The sheer absurdity of index funds
I’m guessing when you go shopping for fruit at your local supermarket you don’t buy one kilo of every fruit they have on offer, regardless of what it looks like, or what the price is. If you’re like any normal person, you’ll choose only that which you like, which looks good, and which is on sale, or at least offered at a good price.
Likewise, if you’re going on a two-week luxury holiday to Paris, you’re not going to book one night in 14 different 5-star hotels, at the rack rate. If you’re anything like me, you’re going to shop around and find the best possible value for your money and book one hotel for the duration of your stay, or maybe two hotels offering great value for 7 days each, if you prefer a bit of variety.
So, why is it that when it comes to investing in the stock market, so many investors nowadays buy an index fund ETF and simply allocate their money blindly to every stock in the index, without any regard to quality or value? All that matters is price. To me, it’s absurd.
Indeed, I’d argue that any financial advisor suggesting that his or her clients buy index funds is bordering on being negligent. In essence, they are saying to invest in something without considering the value of it. Can that be a prudent thing to do in a fiduciary role? I would argue not.
Yes, you can argue that those companies that are big and popular and have come to dominate the indices have attained that position because they are the best companies. In other words, the index self-selects the best quality companies. Maybe so.
But history shows that good companies can be bad investments if you pay too much for them. Likewise, bad companies can still be okay investments, if you buy them cheaply enough.
History is also full of examples of once proud blue chip stocks that were integral parts of stock indices for decades, before then all but disappearing, or even going bankrupt. Household brands like Kodak, Motorola and Nokia are just a few examples from my investing career. Others include Nortel Networks, WorldCom, and Enron. All bankrupt; two of them frauds. And remember, Northern Rock, Bear Stearns, and Lehman Brothers?
The point is, blindly buying stocks just because they’ve been included in a benchmark index strikes me as a very lazy and irrational way to invest your hard-earned savings. You’d never act that way when making other spending decisions in your life. So, why do it when investing?
Our ethos here at Global Value Hunter, as the name spells out, is the antithesis of index fund investing. We scour the globe for the best quality companies available at bargain-basement prices. Why not join us?