Long version: The basic argument for index funds over individual stocks is that you think that a is going to outperform a because of general economic growth and reduced risk through pooling. So if you apply the same logic to index funds, what that argues is that you should find the index fund that covers the largest possible pool.
But it also becomes obvious that this logic only stretches so far—one might think that meta-indexing requires having a stock index fund and a bond index fund that are both held in proportion to the total value of stocks and bonds. So let’s start looking at the factors that push in the opposite direction.
First, historically stocks have returned more than bonds long-term, with higher variability. It makes sense to balance your holdings based on your time and risk preferences, rather than the total market’s time and risk preferences. (If you’re young, preferentially own stocks.)
As well, you might live in the US, for example, and find it more legally convenient to own US stocks than international stocks. The corresponding fund is VTSMX, for the total US stock market. If you want the global fund, it’s VTWSX.
You might have beliefs about small caps and large caps, or sectors, and so on and so on. One mistake to avoid here is saying “well, I have three options, so clearly I should put a third of my money into each option,” especially because many of these options contain each other—the global fund mentioned earlier is also a US fund, because the US is part of the globe.
Asset allocation (what portion of your money is in stocks and bonds) is very important, depends on your age, and will get out of whack unless you rebalance. So use a Vanguard Target Retirement Date fund.
Yes, but those are the important ones. Stocks for high expected returns and bonds for stability. You can generalize “bonds” to include other things that return principal plus interest like cash and CDs.
Important to the goal of increasing one’s wealth while managing the risk of losing it. Certainly there are other possible goals (perhaps maximizing the chance of having a certain amount of money at a certain time, for example) but this is the most common, and the one that I assume people on LW discussing basic investing concepts would be interested in.
Um.… I hate to break it to you...
I’m not sure if you’re referring to the fact that popular banks are returning virtually zero interest or if you’re interpreting “cash” as “physical currency notes”. If the former, I have cash in bank accounts that return .01%, 1%, and 4.09% (each serving different purposes). If the latter, I apologize for the confusion. The word is used to mean different things in different contexts. In the context of investing it is standard to include in its meaning checking and savings accounts, and often also CDs.
Important to the goal of increasing one’s wealth while managing the risk of losing it.
Given this definition, I don’t see why only stocks and bonds qualify.
The word is used to mean different things in different contexts.
True, but given that you said “cash and CDs” I thought your idea of cash excludes deposits. Still, there are more asset classes than equity and fixed income.
Given this definition, I don’t see why only stocks and bonds qualify.
My claim is that equity and fixed income are the important pieces for reaching that goal. With a total stock index fund and a total bond index fund you can achieve these goals almost as well as any other more complicated portfolio. Additional asset classes can add additional diversification or hedge against specific risks. What other asset classes do you have in mind? Real estate? Commodities? Currencies?
True, but given that you said “cash and CDs” I thought your idea of cash excludes deposits.
My claim is that equity and fixed income are the important pieces for reaching that goal.
They are, of course, important. The question is whether they are the only important pieces.
What other asset classes do you have in mind
Real estate is the most noticeable thing here, given how for a lot of people it is actually their biggest financial investment (and often highly leveraged, too). Commodities and such generally require paying at least some attention to what’s happening and the usual context of financial discussions on LW is the “into what can I throw my money so that I can forget about it until I need it?”
Short version: try something like Vanguard’s online recommendation, or check out Wealthfront or Betterment. Probably you’ll just end up buying VTSMX.
Long version: The basic argument for index funds over individual stocks is that you think that a is going to outperform a because of general economic growth and reduced risk through pooling. So if you apply the same logic to index funds, what that argues is that you should find the index fund that covers the largest possible pool.
But it also becomes obvious that this logic only stretches so far—one might think that meta-indexing requires having a stock index fund and a bond index fund that are both held in proportion to the total value of stocks and bonds. So let’s start looking at the factors that push in the opposite direction.
First, historically stocks have returned more than bonds long-term, with higher variability. It makes sense to balance your holdings based on your time and risk preferences, rather than the total market’s time and risk preferences. (If you’re young, preferentially own stocks.)
As well, you might live in the US, for example, and find it more legally convenient to own US stocks than international stocks. The corresponding fund is VTSMX, for the total US stock market. If you want the global fund, it’s VTWSX.
You might have beliefs about small caps and large caps, or sectors, and so on and so on. One mistake to avoid here is saying “well, I have three options, so clearly I should put a third of my money into each option,” especially because many of these options contain each other—the global fund mentioned earlier is also a US fund, because the US is part of the globe.
Asset allocation (what portion of your money is in stocks and bonds) is very important, depends on your age, and will get out of whack unless you rebalance. So use a Vanguard Target Retirement Date fund.
There are more financial assets than just stocks and bonds.
Yes, but those are the important ones. Stocks for high expected returns and bonds for stability. You can generalize “bonds” to include other things that return principal plus interest like cash and CDs.
What’s the criterion of importance?
Um.… I hate to break it to you...
Important to the goal of increasing one’s wealth while managing the risk of losing it. Certainly there are other possible goals (perhaps maximizing the chance of having a certain amount of money at a certain time, for example) but this is the most common, and the one that I assume people on LW discussing basic investing concepts would be interested in.
I’m not sure if you’re referring to the fact that popular banks are returning virtually zero interest or if you’re interpreting “cash” as “physical currency notes”. If the former, I have cash in bank accounts that return .01%, 1%, and 4.09% (each serving different purposes). If the latter, I apologize for the confusion. The word is used to mean different things in different contexts. In the context of investing it is standard to include in its meaning checking and savings accounts, and often also CDs.
Given this definition, I don’t see why only stocks and bonds qualify.
True, but given that you said “cash and CDs” I thought your idea of cash excludes deposits. Still, there are more asset classes than equity and fixed income.
My claim is that equity and fixed income are the important pieces for reaching that goal. With a total stock index fund and a total bond index fund you can achieve these goals almost as well as any other more complicated portfolio. Additional asset classes can add additional diversification or hedge against specific risks. What other asset classes do you have in mind? Real estate? Commodities? Currencies?
Fair enough. I was unclear.
They are, of course, important. The question is whether they are the only important pieces.
Real estate is the most noticeable thing here, given how for a lot of people it is actually their biggest financial investment (and often highly leveraged, too). Commodities and such generally require paying at least some attention to what’s happening and the usual context of financial discussions on LW is the “into what can I throw my money so that I can forget about it until I need it?”