund managers often have trouble consistently beating the market.
Lower costs. Trading stocks almost always comes with a fee. And when you invest in an actively managed fund, you are paying a fund manager to select investments that will make you money. You pay those higher fees even in years when the fund doesn’t do well. Index funds typically charge much lower fees.
Less time consuming. Most of us don't have all day to ponder our investments and retirement plan. If we spend the necessary time to pick individual stocks, that's time away from other important investment decisions such as selecting an asset allocation and rebalancing. If you don’t have a lot of time to devote to your investment portfolio, it could be better to allocate your time to other aspects of retirement planning.
An easier way to manage your investments. It's very difficult to determine your asset allocation and come up with a long-term investment strategy when you have individual stocks that need to be bought and sold regularly. With index funds, you can more easily transfer funds from one account to the next, figure out the asset types you own, and pay your taxes in the most efficient way possible.
Indexing is less risky. Worrying about how the market will do as a whole is tough enough, but it's worse with active management. With an actively managed fund, anything that happens to the investment manager is going to affect your investment. And actively managed funds sometimes include fewer securities, which makes them more susceptible to catastrophic events that can happen to any one company.
If you already have enough money to retire, you certainly don't need to take on the extra risk of individual stocks or an actively managed fund in an attempt to increase your returns. You simply don't need it. And if you’re still building a nest egg, you can't afford the risk because any missteps can create an even harsher reality for you.
David Ning runs MoneyNing, a personal finance site that shares money moves you can make to significantly increase your chances of having a comfortable retirement. He likes to share simple changes that anyone can make, such as picking the best online savings account and figuring out whether a 0 percent balance transfer credit card makes sense.
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patrichwilliams of CA 1:48PM May 11, 2012