Investments

Why I Won’t Invest in Index Funds

I’ve had a lot of recommendations concerning Index Funds as of late. It seems that many people believe that they are the way to go.

I happen to disagree, especially with current market trends.

An Index fund is a business that buys shares in some (weighted funds) or all of the companies listed on the stock market. As a result, the value of your investment goes up and down in relative sync with the stock market itself. These have become famous in recent years as Warren Buffett and others began recommending them for folks who don’t know much about the stock market.

I have a big bone to pick with them, however. When you purchase shares in an Index fund, you don’t own a piece of the individual companies. Instead, you own a piece of a company (or fund, whatever you want to call it) that happens to own pieces of individual companies. You don’t actually own a bit of the individual companies themselves.

I prefer to cut out the middle man because I’m ornery like that. Why pay someone else big bucks so they can buy and benefit from the stocks? If I wanted to go that route, I’d simply start collecting shares on my own (which I might do someday).

My primary concern at the moment isn’t quite that nitpicky, however. My concern is with the fact that the stock market seems to be on the verge of a bear market. As a result, the value of Index Funds could drop dramatically. It’s gotten to the point that Vanguard no longer allows its employees to invest in their own product, the S&P 500 Index Fund.

When a cook refuses to eat their own cooking you need to run for the hills because something is seriously wrong.

I believe I know what it is. Here is a screenshot of the S&P 500 Index:

See that slow, downwards trend? That’s the value of an S&P 500 Index Fund starting to go down around mid-January of this year.

Here’s another one:

This is the Dow Jones Industrial Average. It’s been trending downwards as well this year. Like the S&P 500, the trend is gradual, but it’s still there. In fact, the only major one still trending upwards this year is the Nasdaq:

The Nasdaq is very tech-oriented, so its gains are doubtless tied to the FANG stocks (Facebook, Amazon, Netflix, and Google). I suspect that upwards trend is about to change. Look at this:

This is a long-term view of Amazon’s stock rise. See how steep the trend is? If there is one thing I’ve learned during my research, the steeper the trend, the less sustainable it is. Amazon is the darling of the stock market but you can bet your buttons it won’t be able to sustain that momentum forever. It will tank, and tank hard. The only question is when. If you look very closely at the chart (just click on the image to see it full-size), you can see that the top is already beginning to round out. This may very well signal that the price is about to drop, though it is a bit too early to tell at this point.

I read somewhere (I really wish I had saved the link), that it is the FANG stocks currently supporting the stock market averages. Facebook, Amazon, Netflix, Google (now called Alphabet), and by extension Apple, Microsoft, and Intel are providing around 85% of current gains on the stock market. As a whole, over 60% of the stock market is down, so when the FANG stocks plunge, those invested in Index funds will see their nest eggs wiped out.

The worst part is, that plunge is already starting. Here is a screenshot from Facebook’s stock:

See that big drop, like the stock fell off of a cliff? It will take them months, if not years, to recover. I suspect that the price of the stock will fall even lower before it’s done since they usually do.

Here is Netflix:

Netflix is on its own roller coaster ride downwards.

Google (Alphabet) is the only one of the primary FANG stocks that seems to be in a stable trend upwards:


So out of the four primary stocks fueling market gains, only one of them seems to have the ability to continue to move upwards for the long term.

In addition to this, as I look through what I call the “bargain bin” I am noticing that many of the stocks there began a major downtrend in January, coinciding with the start of the downward S&P 500 trend that’s starting to appear. My guess is that these companies are the “canaries in the mineshaft”–more sensitive to change than the overall market. I’m seeing stocks that traded for $5, $10,  or more a share prior to that time taking a sudden drop–and staying down despite the fact that nothing within the company has really changed.

I may be far from an expert but to me the warning signs are significant enough to pay attention. We may not be in what is called a Bear Market right now (I don’t even think they are calling it a correction yet) but I highly suspect that one is coming. Those who are heavily invested in high-flying stocks like the FANG group or so-called “safe” Index Funds will be hurt the most if I’m correct. Vanguard has apparently seen the writing on the wall but since they will make money on their Index Funds regardless of how well (or poorly) they do, they will continue to market them to the unsuspecting general public as they protect their employees by not allowing them to invest in it.

In conclusion, as a result of my research, my answer is a firm no. No, I will not invest in Index Funds at this time. If Vanguard doesn’t even recommend for its own employees to invest in their product, I refuse to touch it with a ten-foot pole.

I hope you understand my reasoning now. This is why I firmly believe that my best bet is to scrounge around the “bargain bin” for companies already suffering from the downtrend. For the record, all of this could very well blow over–if it does and my concerns are eased, I will consider the investment.

For Further Reading:

Top Economist: Get Ready for a Stock Market Drop

Why the 1929 Stock Crash Could Happen in 2018

‘A storm is brewing’ in the US economy, says economist Diane Swonk

8 Comments

  • Linda Sand

    You make so much sense I sent this to my husband to read. He says we’re not in any index funds right now but, from my point of view, that doesn’t negate the value of your analysis so I want him to read this. Thanks for doing the work and sharing your results.

    • Annie

      Like I stressed in the post, I am FAR from an expert. However, between this trend and the fact that so many ads are floating around promoting index funds, REITS, and whatnot, I am more than a bit cautious. I’ve read in several books (I pay special attention to facts that are repeated over different generations and different books) that if a particular investment is so highly promoted that once hears about it constantly, that investment is overbought and due for a drop. It happened with stocks in 1929 as well as in other time periods. Considering how many emails, ads, and whatnot I’ve received from both readers and through paid advertising concerning the FANG stocks, index funds, and REITS over the past few months, it makes me wonder if the trend is repeating. As a result I plan to avoid any and all stocks in finance as well as REITS and index funds, regardless of the return offered. I’m willing to take risks (I wouldn’t be doing this otherwise) but I’m not willing to ignore what could be a serious warning sign.

      Please note, once again, that I am NOT an expert and I am NOT recommending that ANYONE eliminate index funds and whatnot from their portfolios. I could very well be wrong on this. I pray that everyone does their own research and makes a decision that seems right to them.

  • EcoCatLady

    A sound analysis. Perhaps there’s a distinction to be made between “investing” and “trading?” I think index funds really only make sense for long term investing – and it has to be the sort of thing where you make regular investments every month so you don’t dump a bunch of money in while the cost is high – you keep buying, so when the price goes down you end up averaging out your per share cost. I think there’s a fancy name for that – dollar cost averaging maybe? Anyhow, when you invest that way you’re betting that over the long haul (like 20 years or more) the market will go up.

    Trading, on the other hand, requires a completely different approach. Generally, you’re looking to buy stocks low and then sell them quickly when a profit is assured. One can, of course, invest in individual stocks for the long haul, but I think it requires some extensive knowledge and/or research about the fundamentals of each individual company in order to know which ones are sound and which ones are not – and this is where a good stock broker comes in handy. Of course you have to have a pretty hefty portfolio before it makes sense to pay someone to manage your investments…

    Anyhow, I’m enjoying reading about your adventures with the market, and looking forward to future insights!

    • Annie

      Hi EcoCatLady!

      You are correct. There is quite a difference between short-term trading and investing. However, if you combine the basic principles of the two I do believe that one can maximize their gains overall. For instance, if one discovers a company that has hit their 52-week low, researches it to determine that the overall company is sound but has posted a loss (or lower gains) due to actively paying down debt, expansion, or whatever, you can determine that there isn’t anything wrong with the company–they are just doing what they have to do in order to survive and grow. In that case, if you buy in at that 52-week low and hold until it reaches a new 52-week high, you can exit the trade with a profit without having to trade frequently. By doing this with dividend stocks, you have the added benefit of receiving dividends during the wait–which is a bonus.

      That is just a theory, however. I am currently testing it. Considering the current market, I’m purchasing what I can in batches WITHOUT a safety net (no stops). That way I won’t be sold out at a loss due to the market dropping unexpectedly. I plan to buy and hold until they go back up, selling them around the time I see they’ve hit a new 52-week high or have reached a price that I consider to be a good return on my investment. As I’ve discovered, dividend stocks are a bit more “durable” than non-dividend stocks, especially the ones who have been through more than one downturn, so the odds are in my favor even if I happen to miss something in my inexperience. Failures like Enron are not as common as many believe and stock prices are not always indicative of how well (or poorly) a company is doing. The majority of stock prices seem to be based on emotion–especially in the areas of extremely high or low prices.

  • Karen

    Annie, you are so smart, wise and amazing! Great article. I’m sitting with most of my money out of the stock market right now because of everything you wrote. I got out of S&P 500 index funds a year ago. I got burned during the dotcom bust. Got through the 2008-09 mess without losing anything due to paying attention like you are doing. Once the next crash comes I’ll back in the market when everything is on sale. Hope you realize much smart you are.

    • Annie

      Aww, thank you! You are very smart to stay out of stocks right now if you are concerned. With interest rates rising again, you might want to consider investing in bonds. I gather that some of them are very safe places to put your money during a downturn.

      As for me, oddly enough I am really enjoying this. I’m picking through the dividend stocks that have tanked in price so far, gauging my risk as well as the odds for a price uptick in the future. If their previous lowest low stock price (including back in 09-10) is close to double what they are currently trading at I buy in. I figure that since stocks have a habit of returning to their median price over time that the odds are fairly strong that in a year or so they will at least hit that previous low again–which means a potential doubling of my initial investment. In the meantime I’ll receive dividends while I wait. Of course, I am also aware that I could be very, very wrong, so before any investment I literally say farewell to the money I’ve invested. That way, even if I happen to lose every single penny, I’ve come to peace with that knowledge. It also makes it a LOT easier to deal with the fact that sometimes they go lower than I expect–the story of which I plan to cover in a future post.

  • Kelly Barrington

    Annie
    This is one area we disagree on and I will stand by my index fund long term. To me if the price per stock in my index goes down I’m just buying on sale. But to each his own. I am enjoy reading your journey as always. Good Luck

    • Annie

      Hello Kelly! I hope you will agree to disagree on this point. As I said in my post, while at the moment I am leery, I have not ruled it out for future investments. Take care!