Why Not All Index Funds Are Created Equal | Common Sense Investing

TL;DR

Index funds are a great investment choice, but not all index funds are created equal.

Transcript

I talk a lot about index funds in this video  series. I have told you that low-cost index   funds are the most sensible way to invest,  and that you should do everything that you   can to avoid the typical high-fee mutual  funds that most Canadians invest in. Great,   well that’s easy then. Buy index funds.  Where do I sign up? Unfortunately the   ... Read More

Key Insights

• 💨 Low-cost index funds are the most sensible way to invest, but not all index funds are created equal.
• 👲 Traditional market cap weighted index funds exclude potentially higher-returning small and mid cap stocks.
• 😘 Total market index funds provide diversification and are low-cost options for investors.
• ✋ Fund companies have created higher-fee sector-specific and smart beta index funds as gimmicks to justify charging more.
• 🧑‍🏭 Well-researched factors like size, relative price, momentum, and profitability can enhance portfolio returns, but not all funds targeting these factors deliver as promised.
• 🧑‍🏭 Dimensional Fund Advisors is recommended for capturing well-researched factors.
• 🫰 Many index fund products claiming to track special indexes are gimmicks designed to make investors pay extra.

Questions & Answers

Q: What is an index fund?

An index fund is a type of investment fund that tracks a specific index, such as the S&P 500, by buying the stocks included in the index. When the index changes, the fund's holdings change accordingly.

Q: Why should investors consider total market index funds?

Total market index funds offer exposure to a broader range of stocks, including small and mid cap stocks that historically have had higher returns than large cap stocks. They provide diversification and are low-cost to own.

Q: What are sector index funds?

Sector index funds are index funds that focus on specific sectors, such as the Horizons MARIJUANA LIFE SCIENCES INDEX ETF. They are created to capture investor interest in a particular sector, but they often come with higher fees and speculative motives.

Q: What are smart beta funds?

Smart beta funds try to identify characteristics of stocks that have shown higher returns in the past, such as size, relative price, momentum, and profitability. While well-researched factors can be beneficial, not all smart beta funds deliver on their promises, and some may be based on weak research or data mining.

Summary & Key Takeaways

• Index funds are a sensible and low-cost way to invest, but the financial industry has made it complicated with different types of index funds.

• Traditional index funds like the S&P 500 only track large cap stocks, excluding potentially higher-returning small and mid cap stocks.

• Total market index funds, such as the CRSP 1-10 and MSCI All Country World Index, offer diversification and low costs.

• Fund companies have created sector-specific and smart beta index funds to justify charging higher fees, but their performance and value may not match expectations.