I'm sure you've heard by now that you will be charged lower fees while still being able to capture market growth if you invest in a diversified basket of index funds. But passive investing isn't for everyone. Here are a few reasons index funds might not be the best investment for you:
You want to get rich quickly. No one is getting rich overnight using index funds. However, by consistently putting money away and staying the course when things seem dire you are extremely likely to get rich using index funds. Index investing takes patience to reap the rewards.
You want attention from a fund manager. No one will buy you dinner as a passive investor because no one is making enough money off your wealth to bother. The math clearly points out the enormous fees you are paying to have a sales associate or investment manager attending to your needs.
You want to own the top-performing fund of the year. Index funds will never be the top performer on any list. While the index is generally in the better half of performing funds every year and performance gets better when you look at longer-term charts, an index fund is very unlikely to be the very highest performing fund in any category. You probably won't be able to skillfully pick the top performing fund, and even then, you are taking more risk by making that choice. But your emotions may tell you otherwise, especially when your friend happens to be invested in that top fund. And let's not forget that the friend will be sure to rub it in.
You want instant returns. The additional increase in wealth using index funds over active management isn't all that visible. Sure, there are plenty of studies that make claims about how much richer an average person would be by investing in index funds, but no one can actually tell you how much better off you will be if you become a passive investor. It's difficult to calculate just how much tax you've avoided because of the tax efficiency of passive investing, and no one can determine the extra hair you will have because you didn't tear it out worrying about outperforming the market.
You want something to brag about at the next party. You'll never be the talk of town with an index fund, and most people will brush you off as soon as you tell them you are an index investor. "Oh, average returns," they will say. Even if you know better than that, it's unlikely to make a very satisfying conversation.
You want to never lose money. Investing passively doesn't mean that your investments will never go down. It doesn't guarantee positive returns, even though that's very likely going to be the case if you trust that the world economy is going to keep growing over the long haul. And because there's not likely to be much peer recognition in your social circle, it could be a challenge to maintain composure and hold onto the belief that you'll win out with passive indexing in the end.
Passive indexing takes discipline to keep investing, knowledge of how the pieces work together to benefit you and patience to see things through in the long run. Those who have what it takes will reap huge rewards, but index funds are definitely not for everybody.
Visit MoneyNing.com for more personal finance discussions. This site also helps readers decide whether a 0 percent balance transfer card is worth signing up for and keeps a good list of helpful promotion codes.
More from U.S. News
- 10 Ways to Reduce Taxes on Your Retirement Savings
- 10 Trendy 401(k) Plan Perks
- 10 Secrets of Successful Retirement Savers