Two methods of investing in the stock market enter the ring.
Only one will leave victorious.
Welcome to… INVESTING DEATHMATCH!!!!!!!!!
Hey! Get back here! Don’t you dare click away. This is fucking important and I am stretching a goddamn WWE metaphor past the bounds of decency to make it interesting for you.
So sit your ass down and learn a thing.
Before we ring the bell and start this fight, we should get the basic concept of investing out of the way. Investing in the stock market means you buy tiny chunks of various companies and in return you get tiny chunks of their profits. These tiny chunks add up over time so that you make more money than you would if you just put your money in a savings account.
Got it? For more on investing, we strongly recommend you check out Dumpster Doggy’s Invested Development course or this beginner’s guide over at Half Banked.
Ok. Now I want a good, clean fight…
The reigning champion: Managed funds
For most of the history of the stock market, people have primarily relied on actively managed funds to handle their investments. A managed fund is an investment program that is managed by an investing professional. You give them your money, and they hand pick which stocks to buy with it in an attempt to get you the greatest return on your investment. In exchange, they get a cut of what your investments earn.
Sounds like a good deal, right? Instead of having to educate yourself on stocks and bonds and a whole host of other terrifying investment terms, you just hire someone who knows all that stuff already. Someone with the confidence to do this on national television:
They invest your money on your behalf, making calculated risks and spending time tracking various stocks and companies and stuff. And because they’ve spent their whole career working in the stock market, you can proceed with the assumption that without their help, you’d be up a creek without a paddle. They can make your money work harder than you can.
A small percentage of your investments seems like a small price to pay for that kind of specialized knowledge, right?
… right?
The upstart challenger: Index funds
By contrast, index funds—like their little bro, ETFs or Exchange-Traded Funds—are a relatively new invention. They were first pioneered by Jack Bogle (who went on to found Vanguard) in 1976.
With an index fund, you’re using your money to buy a slice of the entire stock market. So instead of paying a professional to carefully hand pick individual stocks and bonds, you’re just buying a little bit of everything. Then you set it and forget it. No educated, highly paid professional investment manager necessary. Just a cocky newcomer with a surefire strategy.
As a result, the costs of having an index fund are significantly lower than the costs of having a managed fund, since you’re not paying for management.
No one is scrambling to buy and sell your stocks to try and get you a higher rate of return. And no one is risking losing that gamble if the stocks they pick fail to deliver.
Instead, you’re playing the long game: just sit back, relax, and wait for the market to continue its historically upward trajectory, fattening your investment portfolio along with it.
The broad exposure you get (meaning you own stocks in companies that are going to do well and companies that are going to tank and everything in between) decreases your overall risk of losing money. And while you won’t experience the temporary high of watching your managed fund skyrocket when your manager wins a gamble, you also won’t suffer the agony of watching your funds get swallowed by the Sarlacc.
And the winner is…
I’ve been withholding one very important piece of information from you: Managed funds suck.
They’re not even in the same weight class as index funds. This fight is less like pro wrestling and more like an awkward slow dance.
The odds of managed funds winning this match are a mathematical improbability.
No really! The whole reason Jack Bogle even came up with the idea of index funds is because managed funds almost never beat the market. A drunken bonobo flinging poo at a giant spreadsheet of the stock market has as much chance of picking the right stocks to beat the market as your highly trained fund manager.
Factually speaking, the likelihood of an actively managed fund beating an index fund is about 1 in 20. This fight was rigged from the very start.
Index funds are safer, easier, cheaper, and provide you with a higher guaranteed rate of return than managed funds. Full stop. So ladies and gentlemen, I think we have our winner.
Even Warren Buffett, the Wizard of Omaha himself, once said of Jack Bogle, inventor of the index fund, “If a statue is ever erected to honor the person who has done the most for American investors, the hands-down choice should be Jack Bogle.” So yeah, index funds are pretty fucking baller.
But how can this be? How can the conscious, informed efforts of a highly trained professional lose to what basically amounts to an automated process? How is an educated fund manager on a level with that drunken, poo-slinging bonobo?
The market fluctuates up and down from day to day. Various stocks will rise or plummet over the passage of time. But, historically speaking, the stock market as a whole is on a gradual upward trend into the future. And therefore, so is your index fund. No guesswork or calculated risks can beat this fact.
This isn’t just a theory. Peer reviewed studies have shown that the costs of paying for active management far outweigh the returns simply because of the role luck plays in stock picking. You could gamble on getting lucky once or twice… or you could just sit back and let the stock market do its thing.
I would not fucking bet on that fight.
So you can pay a person a big chunk of money to fiddle around trying and failing to make your investments earn more money.
Or you can pay a small chunk of money to set it, forget it, and do just fucking fine over the long term.
Ignore the desperate snake oil salesmen of managed funds. Put your money in a damn index fund where it’ll do the most good with the least cost and effort.
KNOCKOUT
I feel compelled to tell you that neither Jack Bogle, Vanguard, nor any other index fund provider is paying me to write this. I’m writing about the benefits of an index fund for free. Because it’s true.
And if you need further backup, listen to Stephen Dubner’s excellent episode of the Freakonomics podcast on the topic. For while Freakonomics does accept advertising money, they are… ever-so-slightly more famous and powerful than your humble Bitches. As a result, they are able to get the truth straight from the horse’s mouth, through interviews with learned economists.
The stock market is a benevolent yet confusing alien beast crawling with noisy parasites intent on separating you from your money. (Apologies for comparing stock brokers to parasites. I did not mean to insult the parasitic organism community.) It can be extremely frightening and disorienting, especially if you haven’t done your research.
So before you dive into the stock market head first, I wanted to get this out of the way. Index funds are better for you than managed funds. Anyone who tells you differently is trying to sell you a managed fund.
And yes, I have been watching and loving GLOW.
New to investing?
If you’re convinced by this episode of Investing Deathmatch to start investing… try our favorite micro-investing app, Acorns. Acorns sticks your money in ETFs (exchange-traded funds), which are like mini index funds. Everything about them is mini and micro—they even withdraw money from your checking account in lil’ round-ups of change after every purchase you make. SUPER CUTE, YOU GUYS.
VTSMX, baby! At least until I break 10k in my taxable and can switch over to VTSAX!
I’m just thankful I learned that before I started actually investing, and that I only had one previous 401(k) to switch over to index funds instead of whatever the hell I had in it.
ATTA GIRL! You got this dialed down.
Wow, so you don’t use the 401k at all anymore? only index funds?
The money in that 401(k) was invested in various other things that that company offered, I don’t remember what. When I left that company I left it alone for a bit, and once I’d read enough about investing, I rolled that 401(k) over to Vanguard, where that money’s now invested in index funds. My 401(k) with my current company is also invested in the index funds that they offer.
Cool, thanks for sharing that!
Bs, how the hell do you leave a managed fund though?! I wanna but I keep getting spooked!
Every time I’m about ready to move, the market dips and I’m hesitant to sell everything that low in order to open the new account I want…and with the cheaper ETF/index funds, I can’t find a person to call and walk me through it without becoming a customer first!
(Also the start of that is “Bs” as in “multiple bitches,” and not B.S.!)
Mwah! 😉
This is a GREAT question. And honestly… I’m not sure! I would say you should just pull the plug, but you make a great point about the value dipping right when you make the switch. So I open it up to Bitch Nation: anyone have some advice for MH?
Vanguard at the very least offers a Transfer of Assets account – meaning that you open an new account with Vanguard under the same registration as your old account (ie. individual non qualified, IRA, Roth, etc) with a form called a Transfer of Assets which will speed along the, well, transfer of your assets so that when you sell from your previous fund you’re immediately buying into the new one. If the market dips, it should have dipped for both funds. That’s the best I can offer you I think.
Thanks, this is remarkably helpful, it’s stressful not knowing the right words to google! The dip-answer is very reassuring.
And you guessed it, I’m heading to Vanguard. 😉
Seconding the going through the roll-over/transfer process with Vanguard. Let them handle all the actual transferring (and don’t be like me, where I cashed out my 401(k) and then opened a Vanguard account for that money right after instead of transferring it over automatically)!
Do it gradually. If you have 10k invested, pull out 1k every month and switch it over. That way some portions will be lower and some higher, and will even out in the end.
Oh, I love being a cautionary tale! Superb as always, Bitches! You may have just scared me into my boring ETF corner! LOL
Why thank you, Lady! And you’re not so much a cautionary tale as a newbie. We’ve all been there. And I loved your article.
Woohoo, we are big Vanguard fans! My employer 401k is there and we just rolled over my husband’s 403b to a Vanguard IRA in VTSAX… low cost funds here we come!
BOOM BABY!
I mean, any time you have an opportunity to cite Glow photos and gifs, you really should.
Though being the old fuck that I am, I suppose I was hoping for more Mad Max…
https://www.youtube.com/watch?v=pmRAiUPdRjk
As for us, we’re index all day, every day. I don’t know why anyone would mess with active. There’s no logical justification.
Right? That’s what I was all! (On both Glow and index funds.)
Such a nice post .. I enjoyed it a lot. looking forward to such kinds of articles in future.
Hi, Bitches! Just came over from your Financial Diet articles and I am looooooving your blog. Keep it up!
Why thank you, dearest!
In my opinion, you can “beat the market” (get abnormal returns) under one of 3 conditions:
1.) you have access to information that other people don’t have: This is illegal and called insider trading. However, some people still do it despite the risks and it does have a tendency to give abnormal returns, although it’s not without risk as some people like to believe. The market might not react to the news the way you think it will so it’s still important to diversify and not put your money on that one trade, even if you have insider info. However, statistically speaking, insider trading does give abnormal returns. Hence why some people do it despite the risks of spending life in prison for it.
2.) you are faster than everyone else: this is impossible. As a human being, you are not going to be faster than everyone else. However, if you are a really good programer and are willing to invest a couple millions into very expensive tech, it is possible for you to be faster than everyone else and get abnormal returns or find arbitrage opportunities between asset classes, which might include stocks.
3.) you are smarter than everyone else: you have some sort of specialized knowledge/you are a top expert in some sort of a field and you use that knowledge in order to get that abnormal return. For example, let’s say you are really good at accounting. You read through a company’s financial statements and figured out that based on those financials, the company is probably doing fraud and making numbers up on their financial statements out of thin air: numbers aren’t “adding up”, they are capitalizing an item when they are supposed to be depreciating it, the amount of disclosed FX futures/options in the non operating section looks way too high for the amount of sales that the company has in foreign markets, etc… You read up the news on the company and see that no one else is talking about this issue. You then short sell some stocks and sue the company for fraudulent accounting. If you win and discover the next Enron, the stock price falls and you make a lot of money on your short. Likewise, maybe you came up with your own valuation methodology that is more accurate at predicting future cash flows or EPS than what is currently used by analysts. In that case, you can use that as well to get abnormal returns.
If you or the person (or group of people) who actively manage your money meet one of those 3 categories (and if it’s category number #1 you are ok with it morally/ethically and you or your person is really good at not getting caught), you can get abnormal returns and it might make sense for you to stick with your “active manager” or actively manage the money yourself. (I’m broadly defining an “active manager” as a mutual fund, hedge fund, your best friend trading stocks, etc… Basically anyone who is either trading and/or picking specific stocks/industries instead of just “mirroring” the S&P 500/the stock market) If not, you are better off just putting your money into an index fund. Also, keep in mind that if you choose to actively manage/trade stocks yourself and even if you are in category #2 or #3, it will take you significant amount of time and effort (and for #2 money to investment into expensive tech) in order to get those abnormal returns. It will be like having a second job. So it probably would make more sense to just go with an index fund instead unless you are really passionate about it and want to turn it into a second job or a very time consuming hobby for yourself.