- Look, I love investing in index funds
so much that 90 plus percent of my money
is invested in them.
But on the other hand, I also love challenging
my own beliefs because I'm just a freaking weirdo like that.
As uncomfortable as it feels, it's something
that I'm always trying to get better at just
to keep myself as open-minded as possible.
Since I was doing this for myself anyways,
I figured that I'd share some of my findings with you.
So in this video, we're gonna go over some
of the downsides of index fund investing.
I know you're probably like Jarrad, there are none,
well, guess what, you're wrong and so was I,
and I'm gonna tell you about them.
Hey, I'm Jarrad with an A and on this channel,
we talk about all things, personal, finance,
investing and financial independence.
I know crazy to think that there
are any sort of downsides index fund investing
but if we look hard enough then we can find a downside
to just about everything, whether you realize it or not,
I'm sure we're all a little scarred from learning
that the tooth fairy isn't real.
What was a nice little fun, funny story
for our parents to tell us, actually left a deep seated fear
of losing money in the back of all of our minds.
I still wake up every single morning
and look under my pillow for money.
Try explaining that to a girl that you're dating,
who stays tonight.
It's a bit of an awkward conversation,
hashtag it's about darn time that we cancel the tooth fairy.
All in index fund does is buy specific equities
based on the type of index that's tracking AKA copying.
For example, an S&P 500 index will hold
the exact same stocks that are a part of the S&P 500.
The amount of each stock that makes up an S&P 500 index
is based on its market capitalization.
All a market cap tells you
is the total dollar market value of a company.
As you could probably already guess, Apple, Microsoft,
Amazon and Alphabet are the four largest companies
based on market cap.
So there they are the four largest companies
within the S&P 500.
Therefore, they are the four largest holdings
within an S&P 500 index.
When you invest in an index fund,
your money gets spread among every single equity,
that's a part of that specific index fund.
Now how much money gets spread out among each stock
is based on what the index fund is tracking.
An index fund is tracking the S&P 500 is of course going
to hold stocks of the 500 largest publicly traded companies.
But at what percentage?
If you invest $100 into that index fund,
then how much of it is actually gonna go into each company.
In the case of an S&P 500 index,
it's usually gonna be determined by what we talked about
a minute ago, which is the market cap.
In the case of VOO
which is an index fund tracking the S&P 500,
it holds almost 6% in Microsoft, 5.7% in Apple
and 4.49% in Amazon.
So for every $100 that you invest in VOO,
$6 is gonna go to Microsoft, $5.70 is gonna go
into Apple and $4.49 is gonna go into Amazon.
I use that index fund example because it is the easiest way
to understand this overall concept.
When we start to get into other types of index funds
that track different sectors,
whatever held within it is gonna be based on the goals
of that specific index fund.
There is index funds for just about everything.
Real estate, bonds, dividends, large cap companies,
small cap companies, mid cap companies,
they're sector base index funds,
there is international index and so many more.
The first disadvantage of an index fund
is that it is only going to give you average returns
or you should most likely expect it
to only give you average returns.
If you were someone who isn't okay
with accepting an average return on their money,
then this isn't the type of investment
that you'd want to mess with at all.
But if you were someone like me who was willing
to accept average returns then an index fund
is perfect for you.
These were designed in this way on purpose
because your money is spread out
among many different assets
and at many different allocations,
you are naturally going to benefit from the winners
but some of those gains will be offset
by the losers as well.
It's essentially the price that you pay
for taking the passive investing route.
Even though this has turned
out to be one of the most successful
and best ways to invest over the long run,
it makes an active investor absolutely cringe.
Just thinking about index bonds.
Since your money is sprinkled
throughout many different companies,
you're naturally going to miss out on those hot stocks
that absolutely skyrocket.
I was one of those people who missed out
on the insane growth that we saw from Tesla stock
at the end of 2019 and the beginning of 2020
since the majority of my money is invested
in total stock market index funds.
I missed out on that 150% returns over the past six months
and instead accepted a negative 2% return,
that one hurts a little bit
but not really because I'm investing for the long term
and not the short term like six months.
There is lack of control with index bonds
because you don't actually get to choose exactly
what is held within that index fund.
If there's a handful of companies that you never want to own
in your life but they're a part of an index fund
that you might be interested in, then you have no choice
but to opt into owning a piece of each of those companies
that you might absolutely hate.
On the other hand, something like Tesla
isn't even a part of the S&P 500 at the time
of recording this video.
So if you own something like VOO
that S&P 500 index fund, then you would have missed out
on the insane returns that we've seen
with that stock in early 2020.
If you owned an index fund like my favorite one VTI,
then only 0.52% of your money was invested in Tesla stock.
So for every $100 that you invested in VTI,
$0.52 of it went into Tesla.
You might be thinking, well, what the heck?
What if I wanted to invest more money into Tesla?
The index fund doesn't really care about that hunch
that you had about the stock
because it is not in the game of stock-picking.
They're basically telling you to kind of kick rocks
because they know better than you.
I need you to do me a huge favor
and ever so gently tap that thumbs up button please,
do it with your fingers, your toes, your tongue,
I don't care whatever you do,
just make sure that it turns blue.
index funds are known for buying,
holding on to investments and not really messing around
with it them very much at all.
They will of course, add, remove an change the allocations
but not at the same rate as something like
an actively managed mutual fund
or an individual investor.
That is one of the things that makes
them different from actively managed mutual funds.
With actively managed mutual funds,
the manager will constantly buy and sell
to try to cut their losses,
sell what they believe is an overvalued stock
and gain an edge to beat the market.
Even though they're not very successful at this,
they still get an A for effort for trying.
With an index fund, you can't take advantage
of selling out of a stock that might be tanking right now.
For example, if you owned Hertz stock
and you sold tanking or receive news
about their bankruptcy, you could sell out all
of it fairly quickly on your own.
But if the index fund that you owned held hard stuck,
then you'd be stuck owning a piece of that failing stock
until it was eventually removed because the index funds
aren't set up to react to market conditions very quickly.
By quickly, I'm talking on a day to day basis.
We're basically stuck with those losses
and expecting that the winning stocks in your index fund
will offset those losses.
And by the way, they usually do over the long run
but remember, this video is about the downside
of index fund investing so I'm gonna shut my mouth (laughs).
With an index fund, your investing in specific sectors
with different goals which could leave you heavily exposed
to specific market conditions.
If you were someone who owned a real estate index fund
like VNQ at the beginning of 2020,
then you're down around 20% over the past six months.
If you owned a financial focused index fund back
when the market crashed in '08 and '09,
then you probably would have been freaking the heck out.
This can get pretty risky in the short term
depending on how much of your portfolio is invested there
and what your risk tolerance is.
Because you're exposed to that specific index,
it doesn't protect your downside.
You have to do that on your own
through investing additional money into places like bonds
or other index sectors.
Although index fund investing has shown
to be successful over the longterm,
it's an extremely boring way to invest.
It is literally like watching paint dry
or being forced to watch five-year-olds play soccer.
All you really want to do is crack open
an adult beverage just to numb that pain
that you're feeling.
Humans by nature want to medal in everything
because we think that we know best.
So if anyone can fix a problem, then it should be me.
This is not what the average person to hear
when it comes to their hard earned money, that's invested.
If this is you than index funds probably look like
the worst place to put your money
because you kind of just sit there and twiddle your thumbs
and kind of watch what's happening.
Nothing I mentioned should stop you
from wanting to invest in index funds.
While these downsides are great to understand,
anyone with a little bit of investing knowledge
could tell you why these downsides aren't really
a big deal at all.
I know it's not going to stop me from continuing
to invest the vast majority of my money into index funds.
By the way, my favorite longterm investing platform
is M1 finance, I will have a link to check them out down
in the description.
If you do use that link, then it helps support myself
in this channel.
So thank you so much in advance.
Watch my index fund investing playlist right here
to your left and next.
Please make sure to hulk smash that thumbs up button.
Check out the description for more resources
and playlists to help you out with all
of your personal finance and investing needs.
I'll see you in the next one friends, ideos.