Should I Buy An S&P 500 Index Fund?

It’s funny to me how when people start talking about the best way to invest, it seems like they are arguing a black and white issue.  As with most things, and I promise I won’t get into politics and religion (today), things are rarely that simple.  This is most certainly the case with index investing.  While I’m not arguing one over the other, I think it’s important to look at the features of each type of investment to determine what is going to fit into your portfolio.

The argument writers that are pro-index investing will make is that the S&P 500 index is less expensive than actively managed funds, therefore you make more money, and actively managed funds don’t beat their indexes anyway, both of which are compelling arguments.  While there would be no argument that they are less expensive, a simple Morningstar search on the day I shot this video produced almost 1,900 mutual funds which outperformed the S&P 500 index over the past 10 years.  Two things these writers tend to overlook are the tax-efficiency of index funds as they have very low turnover and therefore don’t pass on as many capital gains, and the fact that buying an S&P 500 index fund does not make you diversified.  You are only diversified among the 500 largest U.S. companies, which isn’t necessarily a great place to be in the event our markets go into a contractionary period.

On the flip side, a pro-active management writer would point out that a good active manager can avoid buying investments that have become overvalued and aggressively purchase investments that are undervalued and present a better buying opportunity.  While active managers may be able to take advantage of this, indexes cannot.  Ultimately, your goal in using an active fund manager would be to find someone who can do this and avoid the very steep declines we’ve seen in the last two recessions in the indexes.  If you do some research into the last two recessions (2000-2002 and 2007-2009), you’ll find a significant amount of active managers were able to outperform their indexes in the fall and immediate recovery periods.

At the end of the day, there are good places to use both strategies if you are using them correctly, so try to avoid listening to the media who insists that this is an either/or proposition.

If you have questions regarding the proper use of each in your accounts, please touch base with us here.