Why Experts Advise Investing
in an Index in 2019
ndex investing is a
passive investment
strategy that attempts
to generate similar
returns to a broad stock
market equity index. In
recent times, index
investing has become more and more popular
for a number reasons outlined below. Warren
Buffett, CEO of Berkshire Hathaway and
possibly the most famous investor in the
world, is a major proponent of this passive
investment strategy and recently said that he
has instructed the trustee in charge of his
estate to invest 90 percent of his money into
an index for his wife after he dies1.
PERFORMANCE
Investment fund managers fail to beat the
index net of fees 97% of the time. At first
reading, that might seem odd as people
generally assume that fund managers are the
experts and know the right balance of stocks,
bonds and GICs to invest in to provide
optimum returns for any given investor’s risk
profile. But the simple fact is that index
returns are irrefutable over time. Warren
Buffett remains bullish on index investing
and in February this year said, “I think it’s
the thing that makes the most sense practically all of the time.” Buffett, the famed
billionaire investor, also added that even his
two chief stock pickers at Berkshire Hathaway, Ted Weschler and Todd Combs, have
failed to beat the S&P 500.1
Looking at Canada’s S&P/TSX 60 stock
index: over 10-year periods since inception
(January 29, 1992) to August 19, 2019, the
index has produced a positive return 99.87%
of the time and the average annual return for
ten year periods is 6.72%. These time period,
of course, includes both bear and bull
markets but the fact is that over longer
periods of time, indexes almost always
produce positive returns. Buffett told
CNBC’s Squawk Box in February of this year
that if somebody invested $10,000 in the
S&P 500 back in 1942, it would be worth
$51 million today.
DIVERSIFICATION
An index fund is made up of a broad portfolio
of different individual securities and helps
investors lessen the risk that comes with
investing in just a single security. For
instance, the S&P/TSX 60 is a stock market
index comprising 60 large companies across
ten different sectors listed on the Toronto
Stock Exchange. The performance of these 60
different stocks will fluctuate and vary over
time, but when your money is spread out
among so many separate assets, these ups
and downs are smaller. If you put all of your
principal in two or three different stocks of
your choice, there is a chance that they will
lose some, or all, of their value. Investing in
an index, such as the S&P/TSX 60, the odds
of all 60 companies losing all of their value
are extremely slim. If a couple of stocks in the
index lose value, there are a number of others
from different sectors to pick up the slack and
offset the loss. Although diversification does
not guarantee against loss, it is one of the
most important components of reaching
long-term financial goals while minimizing
risk.
COST EFFECTIVENESS
There are two styles of investment management: active and passive management. When
investors are working with financial advisors,
they will often be directed towards managed
funds that fit into the active management
category. Active management involves the
fund manager putting his or her skills and
expertise to the test by trying to choose the
right securities, at the right time, in order to
outperform the market. As mentioned earlier,
though, this is often in vain as many of the
top stock pickers in the world fail to beat the
index over time net of fees.
Due to actively managed investment funds
requiring more hands-on research and
because they experience much higher trading
volumes, their expenses are naturally higher.
A common investment fund fee structure is
known as “1: 20”. The "1" means 1% of assets
under management and refers to the annual
management fee which is charged by the
hedge fund manager for managing the assets,
regardless of performance. The “ 20” is a 20%
performance fee that the fund charges if it
achieves a level of performance above a
certain threshold 2.
On the other hand, passively managed funds
(which include index funds) do not attempt to
beat the market. Instead, they look to match
the risk and return of the stock market as a
whole or a segment of it. Trading volumes are
considerably lower as the investment manager
will only need to trade periodically to
rebalance the portfolio.
NEXT STEPS
When looking to invest in an index, investors
should carefully review the offerings in the
marketplace, look to protect their principal,
leverage their investment, and compound
returns over longer periods where possible to
maximize returns.
Wisdom Mutual Fund™ invests in a
Participating Bank Note (a “PBN”) with a
principal amount of $1,000 per Unit. Such
principal is fully guaranteed by a Canadian
Schedule 1 Bank, if held to maturity in ten
years. The PBN provides a participation
rate of 100% of the positive price return of
the S&P/TSX 60 index with no cap on
returns, if held to maturity. Leverage is
provided by reduced cash outlay with 50%
due on acquisition and 50% due at maturity
( 10 years) which provides leveraged equity
index investment on 100% of Unit Issue
Price with only 50% paid upfront. The Fund
charges no annual management fees or
performance fees. For more information see
www.wisdomsi.ca
INVESTMENT STRATEGIES
I
1. https://www.cnbc.com/2019/02/26/warren-buffett-wants-90-percent-of-his-estate-invested-in-index-funds.html
2. https://www.investopedia.com/terms/f/fee-structure.asp
By BRIAN MOYLETT, Sales Director at Wisdom Structured Investments