The idea of indexing is to put money that you won’t need soon into one or more low cost index funds for a long time. There are pitfalls with handling your own investments that might cause you to deviate from your strategy. One such pitfall is making quick decisions about your investments.
It is very easy to place stock market trades with a web browser. While connected to your broker’s web site to look at your investments, the trade button is sitting right there on the screen. In a moment of weakness, you might make some trades you later regret. Fortunately, North American markets are only open from 9:30 am to 4:00 pm eastern time, and not too many people are making trades after a beer or two.
When you pay the fees to work with a financial advisor, the advisor usually has to be contacted to make investment changes. One of the good things that most financial advisors do is to talk people out of doing anything rash.
In the coming posts, I will discuss other potential pitfalls of striking out on your own to invest.
Bonus: A Question About Index Funds and ETFs
In a comment a reader asked “I have some index funds, but now I'm wondering about ETFs; when would they be preferable to index funds?”
An Exchange-Traded Fund (ETF) is a fund whose units trade like stocks on the stock market. You can place an order to buy them the same way that you would buy shares of Microsoft. The fact that a fund is exchange-traded does not tell you anything about the type of investments held by the fund. There are index ETFs, actively-managed stock fund ETFs, bond ETFs, and so on.
An index fund is a fund that invests in the stocks that make up a particular index, such as the S&P 500 in the U.S. or the S&P TSX in Canada. Index funds require little management because they just hold the stocks in the index rather than actively buying and selling stocks. Some index funds are ETFs and some are not.
How well an index fund matches its index is more important than whether it is an ETF or not. The main cause of index funds underperforming the index they are trying to match is the Management Expense Ratio (MER). If two funds both mirror the S&P 500, the one with the lower MER is preferable (all else being equal), regardless of whether they are ETFs or not.
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