Sunday, April 20, 2008

Checkout Line Bingo: Why You Should Invest in Index Funds

Time and time again, financial experts recommend that we invest in index funds. But despite their carefully reasoned arguments, index funds and ETFs only account for 17% of equity assets. Despite being the cheaper, better performing solution, most investors don't seem to buy into the pro-index arguments on a visceral level.

And while John Bogle, Peter Lynch, and Warren Buffett may have failed to make people index believers, I thought I'd take a crack at fixing the problem with what I jokingly call "Checkout Line Bingo." (Ramit, feel free to use this concept for a future post)

Everyone has played Checkout Line Bingo. You glance across the lines, trying to factor in the speed of the checker, the number of people in line, the items in their cart, and whether or not they look like they'll slow things down by writing a check or disputing a price scan.

And if you're like me, you usually lose. I hate playing Checkout Line Bingo. It's one of those things where I know I just can't win.

Investing is like picking a checkout line--it is a zero sum game. The checkers can only check out so many people per hour, and which line you pick doesn't affect the overall number, just as choosing which fund or stock you buy doesn't affect the overall market (for every buyer, there is a seller; for every killing, someone gets killed).

If it were an option, I'd much rather there be a single checkout line where the first person in line gets to go to the next open register (a la your local bank branch, or checking in at the airport). That's the equivalent of index investing--you're not going to magically cut to the front of the line, but you're not going to get stuck behind someone asking for a price check on stuffed olives.

What's more, making investment choices is far tougher than picking a checkout line. Rather than 5-10 choices, you have thousands of funds and stocks to choose from. And rather than competing with your fellow shoppers to see who checks out first, you're going up against legions of professional money managers who spend every minute of every day trying to squeeze out the best possible return...and charging you hefty management fees.

Plus, if you pick the wrong checkout line, the worst that can happen is that your Haagen-Daaz melts. If you pick the wrong fund or stock for your retirement savings, you may end up with a one-way ticket to a cardboard box under the nearest overpass.

So when you're feeling bored with index funds, and are tempted to go for "sexy" funds or stocks, think about whether you really want to play Checkout Line Bingo with your life savings.

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