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No. of Recommendations: 12
Topic: "The The Case Against Index Funds," by By Nathan Slaughter
July 20, 2004

I am a member of the Motley Fool Money Advisor, which is a great place to start for new investors. I have been a big reader and a good formum scanner and I think it has been long enough now to know that one thing seems to missing more and more these days from the other side of Motley Fool, that is that they are failing to mention that following the advice in "Champion Funds" (the mutual fund newsletter, the Stock Newsletter or the "Hidden Gems" Newsletter is gambling. Most people should not be toying with these things. You are more likely to lose thatn to win with this advice. Unless you have money to burn, and most of us don't, and you feel youmust gamble awy some of your money with these stocks or mutual funds, then keep the toal to under 5 or 10 pper cent of your portfolio. I think this point is not being stressed very often these days. I think new members coming into Motley Fool could easily arrive during a moonth when this point is not mentioned. So beware.

At the Motley Fool Money Advisor, the good folks recommend members buy a small handful of index funds and bonds ONLY! No Champion Funds, no Hidden Gems. Why? Statistics show that to venture out beyond the index funds, hence "the market," into stocks or mutual funds will make a loser out of nearly all players. Are YOU really going to be that specail player? How are you at the slot machine? Do you think you can be among the winning 15% of pickers year after year? Did you know that group changes year after year? Did you know that reallocating your funds year after year, buying and selling to catch the new winners will cause your earnings to be gobbled by taxes? Learn more below.

The recent article posted here at Motley Fool ("The The Case Against Index Funds) ,"does a terrible disservice to beginning investors who don't realize that seeking out Champion Funds is a BIG GAMBLE compared to investing in a nice set of diversified index funds. The article could dangerously mislead a new investor who has not yet read the books mentioned below.

First of all, the article states that 30% of managed mutual funds will beat the index. While that may be true, more often, MORE THAN 80% OF MANAGES MUTUAL FUNDS DO NOT BEAT THE MARKET, and far fewer do so more than one year in a row. THE PROBLEM IS THAT THE WINNERS DO NOT REMAIN WINNERS MORE TAHN ONE YEAR IN A ROW. So you will have to buy and sell often, causing what is known as turnover or churn. Turnover helps the taxman and the broker who gets to earn more fees from you. So you found one winner, now youhave to sell it and find the next one, (got a crystal ball?) and this will cause a tax loss. Mutual fund winners one year are nearly always next years LOSERS. (see the statistics from Jack Bogle's book "Common Sense on Mutual Funds: New Imperatives for the Intelligent Investor") Read his book to help cure you of this gambling urge. The likelihood that you will be in the group year after year is nonsense incredibly unlikely. Trust Bogle, the man who has nothing to gain - he tells the truth. Bogle is on the side of the investor. After creating Vanguard in the 1970s and the first index fund he watched as the average investor walked in with their life savings saw them drop a huge portion to the brokers the tax man, so he attempted to help us out with the index fund, which if held till retirement saves sifgnificantly over the other manged funds. Bogle got tired of watching the biggest winners being only the brokers on Wall St. He left Vanguard behind, retired and now speaks out against much of the way wall St does business, fighting to help keep the average investor away from the sharks and their costly managed mutual funds. Bogle invests his entire personal wealth, 32% in stock index funds, the rest in bonds. No managed mutual funds nor individual stocks AT ALL.

These days part of Motley Fool is in the business of selling newsletters which encourage people to pick winners. I hope they remind people now and then that investing in that manner is a far greater gamble than doing what the Money Advisor recommneds, sticking with Index Funds.

A while back I ignorantly trusted the hyped up gains I saw posted advertising for the Hidden Gems newsletter, I lost a lot of money with the 7 hidden gems I bought and I am waiting around for them to go back up. I regret ever getting into that mess. The set of Hidden Germs is down 34% overall. I wish I was warned that doing so was sucha gamble. The hype made it seem like such a sure shot, well it isn't. I was oneof the suckers born that minute! I will not make the same mistake with Motley Fool stock picks or their Champion mutual fund picks. I'll stick with the Motley Fool Money Advisor's advice period.

I think the boards here are great. The Motley Fool Money Advisor is a great service and they encouraged me to purchase index funds, not stocks nor mutual funds. So I edged my way over to the "Index Fund Board" and I am investing in a diversified set of index funds from this point on, nothing else. I'll sell those Hidden Gems the minute my losses dissappear or I may just have to sell take the loss at some point. I would have thought that buying 7 of them would have been diversification enough, but only one of them is slightly above what I bought it at and the rest are terribly down.

As for indexes, the lowest fee funds are from Vanguard, or if you don't want to decide how to allocate a set of 6 or so index funds yourself, pay an advisor and buy DFA index funds which perform slightly better, but you lose some to the advisor fee. Either company's index funds will beat 85% of most assorted stocks portfolios or most assorted mutual fund portfolios, with a lot lower risk, lower brokerage fees and taxes too. It's a no brainer.

Prior to these recent months, after the latest Motley Fool Champion Fund newsletter popped up, the Fool recommended INDEX FUNDS AS THE BEST WAY TO GO, but lately, something is changing at good old Motley Fool. The Motley Fool Income Advisor still recommends these index funds which is in direct conflict with the new pro-Mutual Fund newsletter which suggests it may help you find mutual funds that beat the market. Don't forget, the investor's heroes as I've said, experts like Bogle, or Princeton Universities' Malkiel ("A Random Walk Down Wall St."), and William Bernstein ("The Four Pillars of Investing") say that trying to beat the market is a suckers game.

Less than 15% of the investors choose a set of stocks or mutual funds that beat the market, and even fewer do that more than one year in a row. Even worse, those few winning stocks or mutual funds that are winners this year are MOST likely to be losers the following year! (refer to statistics from Bogle, Malkiel). Thirdly, if you try to pick the managed mutual fund winners year after year, buying and selling annually, you will incur high tax losses as you sell (called turnover or churn). The best way to avoid these turnover taxes is by holding a set of 4,5 or 6 Vanguard or DFA index funds for decades all the way through to retirement. NEVER sell them, just hold on long.

Lastly, many index wizards like Bernstein also add in a few addional non stock indexes for diversification, ones that go up when stocks and other portions of the portfolio are going down, to make sure some gains are coming in at all times. These are typically
1. bonds possibly including foreign bonds
2. REITs 3. International indexes such as European, Developed Markets, or International Emerging Markets,
3. commodities (such as PCRIX a Pimco commodities index) Last and least, the commodities portion could include gold, (although this is debatable and one should have no more than 5% of their portfolio in gold according to Bernstein.

So this is what these big shots are doing with their clients, this is what these industry insiders say in their books.

Don't be a fool and try to beat the market, the odds are you will lose. It is gambling to do so and the odds are big time (70-85%) against you. Equalling the market with an index fund will earn you plenty with a far lower risk. In fact it will earn you more tahn 88% of most brokers and stock advisors do for you.

And again, read these books below, before you invest read anyones investment newsletters and never forget what is in it for them (profit from selling newsletters), you'll be happy you did. The books are fun to read by the way, they are witty and enjoyable.

1. William Bernstein ("The Four Pillars of Investing")
2. Princeton Universities' Malkiel ("A Random Walk Down Wall St.")
3. John Bogle "Common Sense on Mutual Funds: New Imperatives for the Intelligent Investor")

Good Luck
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